Article

Factual Summary: To assure performance of the construction of a housing project, Subcontractor (Principal) obtained a guarantee issued by Guarantor in favor of Contractor (Beneficiary) for RM2,075,700.94. The contract specified per-day liquidated damages at the rate of RM30,000 per day in the event of nonperformance and included a fixed date for project completion. When Principal did not meet the project deadline, Beneficiary granted a time extension on the subcontract and the bank guarantee was extended. When Principal failed to complete performance by the revised completion date, Beneficiary issued a certificate of non-completion and demanded payment from Guarantor under the guarantee.

Guarantor refused to pay, claiming that the underlying building contract had been terminated before the demand for payment was made. The Guarantor also contended that Beneficiary did not indicate in its demand that Principal had defaulted. Guarantor then commenced an interpleader proceeding in the trial court to determine whether it was obligated to pay on the bank guarantee, interpleading Beneficiary and Principal.

The intermediate appellate court ruled that Guarantor was obligated to pay the amount stated in the guarantee, plus costs to Beneficiary. The intermediate appellate court dismissed Principal's appeal. The final appellate court affirmed the dismissal.

Legal Analysis

1. Independent Undertaking

The trial court considered whether or not the bank guarantee "was a conditional or an unconditional bank guarantee". The Judge noted that relevant paragraphs were "the same as" the terms of a guarantee recited in Syarikat Perumahan Pegawai Kerajaan Sdn Bhd v. Bank Bumiputra Malaysia Bhd, [1991] 2 MLJ 565, a case that treated the undertaking at issue as independent and concluded that the guarantee was "an unconditional bond or an on-demand bond". On appeal, the intermediate appellate court agreed, ruling that "all that is required to activate [the guarantee] is a written demand". The court stated that "[t]he bank guarantee is a performance bond. Whether a performance bond is conditional or unconditional must depend on the terms of the bond itself" and the terms of the guarantee clearly indicated that "the bank guarantee is an unconditional and 'on demand' bank guarantee..." The final appellate court affirmed, stating "the bank guarantee is an unconditional and an on demand performance bond/bank guarantee. Payment should therefore be effected by the [Guarantor] notwithstanding any contestation by the [Principal] or the [Guarantor] when a valid demand on the bank guarantee is made by the [Beneficiary]. All that is required is a demand simpliciter to trigger the obligation of the [Guarantor] to make payment". It further stated, "[a]n on-demand guarantee is independent of the underlying contract. It must be emphasized that the bank guarantee to which the [Guarantor] and [Principal] are a party to, is a distinct legal document from the underlying contract which is an agreement between the [Principal] and [Beneficiary]. The courts in an on demand (sic) type bond will not inquire into any breach in the underlying contract".

2. Unconditional

Guarantor asserted that Beneficiary was required to assert the basis on which the demand was made. The trial court stated, "The words 'as provided by the letter of guarantee' clearly bear the meaning that the demand made by the [Beneficiary] is based on the said letter of guarantee. This is sufficient as the basis of a demand made on a bank guarantee". Relying on legal precedent, the Judge stated that in the guarantee, "it was not stated that the beneficiary has to expressly state the basis upon which the said demand was made". The intermediate appellate court, agreeing that the undertaking was an unconditional and "on demand" guarantee, ruled that "there is no necessity for the demand letter as contended by [Guarantor] to expressly assert that [Principal] had failed to perform or breached the underlying building contract". The final appellate court concluded, "[a] demand is sufficient to trigger payment".

3. Defenses

Principal contended that it was entitled to challenge a drawing based on the validity of the demand and its purpose having lapsed. The final appellate court looked at the clause "notwithstanding any contestation or protest by the contractor". Noting that litigation was underway, the court stated, "the contractor is precluded by the phrase from raising an objection as to the validity of the demand on the bond".

4. Termination

Principal urged that the purpose of a performance bond lapses once the underlying contract is mutually terminated, making it invalid. The final appellate court noted that there was no mutual termination of the contract, but negotiations. It stated, however, "even if there was a mutual determination, the [Guarantor] is still not absolved of its liability under the bank guarantee as it can only be released by any clause of the contract or by statute or by the decision of a tribunal of competence jurisdiction" [emphasis in original] as per a clause of the bank guarantee.

5. Original Operative Instrument

Principal urged that Beneficiary's demand failed to comply since it did not present the original bank guarantee along with the demand. The trial court stated that "this issue does not effect (sic) the status of [Beneficiary's] demand. Nowhere in the said bank guarantee (or in the underlying contract) is it stated that the original of the said bank guarantee must be produced..." The intermediate appellate court agreed and the issue was not appealed to the final appellate court.

Comment(s):

1. The Malaysian courts have concluded that the bank guarantee is independent. While the opinion does not provide sufficient text for us to make that determination, the decision appears to be consistent with what would have been expected in such a transaction.

2. Unfortunately, the analysis turns on the notion of conditionality rather than independence. A bank guarantee, even if independent and payable on "simple" demand ("clean") is nonetheless conditional in the sense that the obligation of the guarantor is conditional on the timely presentation of a complying demand. The question is whether the conditional guarantee (by their nature, both accessory/dependent/ suretyship guarantee and independent guarantees are conditional) is independent or dependent.

3. The excerpt of the guarantee contains a peculiar clause, namely "if the contractor (appellant), unless relieved from the performance by any clause of the contract or by statute or by the decision of a tribunal of competence jurisdiction, shall in any respect fail to perform under the contractor (sic) commit any breach of his obligation thereunder..." The reference to statute or judicial decisions is unusual but would be implied in any event. But the reference to "any clause of the contract" is troubling. This qualification raises the question of whether the undertaking is truly independent from the underlying contract in that the Guarantor might have to look to the text of the underlying contract to determine its obligation. Of course, if the undertaking is truly independent, such a term can be disregarded as a non-documentary condition. We are not, however, given enough of the text to make this determination.

Excerpt from Text of Undertaking from the Opinion:

"(1) If the contractor (appellant), unless relieved from the performance by any clause of the contract or by statute or by the decision of a tribunal of competence jurisdiction, shall in any respect fail to perform under the contractor commit any breach of his obligation thereunder, then the guarantor (second respondent) shall pay to the principal (first respondent) up to a total aggregate sum not exceeding the amount of TWO MILLION ONE HUNDRED TWENTY TWO THOUSAND SIX HUNDRED FORTY SEVEN AND SEN EIGHTY SEVEN ONLY (RM2,122,647-87) on the principal's demand notwithstanding any contestation of protest by the contractor or by the guarantor or by any other third party, provided always that the total of all partial demands so made shall not exceed the aggregate sum of TWO MILLION ONE HUNDRED TWENTY TWO THOUSAND SIX HUNDRED FORTY SEVEN AND SEN EIGHTY SEVEN ONLY (RM2,122,647-87) and the guarantor's liability to pay the principal as aforesaid shall correspondingly be reduced proportionate to any partial demand having been made as aforesaid."

[JEB/as]

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