Article

Factual Summary: To assure performance of a subcontract related to the installation of undersea pipelines, Contractor (Beneficiary) required Subcontractor (Principal) to obtain a Performance Bond. It obtained one from Bank (Guarantor) for S$956,395.00. The bond was described as being unconditional, payable "upon receipt of your demand in writing and your written statement that the Principal is in breach of his obligations under the underlying contract."

When Beneficiary drew on the Performance Bond, the Principal obtained an interim injunction. On a hearing, the court dismissed the application to restrain Beneficiary and Guarantor and lifted the interim injunction.

Legal Analysis:

1. Independence; Exception; Fraud; Unconscionability: The Judge stated that under Singapore law, "the issuing bank is generally not concerned with the underlying contract on which the bond is based and has no duty to ascertain whether there had in fact been a breach of the underlying contract. Actual proof of default is also not required when calling upon the bond." The Judge stated that the independent character "is however subject to the fraud and unconscionability requirement."

2. Unconscionability: Since Principal's claim was based on unconscionability, the Judge reviewed Singapore law on unconscionability. The Judge quoted from the Court of Appeal in GHL Pte. Ltd., v. Unitrack Building Construction Pte. Ltd. [1999] 4 SLR 604 [Singapore]:

"We are concerned with abusive calls on bonds. It should not be forgotten that a performance bond can operate as an oppressive instrument, and in the event that a beneficiary calls on the bond in the circumstances, where there is prima facie evidence of fraud and unconscionability, the court should step in to intervene at the interlocutory stage until the whole of the circumstances of the case has been investigated. It should also not be forgotten that a performance bond is basically a security for the performance of the main contract, and as such we see no reason, in principle, why it should be so sacrosanct and inviolate as not to be subject to the court's intervention except on the ground of fraud."

The Judge also cited Dauphin Offshore Engineering and Trading Pte. Ltd. v. The Private Office of HRH Sheikh Sultan bin Khalifa bin Zayed al Nahyan [2000] 1 SLR 657 [Singapore], for the proportion:

"We do not think it possible to define 'unconscionability' other than to give some very broad indications such as lack of bona fides."

The Judge also quoted Raymond Construction Pte. Ltd. v. Low Yang Tong, Suit 1715/95, 11 July 1996 [Singapore], unreported:

"The concept of 'unconscionability' to me involves fairness, as distinct from dishonesty or fraud, or conduct of a kind so reprehensible or lacking in good faith that a court of conscience would either restrain the party or refuse to assist the party. Mere breaches of contract by the party in question would not by themselves be unconscionable."

Noting that there was a high degree of strictness of proof, the Judge observed that the [Principal] is required to prove "a clear case of fraud or unconscionability."

Principal pointed out that Beneficiary's claims for payment on the three separate occasions resulted in awards for the Principal and noted that the loss quantified by Beneficiary amounted to S$850,706.00 while Beneficiary claimed S$956,395.00 under the Bond, its full amount. Principal also rebutted each of Beneficiary's claims of breach. While admitting "there were outstanding works," Principal asserted "they were 'minor' and would be resolved during the defects liability period." It also noted that a certificate of substantial completion had been issued.

Beneficiary responded that there had been fifteen breaks that amounted to S$850,706.00. It also complained of significant delays.

The Judge concluded that the favorable adjudication on the claim for payment did not indicate unfairness. Moreover, the Judge noted that there were significant differences between the amounts claimed by Principal and that awarded.

Noting, that if Principal "were able to demonstrate conclusively that there had been in fact no breach, then that would lend weight to its assertions that [Beneficiary] had acted unconscionably." However, the Judge concluded that the evidence did not support the Subcontractor's claim:

"In the present case, both parties have a consistent and plausible story to tell and it is difficult, on the basis of affidavit evidence alone, to reach a firm conclusion on any of the alleged breaches."

The Judge also noted that there was a colorable argument for the Beneficiary's claim of liquidated damages with the result that was "not mala fide."

Comment:

Unconscionability. While the result in this case is correct, the principle of law invoked to reach it is most troubling. Unconscionability should not be a basis on which to interrupt a claim of payment under a letter of credit absent the presence of letter of credit fraud. Indeed, the standard articulated by the court, namely, convincing proof that there was no breach whatsoever by the subcontractor or any basis on which to claim liquidated damages, is the standard for determination of whether or not there is letter of credit fraud.

One wonders, then, why the courts in Singapore would introduce a vague rule in lieu of the wellestablished exception predicated on letter of credit fraud. The suspicion is that the overly rigid notion of "fraud" predicated on common law analysis and requiring scienter (which is not the LC fraud standard anywhere else) has led the courts to seek a more flexible and realistic standard. The problem with this notion of unconscionability is that it goes too far in the other direction. The better solution is that adopted by the UN LC Convention Article 19 (Exception to payment obligation), which provides:

1. If it is manifest and clear that:

(a) Any document is not genuine or has been falsified;

(b) No payment is due on the basis asserted in the demand and the supporting documents; or

(c) Judging by the type and purpose of the undertaking, the demand has no conceivable basis, the guarantor/issuer, acting in good faith, has a right, as against the beneficiary, to withhold payment.

2. For the purposes of subparagraph (c) of paragraph 1 of this article, the following are types of situations in which a demand has no conceivable basis:

(a) The contingency or risk against which the undertaking was designed to secure the beneficiary has undoubtedly not materialized;

(b) The underlying obligation of the principal/ applicant has been declared invalid by a court or arbitral tribunal, unless the undertaking indicates that such contingency falls within the risk to be covered by the undertaking;

(c) The underlying obligation has undoubtedly been fulfilled to the satisfaction of the beneficiary;

(d) Fulfillment of the underlying obligation has clearly been prevented by willful misconduct of the beneficiary;

(e) In the case of a demand under a counterguarantee, the beneficiary of the counterguarantee has made payment in bad faith as guarantor/issuer of the undertaking to which the counter-guarantee relates.

[JEB/sal]

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