Article

Factual Summary: When Owner/Beneficiary contracted with Contractor/Principal for construction of a bioethanol processing plant they incorporated "the General Contract for Lump Sum Contracts" of the Institute of Chemical Engineers. These rules contained conditions of detailed provisions regarding acceptances of the project, warranties, cure, and issuance of an acceptance certificate. Clause 36.3 provides "The Acceptance Certificate shall list any known Defects which the Contractor is bound to make under good under the provisions of Clause 37 (Liability for Defects) and any minor items still remaining to be completed following the issue of a Take-Over Certificate."

The rules also require a performance bond: Chemical Engineers Rules Clause 3.7 provided that:

Upon the issue of the Acceptance Certificate the Performance Bond shall become null and void (save in respect of any pending or previously notified claims). 3.8 The Performance Bond shall be returned to the Contractor immediately after it becomes null and void, save where there are pending claims (including previously notified claims) at such date, in which case it shall be returned following final determination and (if applicable) payment of such claims and shall in the meantime remained valid.

3.9 Where the Performance Bond is subject, pursuant to its terms, to a fixed expiry date, the Contractor shall, not less than...14 days prior to such expiry date, amend or replace the relevant bond with a duly executed amended or replacement Bond if the date upon which the Purchaser will be obliged to return the said bond to the Contractor is not certain to occur prior to such expiry date...3.10 If the Contractor fails to provide an extension to a Performance Bond or replacement Performance Bond pursuant to clause SC 3.9, the Purchaser shall have the right to call the outstanding balance of the Performance Bond and hold the same on security for compliance by the Contractor with its obligations and liabilities under the Contract.

Accordingly, Contractor/Principal provided Owner/Beneficiary with a performance bond issued by Guarantor in the amount of £18,480,000. The bond was intended to secure Contractor/Principal's obligations and liabilities under the contract.

On issuance of an "Acceptance Certificate" by Owner/Beneficiary, the Performance Bond would by its terms, "become null and void (save in respect of any pending or previously notified claims) ... [and should] be returned to [Contractor/Principal] immediately after it becomes null and void". The bond was to expire on 31 August 2010.

Owner/Beneficiary began operating the plant on 17 February 2010. In March 2010 Owner/Beneficiary received complaints that the plant was producing offensive odors, and on 16 March 2010, Owner/ Beneficiary issued a "Defect Notice" to Contractor/ Principal. It is unclear whether Contractor/Principal did any work to resolve the issue. On 19 August 2010, Owner/Beneficiary issued the Acceptance Certificate, "subject to outstanding defects being rectified as per the attached schedule and subject to resolution of liability of certain of the rectification works ...". The Acceptance Certificate included a list of 45 defects, including the odor problem.

Shortly after receiving the Acceptance Certificate, Contractor/Principal asserted that since there were no "pending or previously notified claims", the performance bond was null and void as between Contractor/Principal and Owner/Beneficiary, and should be immediately returned to Contractor/ Principal. The Owner/Beneficiary argued that it was entitled to the bond in the event that any defects were not fixed. The parties attempted to resolve their differences. Without conceding that the performance bond was null and void, Contractor/Principal agreed to extend the bond until 31 December 2010 in the amount of £2,300,000. If a final agreement could not reached by 31 December 2010, it was agreed that the bond would be extended once again until 28 February 2011.

When the parties had not come to an agreement by 23 February 2011, Owner/Beneficiary submitted a demand to Guarantor without the knowledge of Contractor/Principal. On 25 February 2011, Contractor/Principal sought an injunction to restrain Owner/Beneficiary from making a demand on the performance bond. Although Owner/Beneficiary did not receive notice or appear in court because the notified employee was suffering a serious illness, the Judge granted the injunction subject to the condition that Contractor/Principal extend the bond until the end of April 2011. On 28 February 2011, Contractor/ Principal discovered that Owner/Beneficiary had already made a demand on the bond. Contractor/ Principal sought, and was granted, a variation of the injunction requiring Owner/Beneficiary to withdraw its demand.

On 15 March 2011, there was a full hearing on the matter. The Judge found that Contractor/Principal had a strong case that the performance bond was null and void and that the injunction should continue. Owner/Beneficiary retained the £2,300,000 bond, but was restrained from making a demand on it.

Legal Analysis:

1. Independence Principle Exceptions; Injunctions; Fraud; LC Fraud: In opposing the continuation of the interim injunction barring it from making a demand on the performance bond, Owner/

Beneficiary argued that "English jurisprudence over the years has established that there is really only one ground upon which a call on an on-demand bond can be restrained, and that is fraud; furthermore...courts have historically required the clearest or very clear evidence of fraud to justify intervention by injunction." However, the Judge stated that "[t]here has been little jurisprudence on circumstances which arise in which there are contractual provisions between contractor and purchaser/employer which impose restrictions or which prevent calls from being made on bonds or letters of credit."

In ruling that fraud was not the only ground upon which a beneficiary can be restrained from making a demand on an on-demand bond, the Judge quoted Sirius International Insurance Co. v. FAI General Insurance Ltd.11:

Fraud is not the only ground upon which a call on the bond can be restrained by injunction... There is no legal authority which permits the beneficiary to make a call on the bond when it is expressly disentitled from doing so... In principle, if the underlying contract, in relation to which the bond has been provided by way of security, clearly and expressly prevents the beneficiary party to the contract from making a demand under the bond, it can be restrained by the court from making a demand under the bond.

The Judge stated that:

It is possible to get into an academic debate as to whether the proposition which I raise at [Paragraph] 33(d) reflects a type of fraud in that the beneficiary is seeking to call on the bond when it knows or can be taken to know that the underlying contract forbids it from doing so or whether the proposition reflects another exception to the practice that the courts will only rarely intervene to restrain calls being made or honoured. It is unnecessary to decide this but in my view it represents a second type of exception. One can pose this example: on a commercial contract in which there is a bond in favour of the beneficiary party, the parties reach a full and final settlement which expressly requires the bond to be returned to the other party and no further calls to be made on the bond. If the beneficiary party in those circumstances seeks to call on the bond, in breach of the settlement terms, the court could properly restrain the beneficiary from doing either because it is committing a straight breach of contract or because it is or should be taken to be clear fraud by the beneficiary.

The Judge also stated that

Of course, as a matter of commercial common sense and practice, the bond on its face and as between [Owner/Beneficiary] and the Bank remains valid but as between [Owner/ Beneficiary] and [Contractor/Principal], they must treat it as "null and void" and [Owner/ Beneficiary] must return it to [Contractor/ Principal]. Once the original has been returned to [Contractor/Principal], [Owner/Beneficiary] cannot call on it.

2. Likelihood of Contractor/Principal Prevailing: Contractor/Principal argued that it had a strong case for performance bond being null and void under the terms of its agreement with Owner/ Beneficiary. The Judge agreed that Contractor/ Principal had a strong enough case to justify continuing the injunction, finding that the contract terms made it clear that "[u]pon the issue of the Acceptance Certificate the Bond shall 'become null and void' in respect of 'any pending or previously notified claims'", and that "there appears to have been no claim before the Acceptance Certificate which could be described as 'pending or previously notified'".

3. Remedies; Injunction: In ruling that continuing the injunction was the appropriate remedy, the Judge noted,

[C]alling of the bonds as in this case gives rise to a very real risk of damage to the commercial 1. 1 [2003] 1 All ER (Comm) 865 [England]

reputation, standing and creditworthiness of [Contractor/Principal] which would be very difficult to quantify; there would be a very real risk that [Contractor/Principal] would not prequalify for tenders because often tenderers have to disclose whether there have been recent calls on the bonds and if so on what grounds.

Comments: The line between a contract dispute and an abusive drawing is thin as this case illustrates. The surprise is that it comes from the English courts without even a nod to the independence principle.

Text:

The opinion contained the following excerpt from the Performance Bond:

The Bank hereby irrevocably and unconditionally undertakes to pay to the Purchaser upon the fifth business day immediately following that on which it receives a written demand from the Purchaser in accordance with Clause 4 below an amount equal to the lesser of:

2.1 the amount specified in such demand and

2.2 the Bond Amount less the aggregate of all amounts previously paid under this Bond.

3. The Bank's obligation to make payments under this Bond shall arise on receipt of a demand made in accordance with the provisions of this Bond without any further proof or condition and without any right of set-off or counterclaim, and the Bank shall not be required or permitted to make any other investigation or enquiry. For the avoidance of doubt this Bond is not a guarantee and the bank's obligations hereunder do not have the character of suretyship...

6. This Bond is irrevocable. This Bond will be valid up to the earlier of:

6.1 14.00 hrs London time on 31 August 2010...

6.2 the date on which all payments under this Bond equal the bond amount.

The Bank shall be liable to pay the Bond Amount or any part thereof under this Bond only if the Purchaser serves a written claim or demand on the Bank (and which should be received by the bank) on or before 14.00 hrs London time on 31 August 2010, after which time this Bond shall cease to be ineffective in all respects whether or not the original of this Bond is returned to the bank...

[JEB/ph/kae]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.