Article

Factual Summary: The beneficiary (a German company) and the applicant (a Pennsylvania corporation) formed a consortium to bid on a contract with a Taiwanese power company to build a desulfurization system. The beneficiary submitted the bid, and it was accepted. The contract between the beneficiary and the power company required the beneficiary to post a bond in the amount of $15.5 million to cover liquidated damages resulting from delays in the construction or defects in the final system.

The beneficiary and the applicant agreed among themselves that the beneficiary would be responsible for approximately 29%, and the applicant for 71% of the performance of the contract. Accordingly, the applicant caused a standby to be issued for $10.5 million to cover its share of the bond supplied by the beneficiary. The contract between the beneficiary and the applicant was silent with respect to renewal of the standby, but it incorporated the terms of the standby which stated that "the maturity date of this letter of credit shall not be extended beyond October 31, 1997."

After numerous delays in the construction project the relationship between the applicant and beneficiary deteriorated and the applicant filed an arbitration claim against the beneficiary for $11 .4 million. The beneficiary counterclaimed for $1.6 million. One of the central issues in the arbitration was whether the contract between the applicant and the beneficiary required the applicant to renew its standby obligations covering its share of possible liquidated damages beyond the expiration date of the standby. Fearing that the arbitration panel would not reach this issue until after the standby expired, the beneficiary filed this motion for preliminary relief.

Legal Analysis:

1. Underlying Contract: Order to Replace LC: The court first noted that a different test applies to preliminary relief where the status quo is to be maintained from a situation where an affirmative action must be taken. Under the former test, the beneficiary must prove that irreparable injury will result without the injunction and it has a probability of success in the pending arbitration. In the latter case, the beneficiary faces a higher standard of demonstrating that it is entitled to relief or that irreparable injury will clearly result from a denial of the injunction.

The applicant argued that requiring it to supply a new standby was an affirmative act, and, therefore the stricter test should apply. The beneficiary countered by arguing that the standby was still currently effective and any injunction would merely preserve that status quo. The court, however, without stating which test would apply in this situation decided that the beneficiary could not meet even the less strict test of preserving the status quo.

The beneficiary pointed to the applicant's financial situation to demonstrate that if the standby was not renewed, and its bond was called upon, it would suffer irreparable harm because the applicant would not be able to cover its share of the obligation unless the standby was in place. The court rejected this argument by noting that, due to the timing of the performance tests on the construction project, it was unlikely that the beneficiary would be called upon to pay any liquidated damages until well after the arbitration was settled. Additionally the court noted that the financial condition of the applicant would make it extremely difficult for it to obtain a new standby despite any court order. The beneficiary countered this argument by noting that the applicant had relied on its parent corporation's credit to obtain the current standby and could do so again. The court, however, noted that the financial situation of the parent corporation was unlikely to change during the pending arbitration. Therefore, there was no immediate need for action to prevent an irreparable injury.

The court also noted that the beneficiary could not demonstrate a sufficient likelihood of success in the pending arbitration because the contract between it and the applicant was silent about any extension of the applicant's obligations, and indeed, had incorporated the language of the standby which clearly terminated the applicant's obligations as of 31 October 1997.

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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.