Restraining call on a performance bond – functional and commercial reasons

As stated in an earlier post, the provision of refund or performance bond is a key element in shipbuilding contract. This is especially significant between parties from different jurisdiction. The nature of such instrument can either be conditional or on-demand, depending on the terms upon which it may be invoked. An on-demand bond is payable without proof or condition independent of the underlying contract. Its purpose is to provide a security which is to be readily, promptly and assuredly realizable when the prescribed event occurs. The English position regarding on-demand bond is that the bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice [1].

However, the position in Singapore is wider. Apart from fraud (which is the traditional ground for restraining a call on a performance bond), unconscionability is a separate and independent ground for the court to grant an interim injunction restraining a beneficiary from making a call on a performance bond. In a recent case [2], the Singapore Court of Appeal reiterated this position and highlighted that the “juridical basis for adopting unconscionability as a relevant ground (separate from and independent of fraud) lies in the equitable nature of the injunction. Considerations of conscionability are applicable in relation to the use of the injunction in other areas of the law, and there is no reason why these considerations should not be applied for the purposes of determining whether a call on a performance bond should be restrained so as to achieve a fair balance between the interests of the beneficiary and those of the obligor.” (Paragraph 13, lines 3 to 8)

It also added that the Singapore position on the circumstances in which the court may restrain a call on a performance bond is justified for functional and commercial reasons.

§ A performance bond (especially one given by the contractor-obligor in a building contract) serves a different function from a letter of credit.

The latter performs the role of payment by the obligor for goods shipped to it by the beneficiary (typically via sea or air from another country), and “has been the life blood of commerce in international trade for hundreds of years”... Interfering with payment under a letter of credit is tantamount to interfering with the primary obligation of the obligor to make payment under its contract with the beneficiary. Hence, payment under a letter of credit should not be disrupted or restrained by the court in the absence of fraud. In contrast, a performance bond is merely security for the secondary obligation of the obligor to pay damages if it breaches its primary contractual obligations to the beneficiary. A performance bond is not the lifeblood of commerce, whether generally or in the context of the construction industry specifically. Thus, a less stringent standard (as compared to the standard applicable vis-à-vis letters of credit) can justifiably be adopted for determining whether a call on a performance bond should be restrained

§ Where the wording of a performance bond is ambiguous, it would entitle the court to interpret the performance bond as being conditioned upon facts rather than upon documents or upon a mere demand

§ Even where a performance bond is expressed to be payable “on first demand without proof or conditions”, there is no reason why fraud should be the sole ground for restraining the beneficiary from receiving payment.

To adopt such a position is to “apply a standard of proof which will virtually assure the beneficiary [of] … immediate payment … and … does nothing more than to transfer the security from the [paying bank] … to the beneficiary” … This may in turn cause undue hardship to the obligor in many cases. For instance, where a call is made in bad faith, especially a call for payment of a sum well in excess of the quantum of the beneficiary’s actual or potential loss, the beneficiary will gain more than what it has bargained for. Furthermore, if the amount paid to the beneficiary pursuant to a call is subsequently proved to be in excess of the quantum of its actual loss, the obligor runs the risk of being unable to recover any part of the excess amount should the beneficiary become insolvent.

§ Excessive or abusive call can cause unwarranted economic harm to the obligor. This is particularly relevant in the context of the construction industry, where liquidity is frequently of the essence to contractors

§ The mere fact that the employer beneficiary agreed to accept a performance bond in lieu of a cash deposit should not be material in determining whether a call on a performance bond should be restrained

Reference:
[1] Edward Owen Engineering Ltd v Barclays Bank International Ltd & Umma Ban
[2] JBE Properties Pte Ltd v Gammon Pte Ltd [2010] SGCA 46

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