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Call on performance bond could be restrained by interim injunction

19 May 2011

Case summary: Simon Carves Ltd v Ensus UK Ltd [2011] EWHC 657 (TCC), 23 March 2011

The claimants in Simon Carves Ltd v Ensus UK Ltd succeeded in restraining the defendants from activating an ‘on demand’ performance bond by relying on the terms of the contract in connection with which the bond was originally given as a security.

Previous case law has shown that, save for instances involving an allegation of fraud, the courts would not normally grant an injunction to prevent the presentation of a guarantee or a letter of credit, pending the resolution of an underlying dispute between the parties in question. This case provides helpful guidance where a bond has been provided under a contract which, subject to certain conditions having been met, expressly prevents the beneficiary from making a demand under the bond. An injunction was granted even though there was no allegation of fraud.
 

Simon Carves Ltd (SCL) was employed by Ensus UK Ltd (Ensus) to build a chemical plant. SCL gave Ensus an ‘on demand’ performance bond as security for its obligations and liabilities under the construction contract (contract). The contract stipulated that, once the acceptance certificate (stating that the plant is accepted as from the date of the certificate in question) had been issued by Ensus, the performance bond was null and void (save as to any pending or previously notified claims) and must be returned to SCL. Ensus issued its acceptance certificate, but this was stated to be ‘subject to outstanding defects being rectified’ and ‘subject to resolution of liability of certain rectification works’. There followed an impasse in the negotiations over the cost and scope of the remedial works. SCL sought an injunction to restrain Ensus from presenting the performance bond to the issuing bank, no doubt aware of the fact that their performance bond was about to expire and might be presented.

The nature of ‘on demand’ instruments

Letters of credit and other ‘on demand’ instruments such as performance bonds are a standard feature of commercial contracts whereby a financial institution (the Issuer) gives security for those who undertake to provide goods or services to third parties. The terms of these instruments stipulate the circumstances in which the beneficiary is entitled to have recourse to the funds which underpin the ‘on demand’ instrument. Because an ‘on demand’ instrument is, save as for its terms, equivalent to cash, the Issuer is not usually concerned with any disputes under the underlying contract between the parties, and will invariably pay cash upon being presented with an ‘on demand’ instrument which has not expired.

The courts have traditionally held that it is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by a bank, such as where there has been a clear case of fraud.

Why was this case different?

Akenhead J affirmed that the courts will not normally interfere with the workings of irrevocable instruments save in situations involving fraud. However, his decision is of interest because he further stated that, in principle, there is no legal authority which would allow a beneficiary of an ‘on demand’ instrument to make a call on it in circumstances when it is not entitled to do so. The contract between SCL and Ensus unequivocally stipulated that, subject to there being no pending or previously notified claims, Ensus had no right to call on the bond. In this context, Akenhead J decided that Ensus had not made a ‘claim’ when it issued its acceptance certificate subject to certain conditions nor did it make one subsequently in the course of its negotiations with SCL. Therefore, the court was of the opinion that, once Ensus issued its acceptance certificate, the bond became null and void and had to be returned to SCL.

In this case, the underlying construction contract was of crucial importance in aiding the court reach its decision since the contract stipulated the conditions which governed the use of the performance bond. Thus, while the bond itself was a standard ‘on demand’ instrument, conditions attaching to the bond’s use rendered it less of a standalone cash equivalent and this enabled the court to look at the underlying construction contract when deciding whether to grant an interim injunction.

Akenhead J added that this kind of injunction application would still fall under the American Cyanamid rules but that, in addition to there having to be a serious issue to be tried, the party seeking an injunction against a beneficiary of an ‘on demand’ instrument would need to have a strong case. Given the facts and the provisions of the underlying construction contract, the court was persuaded that SCL had a strong case; and, given the potential risk to SCL’s creditworthiness and commercial reputation, the court did not think that damages would be an adequate remedy.

Comment

This decision is interesting because it draws a distinction between irrevocable ‘on demand’ instruments which operate as standalone documents and those which operate subject to rules contained within the underlying commercial contract between the parties. While the former will be unaffected by this decision, in instances involving the latter, the courts will be able to grant an interim injunction, depending on the relevant rules contained within the underlying contract. From a legal standpoint, Akenhead J’s decision is beneficial since it has filled a void in this area of law. From a commercial standpoint, additional nuance and clarity in this regard should reduce uncertainty and potential for disputes between the contracting parties for whom the ‘on demand’ instrument forms an important part of a commercial deal.

Further Information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legisation in commerical dispute resolution.  For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.