In what circumstances will a court grant an injunction to restrain an employer from making, and a bank from paying, a demand made under an on demand performance bond?
This issue was considered by the Federal Court of Australia in the following case:
Clough Engineering Limited v Oil and Natural Gas Corporation Limited and Others  FCAFC 136
An Australian contractor entered into a contract with an Indian employer to provide onshore and offshore gas facilities. The contract required the contractor to procure an on demand performance bond for 10% of the contract price.
The construction contract contained the following words in clause 3:
“The [employer] shall have the right under [the performance bond] to … claim the amount [under the performance bond] in the event of the Contractor failing to honour any of the commitments entered into under this Contract.”
The form of bond was annexed to the contract. It was an on demand form of bond. Under clause 2, the bank was required to pay without “demur” or “protest”, and “without reference to the contractor” and even where disputes were pending before a court or arbitrator.
Disputes arose between the parties. The employer terminated the contract and issued a demand under the performance bond. The contractor immediately sought and obtained interlocutory injunctive relief (until trial of the matter) restraining the employer from taking further steps to demand or obtain payment from the banks under the performance bond; and restraining three Australian banks from paying under the performance bond.
The employer applied to the court for the injunctions against it to be discharged. The judge discharged the injunctions against the employer and the banks, but stayed execution of his orders, pending determination of the contractor’s appeal to the Federal Court.
When will the court grant injunctive relief?
Under Australian law, the court will grant an injunction against a bank from paying out under an on demand bond where:
- the court restrains the employer from acting fraudulently; or
- the court restrains the employer from acting unconscionably, in contravention of the Trade Practices Act 1974 [Editors’ note: there is no equivalent statute in the UK].
In addition, whilst the courts will not restrain a bank from acting under an unqualified obligation to pay, it will restrain the employer from breaching a contractual obligation not to call upon the bond, on normal principles relating to the enforcement by injunction of negative stipulations in contracts.
In this case, there was no allegation that the employer had acted fraudulently. Our report will focus on the circumstances in which a court will grant an injunction to restrain an employer from acting in breach of a contractual promise not to call upon an on demand performance bond.
Breach of a contractual promise
The court noted that it was a question of construction in each case as to whether the contractual provisions qualified the employer’s right to call on the performance bond. The contract (and the form of bond in the contract) had to be read as a whole.
When construing the contract, the authorities emphasised the importance of the commercial background in which on demand performance bonds were provided. On demand performance bonds were viewed as equivalent to a letter of credit. It followed that clear words were required to support a construction which prevented the employer from calling an on demand performance bond.
Did clause 3 of the contract contain such clear wording? The contractor argued that it did: the critical condition was: “in the event of the Contractor failing to honour any of the commitments entered into under this Contract”. These words (the contractor argued) meant that the employer was not entitled, under clause 3 of the contract, to call upon the on demand performance bond unless there were actual failures on the contractor’s part to perform the contract.
The court’s construction
The court found that clause 3 did not contain clear words preventing the employer from making a call under the bond where there was a dispute as to whether the contractor was in breach. It was clear from clause 3 of the contract, together with clause 2 of the guarantee, that the contractor was to take the risk of being out of pocket pending resolution of any dispute between the parties.
In the UK (where there is no statutory prohibition on unconscionable conduct equivalent to the Trade Practices Act in Australia), a contractor seeking to restrain an employer from demanding and/or a bank from paying, under an on demand bond has little recourse, except in the case of fraud.
It is therefore interesting to consider whether, in the UK, a contractor could obtain an injunction against the employer on the basis of the employer’s breach of a contractual promise. In principle, it is a question of construction of the underlying contract as to whether the performance bond is provided:
- solely by way of security (i.e. a source of funds when the contractor’s liability has been established); or (in addition to security);
- as a risk allocation device (i.e. a means of determining which party bears the risk of being out of pocket until any dispute on the employer’s entitlement has been determined).
It is clear from this Australian case that commercial practice plays a large part in construing the contract; any clause in the construction contract which restricts the employer’s right to call upon an on demand performance bond would have to do so in very clear terms before a court will conclude that the clause has this effect.
Does the standard FIDIC wording (excluding the Gold Book), have such clear wording?
“The Employer shall not make a claim under the Performance Security, except for amounts to which the Employer is entitled under the Contract”.
Could the FIDIC wording be used by a contractor to obtain an injunction against an employer from calling upon an on demand performance bond?
Employers will no doubt wish to delete this wording to avoid any such argument being raised. From an employer’s perspective, the construction contract should simply provide that if the employer makes a call upon an on demand performance bond and it is subsequently determined that the amount called exceeded its entitlement, the employer is required to account to the contractor for the excess.