Introduction

In our March 2013 newsletter we explained, amongst other things, the characteristics of an "on-demand" (as opposed to a "conditional") bond provided as security for performance of a contractor's obligations in respect of an underlying contract with an employer. A key distinction is the steps that the beneficiary must take in order to make a call on the bond.

In the case of a bond properly described as "on-demand", it is often the case that the beneficiary can make a call simply with a written request, with no requirement to establish that the call is justified owing to a breach of the contractor's obligations. In those circumstances, the contractor's only recourse to prevent an unjustified call by a beneficiary is to apply to the relevant Courts for interim relief in the form of an injunction preventing the call.

Historically the English Courts have shown a reluctance to intervene to prevent a call under an on-demand bond. The traditional exception to that approach was where it could be demonstrated that there was a fraud connected to the bond. However, recent English authorities have suggested a movement towards preventing calls from beneficiaries in respect of on-demand bonds in circumstances where the beneficiary was not entitled to make the call under the terms of the underlying contract. A recent example of this development in English law is found in the case of Doosan Babcock Limited v Comercializadora de Equipos y Materiales Mabe Limitada [2013] EWHC 3010 (TCC) (and [2013] EWHC 3201 (TCC)).

Background facts

The Applicant, Doosan Babcock ("Doosan"), was contracted to supply two boilers to the Respondent, Comercializadora de Equipos y Materiales Mabe Limitada ("MABE") for use in a power plant in Brazil. The contract was based on the FIDIC form and incorporated an arbitration clause.

Two performance guarantees in the form of on-demand bonds had been provided as security for Doosan's obligations under the contract. The bonds, which only required a written statement from MABE that Doosan had not performed its obligations for a call to be made, were to expire on the issue of a Taking over Certificate for the boilers or on 31 December 2013, whichever was earlier.

Doosan's case was that it was entitled to the Taking Over Certificates as the boilers had been taken into use by MABE on 30 November 2012 and 10 May 2013 respectively. MABE relied on a provision of the contract which it claimed entitled it to withhold issuing a Taking Over Certificate in circumstances where the boilers were being used as a "temporary measure". MABE also suggested in correspondence from its solicitors that it had a "claim for damages" against Doosan, raising the prospect that MABE might make a call under the bonds.

To prevent a call on the bonds, Doosan applied to the High Court of England and Wales under Section 44(3) of the Arbitration Act 1996 (the "Act") for an injunction to prevent MABE from making a call. Under Section 44(3) of the Act, an English Court may, on the application of a party or proposed party to the arbitral proceedings, make such order as it thinks necessary for the purpose of preserving evidence or assets – it having been held in Cetelem SA v Roust Holdings [2005] EWCA Civ 618 that the preservation of the value of a right could constitute an asset.

Decision

The Court considered the guidelines set forth in Simon Carves v Ensus UK [2011] BLR 340 regarding the extent to which a Court could prevent a payment in respect of an on-demand bond. The guidelines were broadly as follows:

  1. Provided that the terms of the bond have been complied with, a Court will not prevent a bank from paying out, or a beneficiary from calling, on an on demand bond unless there is clear evidence of fraud at the interim injunction stage.
  2. However, the beneficiary is not permitted to make a call on a bond when it is expressly disentitled from doing so, most notably when the underlying contract clearly and expressly prevents the beneficiary from making a demand on the bond.
  3. In a without notice or interim injunction, an applicant seeking to prevent a call from a beneficiary should demonstrate that it has a strong case (albeit that the merits of the case would not need to be determined at that stage).

The Court concluded, without deciding the issue, that Doosan had established a strong case to the effect that the boilers had not been taken into use by the employer as a "temporary measure". It described the suggestion that the boilers were in operation as a temporary measure as "little short of ludicrous" at least on the material before the court. The Court concluded that to permit MABE to make a demand would be to allow it to take advantage of its own breach of contract in failing to provide the Taking Over Certificates.

This decision was revisited when the hearing resumed two weeks later (EWHC 3201 (TCC)). At the resumed hearing, the Court reaffirmed its earlier decision and continued the injunction but gave MABE liberty to apply to vary the order once an arbitrator had decided whether MABE was in breach of contract (Doosan having undertaken to issue a request for arbitration under the ICC Rules as soon as practicable). If the arbitrator had not decided this issue by 31 December 2013, being the expiry date for the bond, then MABE could apply to vary the order. On such an application a material consideration would be whether or not Doosan had arranged for the bonds to be extended beyond that date.

Conclusion

As the judgment notes, this case, together with the earlier case of Simon Carves, represents a "principled and incremental approach" to extending the law on preventing calls under a performance bond. It is evident that the English Courts will now have regard to the terms of the underlying contract between the contractor and employer when considering whether an injunction to prevent the employer/beneficiary from making a call under the bond is appropriate.

Both this case and the case of Simon Carves concerned applications for an injunction against the beneficiary. However, it remains to be seen whether an English Court would have the same regard to the terms of the underlying contract in an application by a contractor against a bank to prevent it from making a payment under an on-demand bond.