With the construction industry facing continued uncertainty, we explore how contractors can navigate emergency proceedings to retrain bond calls.
Contractors on complex projects are often required to provide on-demand bonds, usually from banks, as security for their contractual obligations including timely completion and performance. Employers favour these bonds as they require the issuing bank to pay the employer where it makes a compliant demand irrespective of whether the contractor’s default is disputed. This ensures an employer is “paid now”, although the contractor is free to dispute the employer’s entitlement later. Bond calls are therefore often highly disputed. The stakes are high for both parties, but particularly for the contractor who will normally be liable to reimburse the issuing bank under a counterindemnity.
Given the nature of on-demand bonds, a contractor’s options to resist a call are limited. The contractor can apply for an injunction to prevent the employer from calling the bond or the bank from making payment after a call has been made. In practice, both options are often pursued. Importantly, any injunction must be obtained within a short timeframe as banks are generally obliged to make payment within a matter of days (and sometimes even on the day of the demand).
This type of injunctive relief was historically obtained from domestic courts (eg, in the jurisdiction where the bank and/or employer are based). However, recent statistics from the International Chamber of Commerce show contractors are increasingly turning to emergency arbitration to obtain this injunctive relief.
Emergency arbitration is designed specifically to provide urgent interim relief. Traditionally, a party was required to wait for the arbitral tribunal that would determine the main dispute to be fully constituted – which can take several weeks – before filing a request for interim relief. Emergency arbitration avoids this delay by allowing an institution-appointed sole arbitrator to issue provisional measures pending the main tribunal’s formation. The procedure is fast paced with an interim order (to hold the status quo) sometimes being given almost immediately and a formal decision being issued generally within a few days or at most two weeks. It is now available under many arbitration rules, including: The International Chamber of Commerce (ICC); The Singapore International Arbitration Centre (SIAC); The Hong Kong International Arbitration Centre (HKIA); The London Court of International Arbitration (LCIA); The Australian Centre for International Commercial Arbitration (ACICA); and the latest Stockholm Chamber of Commerce (SCC) Arbitration Rules.
Emergency arbitration also gives parties greater freedom to choose the most appropriate legal system for seeking interim relief. This can be useful in international projects where the employer, contractor and bond issuer are commonly based in different jurisdictions, which can raise complex questions as to the appropriate domestic court for interim relief and risks one party being perceived as having a “home advantage”.
However, despite its advantages, emergency arbitration introduces additional dimensions that should be assessed carefully. Notably, as with any arbitration proceedings, it is a consent-based process which requires an arbitration agreement binding on the relevant parties and is therefore not free from jurisdictional challenges and enforcement issues. The other side is also always on notice of the proceedings because there is no mechanism in arbitration for a party to make an ex parte application like in many court systems, which some contractors in particular may prefer if trying to stop (or at least delay) an imminent bond call. This article examines the factors that parties to construction contracts should consider when using emergency arbitration.
A SHIFT IN SUBSTANTIVE PRINCIPLES?
Applications for injunctive relief to restrain bond calls are commonly determined based on an application of the law governing the relevant bond and/or construction contract pursuant to which the bond was provided, or the law of the forum where relief is being sought. The applicable law may itself be disputed, so thought should be given to this when considering whether to seek injunctive relief.
Under most common law systems, injunctions to restrain a bond call are difficult to obtain, especially against banks which would otherwise be in breach of their bond obligations if they refuse payment. English law, for instance, will only grant injunctions in exceptional circumstances.
Under English law, the contractor will typically need to establish either that:
- the employer’s call was clearly not permitted by the construction contract; or
- the employer’s bond call was fraudulent, such that the “only realistic inferences” are that the employer could not honestly have believed that it was entitled to make the demand and that the bank was aware that the demand was fraudulent. This is an exacting standard that contractors rarely succeed in establishing.
Establishing either ground is also not determinative, and the English courts will ultimately consider whether the balance of convenience favours the injunction being granted, which usually requires “extraordinary facts”, such as the contractor’s insolvency.
Other common law jurisdictions apply similar principles albeit with some important differences. For example, both Singapore and Malaysian law recognise “unconscionability” as a further ground to restrain bond calls. Unconscionability arises where the employer’s call was unfair or constitutes “reprehensible” conduct. It is a fluid concept allowing contractors to rely on grounds which extend beyond the strict fraud exception under English law, including the proportionality of the sums called, bad faith by the employer and the employer’s contribution to the event underlying the call. Nevertheless, unconscionability remains a high threshold that is highly fact specific and difficult for contractors to establish.
Injunctive relief is also available in civil law jurisdictions, although the ease of a contractor obtaining such relief can vary significantly between countries. In our experience, among the civil law jurisdictions in Asia, the courts of Thailand and Korea appear more inclined to grant injunctions to restrain bond calls when compared to certain regional counterparts, such as Indonesia.
A move towards international standards?
Given the complexities arising from differences in the standards to be applied for issuing an injunction depending on the applicable law and forum, emergency arbitration has created an opportunity for emergency arbitrators to sidestep those complexities and choose to apply more general standards. There have been several known occasions of emergency arbitrators determining interim relief applications based on “international standards” rather than established domestic law.
In our experience, the types of international standards which emergency arbitrators are known to have considered include where a contractor shows that:
- the bond call has a risk of serious or irreparable harm to the contractor;
- the injunction is urgently required relief; and
- granting the injunction will not prejudge the merits of the dispute.
Some tribunals have also required contractors to establish that the balance of hardships weighs in its favour. A contractor’s insolvency, for example, may be a compelling factor.
The application of such international standards is significant. This could allow a party to avoid otherwise high evidentiary thresholds, leading some contractors to argue that international standards should be applied because an emergency arbitrator is not bound by the applicable substantive law governing the dispute “since the grant of provisional relief is not by nature a matter of substantive law”. This view has not been widely accepted, and the prevailing view remains that domestic law should take priority, with international standards serving as supplemental principles to the extent necessary. However, the correctness of either position remains unsettled and, in our experience, can add further complexities to emergency arbitrations.
That said, there is a clear takeaway. The consideration of international standards tends to place an emphasis on the parties’ conduct and circumstances prior to the emergency arbitration. Parties should therefore carefully manage their conduct and correspondences leading up to a bond call, in particular setting out cogent explanations for their actions.
Several other factors could also affect the effectiveness of emergency arbitration as a forum for interim relief.
First, the emergency arbitrator is generally appointed by the relevant arbitral institution rather than the parties. The lack of party input may mean that the emergency arbitrator may not be someone a party would have nominated otherwise.
Second, if the injunction sought is against the bank that issued the bond, an emergency arbitration will only be possible if the bond includes an arbitration clause. If not, an emergency arbitrator would lack jurisdiction over the issuing bank. The domestic courts would be the appropriate forum in such a case.
Third, contractors often initiate parallel injunction applications across various fora. Major international arbitration rules, including the ICC, LCIA, HKIAC and SIAC, allow parties to approach domestic courts for interim relief notwithstanding an emergency arbitration having been initiated. Thus, a contractor may try to hedge its bets by commencing emergency arbitration proceedings concurrently with an injunction application in the domestic courts. However, the arbitration laws of certain jurisdictions may not allow this. For example, Section 12A(6) of the Singapore International Arbitration Act restricts the Singapore courts’ ability to grant interim injunctive relief to occasions where an emergency arbitrator is unable to do so effectively. Further, where courts are aware of a party bringing parallel injunction applications in multiple jurisdictions, they may reserve their decision until the emergency arbitrator has decided the application.
Fourth, the determinations of emergency arbitrators are generally issued as orders or decisions, rather than awards. The enforceability of emergency arbitration decisions is unsettled in most jurisdictions. Certain jurisdictions, such as Singapore, Hong Kong and Malaysia, have introduced legislation requiring domestic courts to recognise and enforce the orders and decisions of emergency arbitrators in a manner similar to an award of any arbitral tribunal. Many jurisdictions, however, have not enacted similar legislation including countries where global construction companies are headquartered such as the UK, Japan and South Korea. While this may have limited practical impact as parties often voluntarily comply with emergency arbitration decisions to avoid any negative impression of their conduct in the main arbitral proceedings, this may give rise to uncertainty if enforcement becomes an issue.
A consideration that may count against emergency arbitration, particularly for contractors, is that arbitration must always be on notice, in that the other side will be aware about the proceedings from the start. This contrasts to many court systems (both common law and civil) where parties usually have the right to approach the court ex parte (ie, without notice to the other side) in certain emergency situations (although if a successful order is obtained ex parte, it must then be notified to the other side who is then entitled to make submissions to the court usually in relatively short order). Ex parte procedures can sometimes be used by contractors to delay impending bond calls. Indeed, even if the contractor is only able to delay the bond call for a short period of time, this may have some commercial or tactical advantage for the contractor, such as allowing the contractor some short-term breathing space to negotiate with the employer and possibly also the bank. If this is a factor, then emergency arbitration may not be the right move for contractors in such a situation.
Although construction activity has been on the rise globally, the industry continues to be impacted by instability and it is likely that we will see more distressed projects and bond calls. This is a timely reminder that parties involved in construction projects should familiarise themselves with the grounds for bond calls under their construction contracts. If these are being drafted, contracts should specify in clear and obvious terms the situations in which bonds can be encashed and any formal preconditions for a call, including whether the employer must first raise and determine a timely claim. Disputes often arise from disagreements on the interpretation of such contractual restrictions.
Given the advantages of emergency arbitration, parties may also consider including arbitration agreements in both their construction contracts and bonds, although banks may resist this. If included, these should be coupled with provisions allowing proceedings under both contracts to be consolidated. As disputed bond calls often raise multiple proceedings, a consolidation agreement would allow these to be settled in a single forum which minimises costs and avoids inconsistent decisions.
With emergency arbitration gaining popularity with contractors, the rising number of emergency arbitrations worldwide is likely to continue. Parties to construction contracts should therefore carefully consider the legal and practical implications of emergency arbitrations and how best to navigate the process.