Injunctions restraining employers from making calls on ‘on demand’ bonds
In the November 2008 edition of the Updater we reported on the Australian case of Clough Engineering Limited v Oil and Natural Gas Corporation Limited and Others  FCAFC 136, which considered whether the court would grant an injunction to restrain an employer from making a demand under an ‘on demand’ performance bond.
In the Clough case, the contractor argued (amongst other things) that:
- the employer was prohibited, under the building contract, from making a call under the bond unless the contractor was in breach of contract;
- the contractor was not in breach of contract; and
- the contractor was therefore entitled to an injunction restraining 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.
The court found that the building contract 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. The contractor’s claim for an injunction was therefore unsuccessful.
What is the position under English law?
A case in the UK (decided in 2007, but which has only recently been reported) addresses the same point.
Permasteelisa Japan KK v Bouyguesstroi and another  EWHC 3508 (TCC)
The sub-contractor was engaged to supply and install curtain walling for an office development in Russia. The sub-contractor was required, under the sub-contract, to procure an ‘on demand ‘performance bond in favour of the contractor (which it did).
The sub-contract provided:
“In case the subcontractor fails to comply with one of its contractual duties and/or obligations and if such default exceeds a period of ten (10) days after the contractor gives the subcontractor formal written notice of remedying such a default … the [contractor] shall be entitled to the following measures … call all or part of bank guarantees.”
The sub-contract contained an arbitration clause which provided for arbitration in London under the UNCITRAL Rules, to be administered by the LCIA.
The contractor made a call upon the bond.
The injunctions sought by the sub-contractor
The sub-contractor responded by:
- seeking (amongst other things) an injunction against the contractor restraining it from making any further call under the bond; and obliging it to pay any sums received under the bond into a bank account in London; and
- giving notice of arbitration to the contractor, seeking various remedies, including an interim measures award under UNCITRAL Rules restraining the contractor from making any further call under the bond, and obliging it to pay any sums received into a bank account in London.
The court’s interim orders
The court granted an interim injunction against the contractor, pending a full hearing to determine whether to continue the injunction. At the time of the full hearing, the arbitral tribunal had not yet been fully appointed. The following is a report of the full hearing.
The sub-contractor’s arguments: for the injunction
The sub-contractor claimed (amongst other things) that:
- Under the sub-contract, the contractor was only entitled to make a call under the bond if the sub-contractor had failed to comply with one of its contractual duties; formal notice of such failure had been given; and the sub-contractor remained in default for a period of at least 10 days after such formal notice.
- The sub-contractor had not failed to comply with its contractual duties.
- Even if the sub-contractor had failed to comply with its contractual duties, the contractor had issued a demand under the bond before the expiry of the required ten day period, so had failed to comply with the contractual requirements entitling the contractor to make a call under the bond.
- In the light of the above, the sub-contractor had a seriously arguable case that the contractor was not entitled to call the bond on the principles in American Cyanamid v Ethicon  AC 395; and the balance of convenience was in favour of continuing the injunction.
- The sub-contractor was entitled to an injunction under section 44(3) of the Arbitration Act 1996 (the Arbitration Act) on the grounds that it sought to preserve assets until an arbitral tribunal had been appointed under the sub-contract and was able to hear an application for an interim measures award under the UNCITRAL Rules.
The contractor’s arguments: against the injunction
The contractor argued:
The court should not grant an injunction against the contractor restraining it from calling upon an ‘on demand’ performance bond unless a seriously arguable case of fraud had been established (which was not the case here).
- The court should not grant an injunction affecting the proceeds of the bond unless there was a good arguable case that there was a risk of dissipation by the contractor.
- The contractor was entitled to call on the bond and any argument as to the underlying merits should be resolved by arbitration.
- Would the court grant an injunction where the dispute (under the building contract), was to be determined by arbitration?
Court injunctions and arbitration
The court reasoned as follows:
- Under section 44 of the Arbitration Act, the court had the same power to grant interim injunctions for the purpose of and in relation to arbitral proceedings as it had for the purpose of and in relation to legal proceedings.
- However, this power was limited to cases of “urgency” where the order was necessary for the purpose of preserving evidence or assets. In addition, the court would only act if or to the extent that any arbitral tribunal had no power or was unable to act effectively.
- The court was entitled to issue an injunction in this case because the arbitral tribunal had not yet been fully appointed (so it had no power or was unable to act effectively); an application for an injunction in relation to a call on a bond was one of “urgency”; and the injunction sought related to the preservation of assets.
- Where section 44 of the Arbitration Act applied, the court would generally apply the same principles when determining whether to continue the injunction as it would if the same dispute were before it in court.
What principles should the court apply?
The court would grant an injunction in the following circumstances:
- Where it was seriously arguable that the beneficiary could not honestly have believed in the validity of the call on the bond.
Applying this principle, the court would not grant an injunction because no case of fraud had been made out.
- there was an express contractual term in the underlying contract which restricted the circumstances in which the beneficiary could call on the bond; and
- it was established that the beneficiary was not entitled to make a call on the bond.
This principle was supported by the Court of Appeal in Sirius International Insurance Co v FAI General Insurance Limited and Ors  1 WLR 2214 (The House of Lords reversed the decision on appeal, but on different grounds).
Applying this principle, the court would not grant an injunction because it had not been positively established that the contractor was not entitled to call upon the bond. The sub-contractor had established that there was a seriously arguable case that the contractor was not entitled to call upon the bond - but that was not sufficient.
- If (contrary to the above) the court should take a less rigorous test, applying a test of the balance of convenience, the court would still not grant an injunction because:
- the effectiveness of performance bonds should take priority; and
- if a call on the bond was delayed, the bond might well expire before the arbitral tribunal was effective.
- The court would not grant a freezing injunction affecting the funds because the sub-contractor had not established that there was a serious risk of dissipation of the proceeds of the call; and, in addition, the court was unlikely to make such an order where (as here) the assets were overseas.
As we stated in our report on the Clough case - from an employer’s perspective, the construction contract should not purport to restrict the circumstances in which an employer is entitled to make a call on an ‘on demand’ bond (e.g. by stating that the bond can be called only upon the contractor’s breach of contract). If the construction contract does restrict the circumstances in which an employer is entitled to make a call on an ‘on demand’ bond, there is a risk that the contractor could obtain an injunction restraining the employer from making any demand on the bond on the basis that the contractor is not in breach of contract and, by making a call on the bond, the employer is in breach of the express terms of the construction contract.
The construction contract should simply provide that if the employer makes a call under the bond and it is subsequently agreed or determined that the amount called by the employer exceeds its entitlement, the employer is required to account to the contractor for the excess.