Banking Law

Citation(2010) 11 SAL Ann Rev 104
Published date01 December 2010
AuthorPOH Chu Chai LLB (Singapore), LLM, LLD (London); Advocate and Solicitor (Singapore).
Date01 December 2010

Performance bonds and guarantees

Underlying principles

5.1 The law pertaining to performance bonds and guarantees was first developed by the English Courts in the 1960s and certain principles have emerged from this development. Performance bonds were supposed to have their origins in the realms of letters of credit so that many of the principles applying to letters of credit were also applied to performance bonds. What Lord Denning MR said in Edward Owen Engineering Ltd v Barclays Bank International [1978] 1 QB 159 at 169 and 171 on the legal nature of a performance bond bears repeating:

A performance bond is a new creature so far as we are concerned. It has many similarities to a letter of credit, with which of course we are very familiar. It has been long established that when a letter of credit is issued and confirmed by a bank, the bank must pay it if the documents are in order and the terms of the credit are satisfied. Any dispute between buyer and seller must be settled between themselves. The bank must honour the credit.

All this leads to the conclusion that the performance guarantee stands on a similar footing to a letter of credit. A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice.

5.2 A performance bond like a letter of credit is in practice used as an instrument to effect payment to a beneficiary. In order to give effect to this object, a number of principles operate to ensure its efficacy as an instrument of payment. These principles were succinctly identified by the Singapore Court of Appeal in Bocotra Construction Pte Ltd v Attorney- General [1995] 2 SLR(R) 262 (‘Bocotra Construction’) at [34]-[35], to include the following principles:

(a) The “autonomy“ principle - the guarantee constitutes a separate contract from the underlying transaction. The appellants are not privy to the guarantee.

(b) The “cash in hand“ principle - reflecting the importance of promoting commercial efficacy and certainty in the use of letters, guarantees and bonds. This ties in with the “autonomy“ principle.

(c) The “fraud“ exception - the sole exception to the “autonomy“ and “cash in hand“ principles arises where the plaintiff can establish fraud in the circumstances of the call or payment. This permits injunctive relief.

(d) There is no distinction between cases where an injunction is to restrain a bank (on payment) or the beneficiary under the guarantee (on calling for payment).

Principles (a) to (c) above were all alluded to and supported by the judge below. The weight of authority suggests that these principles are well entrenched. It is important to establish at the outset principle (d) above: contrary to the appellants“ submissions, there is no distinction between the principles to be applied in cases dealing with attempts to restrain banks from making payment or those dealing with restraint of callers from calling for payment.

5.3 The above principles clearly represent the law as developed by the English courts and endorsed by the Singapore Court of Appeal in Bocotra Construction.

Developments in Singapore

5.4 However, in Singapore, the courts now embrace a further exception based on unconscionability, apart from fraud, to restrain payment under a performance bond. This exception is now deeply entrenched in the Singapore legal system having been affirmed and applied in numerous decisions emanating from the Singapore Court of Appeal. The origin of this new exception is shrouded in controversy. In GHL Pte Ltd v Unitrack Building Construction Pte Ltd [1999] 3 SLR(R) 44 (‘GHL’), the Singapore Court of Appeal traced the development of this new exception to Royal Design Studio Pte Ltd v Chang Development Pte Ltd [1990] 2 SLR(R) 520 (‘Royal Design Studio’). LP Thean JA, delivering the judgment of the Court of Appeal, said (GHL at [54]):

Royal Design Studio was decided on the ground of unconscionability, although the word “unconscionability“ was not expressly used there; but the circumstances in which the injunction was continued were clearly those warranting the description of unconscionability.

5.5 In Royal Design Studio, LP Thean JA granted an injunction to restrain a beneficiary from calling for payment under a performance

bond on the ground that (Royal Design Studio at [20]): ‘We are not concerned with the “irrevocable nature of the obligation assumed by the relevant bank“; we are concerned with the relationship between the parties under the main or underlying contract they made and the dispute arising from such relationship.’ The decision in Royal Design Studio is clearly inconsistent with the subsequent Court of Appeal decision in Bocotra Construction (above, para 5.2), where the court categorically decided that ‘there is no distinction between the principles to be applied in cases dealing with attempts to restrain banks from making payment or those dealing with restraint of callers from calling for payment.’ The court in Royal Design Studio specifically decided that it was not bound by the fraud exception because it was dealing with an attempt to restrain the beneficiary and not the bank. The only conclusion one can draw from these two cases is that Royal Design Studio must have been wrongly decided as it is entirely inconsistent with the clear principles enunciated in Bocotra Construction, and in particular, the holding that no distinction was to be made between the bank and the beneficiary when an attempt was made to restrain payment under a performance bond or guarantee.

5.6 The unconscionability principle is targeted primarily at the beneficiary of a performance bond and not the bank. In practice, the unconscionability principle has no practical impact on a bank as its role is merely to make payment on the bond. In Bocotra Construction, the court decided that no distinction was to be drawn between an attempt to restrain a bank and an attempt to restrain a beneficiary. The significance of this principle is that if the bank cannot be restrained from making payment except on the ground of fraud, a similar standard also applies to the beneficiary. This means that if the bank cannot be restrained except when it is acting fraudulently, the beneficiary equally cannot be restrained unless he is acting fraudulently. This may explain why the English courts only recognised one exception based on fraud to restrain payment as they have consistently held that no distinction is to drawn between restraining a bank and restraining a beneficiary.

5.7 In New Civilbuild Pte Ltd v Guobena Sdn Bhd [1998] 2 SLR(R) 732 (‘New Civilbuild’), Lee Seiu Kin JC (as he then was) expressed the view that Bocotra Construction did not in fact establish that unconscionability constituted a separate ground, apart from fraud, for restraining payment under a performance bond. However, in GHL (above, para 5.4), the Singapore Court of Appeal disagreed with the decision in New Civilbuild. LP Thean JA, delivering the judgment of the court, said (GHL at [51]):

We should add that the concept of “unconscionability“ was adopted after deliberation, and was not inadvertently inserted as a result of a slip; nor was it intended to be used synonymously or interchangeably with “fraud“. There is nothing in that judgment which can be said to

indicate or suggest that the court did not decide that “unconscionability“ alone is not a separate ground as distinct from fraud. We accept that to that extent, Bocotra is a departure, and if we may respectfully say so, a conscious departure, from the English position.

5.8 Apart from the use of terminology like ‘fraud’ or ‘unconscionability’ in Bocotra Construction (above, para 5.3) the unconscionability principle has no room to operate when it comes to a bank. A bank may act fraudulently when it seeks to make payment to a beneficiary knowing that the beneficiary has no right to receive the payment. This may occur when the beneficiary tenders forged documents to substantiate his demand for payment and the bank is aware...

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