Case Note

• Citation: (2011) 23 SAcLJ 367
• Author: Delphia LIM Hui Min LLB (Hon) (National University of Singapore); Advocate & Solicitor (Singapore); Associate, Drew & Napier LLC.
• Date: 01 December 2011
• Published date: 01 December 2011

INTERLOCUTORY INJUNCTIONS AFFECTING DEMAND GUARANTEES IN INTERNATIONAL COMMERCE

Conflicts and Confusion

Shanghai Electric Group Co Ltd v PT Merak Energi Indonesia

[2010] 2 SLR 329

This note considers the implications of the Singapore High Court‘s decision in Shanghai Electric Group Co Ltd v PT Merak Energi Indonesia [2010] 2 SLR 329 for Singapore‘s jurisprudence on the two areas of choice of law and demand guarantees.

I. Introduction

1 The decision of the Singapore High Court in Shanghai Electric Group Co Ltd v PT Merak Energi Indonesia1 (“Shanghai Electric”) is the first decision in Singapore and, it appears, the Commonwealth,2 to determine the issue of whether restraining a call on and payment under a demand guarantee is a procedural matter for the lex fori, or a substantive matter, such that a law other than that of the lex fori may

apply. This decision has significant implications for local doctrine pertaining to the two areas of choice of law and demand guarantees.

2 The plaintiff in Shanghai Electric,3 a Chinese company, entered into a contract with the first defendant, an Indonesian company, to construct a power plant in Indonesia. Pursuant to the contract, the first defendant paid the plaintiff an advance of 10% of the contract price. The plaintiff procured an advance payment guarantee in the first defendant‘s favour from the second defendant, the Singapore branch of the Bank of China, to secure the return of the advance payment. The guarantee was a demand guarantee. Both the construction contract and the guarantee provided for English law to be their governing law. Disputes arose in connection with the construction contract. On the basis that the plaintiff had breached the contract, the first defendant terminated the contract and called on the guarantee. The plaintiff applied ex parte to the Singapore High Court to restrain the second defendant from making payment and the first defendant from making further demands on and receiving payment under the guarantee. (In this note, such injunctions in relation to demand guarantees will for convenience be referred to as “bond injunctions”.)

3 The ex parte application was granted. The first defendant applied to have the bond injunction set aside. The first defendant‘s setting aside application was granted by the court in Shanghai Electric.4 In doing so, the court determined that the grant of the injunction was a substantive matter, and that the applicable law was that agreed by the parties to govern the guarantee and the underlying contract.5 4 In order to fully explain the significance and implications of this aspect of the court‘s decision, it is useful to set out certain background matters. This is done in paras 7-20 of this note. First, the nature of demand guarantees and the purpose of bond injunctions will be explained, to show the practical relevance of the decision in Shanghai Electric6 to parties to an international transaction involving demand guarantees. Local jurisprudence on substance and procedure and bond injunctions is then briefly canvassed.

5 Paragraphs 21-55 of this note address the implications of the decision for local approaches to defining substance and procedure. Certain general categorisations traditionally used to distinguish between substance and procedure can no longer hold, if this decision is followed. The reasons for the court‘s characterisation of the application as substantive also cast light on the nature and effect of bond injunctions and demand guarantees.

6 Where the issue is identified as a substantive matter, the next step is to categorise the issue in order to identify the connecting factor that will point to the applicable legal system.7 In Shanghai Electric,8 the contractual categorisation of the issue was assumed. In paras 56-61 of this note, some of the unique problems with regard to categorisation in choice of law that are posed by international demand guarantees will be considered.

II. Background

7 Demand guarantees9 are commonly used as performance guarantees to secure the performance of contracts; they may also be advance payment guarantees, which secure the return of monies paid out in advance by one party in consideration of the other‘s performance of certain contractual obligations.10 The hallmark of a demand guarantee is the contractual entitlement it gives to a beneficiary to receive the monies secured upon a mere demand, without the need for the disputes arising from the underlying contract to be first resolved.11

The demand guarantee represents an agreed allocation of risk; it renders the principal, and not the beneficiary, out of pocket pending resolution of their underlying contractual disputes.12

8 Under the terms of demand guarantees, all that is usually required for a beneficiary to receive payment is for the beneficiary to make a written demand to the issuing bank in the requisite form.13 The beneficiary does not have to prove that it has suffered any loss resulting from a breach by the principal. Giving unqualified effect to the strict terms of demand guarantees can hence have harsh consequences for the principal. There appears to be uniform agreement among most, if not all, jurisdictions, that even though a valid demand has been made, the beneficiary‘s entitlement to payment is subject to exception.

9 Principals to demand guarantees frequently apply to the courts to enjoin the beneficiary from making a demand or further demands on the guarantee, and/or the issuing bank from paying out under any demand. Applications for bond injunctions will be granted where (a) the demand is found to be not in compliance with the formal requirements of the demand guarantee, and/or (b) where the circumstances of the case are such that the courts find that restraint should be ordered notwithstanding a valid demand. For ease of reference, the circumstances in which a court in any country will order such restraint notwithstanding a valid demand are referred to as “the Exception”.

10 There appears to be a general consensus that fraudulent demands would fall within the Exception.14 Still, different jurisdictions have divergent definitions of fraud, and more broadly, the nature and scope of the Exception.15 The law in Singapore is a striking example of

such divergence. While most jurisdictions limit the Exception to fraud, the Singapore courts have added a concept of “unconscionability”.16

11 Demand guarantees are used heavily in international transactions. The place of performance of the underlying contract, the place the guarantee was issued, the place where payment under the guarantee will be made, the country of the parties and/or the governing laws of the guarantee and the underlying contract may well be different. The existence of foreign elements and the varying definitions of the scope of the Exception across different jurisdictions afford parties to a bond injunction application opportunities to argue for the application of the system of law that most favours their case.

12 Hence, it was not surprising that the beneficiary in Shanghai Electric17 argued for English law to apply. The Exception in English law is significantly narrower than the Exception as defined in Singapore. English law was a candidate as it was the law expressly agreed by the parties to govern the guarantee and the underlying contract. On the other hand, the principal asserted that the lex fori ought to apply.

13 It is trite that procedural matters are governed by the lex fori while substantive matters are governed by the law to which the court is directed by its choice of law rule.18 Defining the line between substance Letters of Credit (“Explanatory Note”). According to the Explanatory Note, this “has been a particularly troublesome and disruptive area in practice … because of [among other things] the divergent notions and ways with which such allegations have been treated both by guarantor/issuers and by courts approached for provisional measures to block payment”. In England, the Exception has been expressed as fraud in the contents of the demand or the documents presented to claim payment under the on-demand instrument: see United City Merchant (Investments) Ltd v Royal Bank of Canada [1982] 2 WLR 1039 at 1045E, per Lord Diplock. In the US, the Uniform Commercial Code expressly covers forged or fraudulent documents, and situations where “honor of the presentation would facilitate a material fraud by the beneficiary on the issuer or the applicant”, hence endorsing a conception of fraud encompassing fraud in the underlying transaction and not only the demand or documents presented. It was noted in United Trading Corporation SA and Murray Clayton Ltd v Allied Arab Bank Ltd [1985] 2 Lloyd‘s Rep 554 that the conception of fraud in the US was “far wider than [in England] and would appear to include ordinary breach of contract”. In Canada, the wider scope of the Exception has been endorsed: see Bank of Nova Scotia v Angelica- Whitewear Ltd [1987] 1 SCR 59 at 83. In general, see Ali Malek QC & David Quest, Jack: Documentary Credits (Tottel Publishing, 4th Ed) at pp 254-262, paras 9.15-9.30.

and procedure, in the sense used in private international law, was thus a central issue in Shanghai Electric.19

A. The law in Singapore on substance and procedure before Shanghai Electric

14 The division between substance and procedure for choice of law purposes has not been an easy one to draw; it is also drawn differently in different jurisdictions.20 The traditional common law drew a distinction between the existence of a right and its enforcement; matters relating to the former are substantive, while matters relating to the latter are procedural. Case law in major Commonwealth jurisdictions, for example, the High Court of Australia‘s decision in John Pfeiffer Pty Ltd v Rogerson21 (“John Pfeiffer”), have moved away from the traditional approach, adopting instead a functional approach of asking whether...