RESTRAINING A CALL ON A PERFORMANCE BOND: SHOULD ‘FRAUD OR UNCONSCIONABILITY’ BE THE NEW ORTHODOXY?

• Published date: 01 December 2000
• Date: 01 December 2000
• Author: ADRIAN SP WONG

I. INTRODUCTION

A performance bond is most commonly used in the construction industry where a contractor puts up such a bond to the owner to secure his performance of the building contract. The purpose of such a performance bond is usually to meet any claims for contractual damages that the owner might have as a result of any breaches of the construction contract.1 Typically, a bank or guarantor will issue the performance bond in favour of the owner or employer (‘beneficiary’) for or on the account of the contractor (‘account party’).

A performance bond may or may not be made subject to conditions. For a conditional bond, satisfaction of any condition precedent to the right to call on the bond is required before the beneficiary is entitled to call on and receive the moneys guaranteed under the performance bond.2 Under a ‘simple demand’ or unconditional bond, however, once a valid demand or call is made, the guarantor is obliged to pay the beneficiary according to the terms of the bond or guarantee.3 As stated by the Malaysian Federal Court in China Airlines Ltd v Maltran Air Corp Sdn Bhd:

There are two types of performance bond (sic). The first type is a conditional bond whereby the guarantor becomes liable upon proof of a breach of the terms of the principal contract by the principal

and the beneficiary sustaining loss as a result of such breach. The guarantor’s liability will therefore arise as a result of the principal’s default. The second type is an unconditional or ‘on demand’ performance bond which is so drafted that the guarantor will become liable merely when demand is made upon him by the beneficiary with no necessity for the beneficiary to prove any default by the principal in the performance of the principal contract.4 [emphasis mine]

Speaking extra—juridically, LP Thean JA once said that ‘the legal position in Singapore [concerning how to restrain a call on a ‘simple demand’ performance bond] has been settled by the decision of the Court of Appeal in Bocatra Construction Pte Ltd and Ors v Attorney General (No 2)’.5 Unfortunately, differing interpretations of the Bocatra decision6 by subsequent High Court cases have spawned two opposing views as to what grounds may be tendered by the account party to restrain a call.

In a few decisions of the Singapore High Court, ‘fraud’or‘unconscionability’ were expressly approved as alternative grounds for the restraint of a call on a performance bond. The judges, who decided these cases, premised their view on their interpretation of Bocatra. The opposing judicial view, which is firmly rooted in a long line of English precedents and also allegedly derived from Bocatra, is that only proof of ‘fraud’ would suffice.

In the recent decision of GHL Pte Ltd v Unitrack Building Construction Pte Ltd & Anor,7 the Singapore Court of Appeal acknowledged this divergence of opinion and attempted a resolution. There, in addition to bestowing judicial imprimatur on several novel points of law, the court also explicitly held that Bocatra revolutionised the law and departed consciously from the English position. With respect, this writer is unable to agree with the pronouncements in the GHL decision.

This paper will therefore strive to lay out, what in this writer’s humble view, are the true parameters of the holding in the Bocatra case, and present a survey of relevant cases, some of which were not cited to the court in the GHL case. Secondly, the requisite standard of ‘fraud’

sufficient to warrant an interlocutory restraint on a call on a performance bond will also be discussed. This is another related matter that requires a definitive answer in view of certain pronouncements in GHL.

Recently, English courts have expressly held that implicit in the nature of a performance bond, there must be an ‘accounting’ of rights and obligations between the parties after a call on the bond. This interesting development will also be explored since it has been recently imported into Singapore by the High Court.

II. ‘FRAUD’ AS THE SOLE GROUND FOR AN INTERLOCUTORY INJUNCTION

A. General

It is well-established by case-law, prior to Bocatra, that ‘fraud’ is the sole ground that can be raised by the account party for interlocutory, injunctive relief to either prevent a beneficiary from calling on a demand bond, or the guarantor from paying according to the terms of the bond.8 In the leading case of Edward Owen (Engineering) Ltd v Barclays Bank International Ltd and Anor,9 Lord Denning MR said:

…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. … 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.10 [emphasis mine]

B. Bocotra Construction Pte Ltd v Attorney General (No 2)

Before considering the Bocatra decision in some detail, it is important to emphasise the issue that needs to be resolved — did Bocatra really depart from the English position outlined above? This author respectfully submits that in Bocatra, the court simply re-affirmed the English position. In fact, as the ensuing discussion will show, the Court of Appeal clearly held that an interlocutory injunction restraining a beneficiary from calling on a performance bond will only be granted on the ground of ‘fraud’.

The facts of Bocatra are refreshingly simple. The Director-General of the Public Works Department (‘PWD’) appointed the appellant as contractor for certain works to be done on the Central Expressway from Bukit Timah Road to Chin Swee Road. Under the construction contract, the appellant furnished to the Director-General a performance guarantee. The appellant, unfortunately, did not meet the deadline for completing the works and this prompted the Director-General to notify the appellant of his intention to call on the guarantee. Thereupon, the appellant initiated proceedings against the PWD.

By reason of s 27(1)(a) of the Government Proceedings Act,11 the appellant could not seek an interlocutory injunction against the Government; and so it sought, inter alia, a declaration that the Director-General was not entitled to call on and receive the sum under the performance guarantee, until the dispute between the parties had been resolved by arbitration. An important point to note is that the appellant did not allege that the respondent acted without honest belief of its entitlement to make a call. What this means is that there was no allegation of fraud on the part of the respondent as beneficiary of the unconditional bond.12 On appeal, the Court of Appeal affirmed the trial judge’s decision and found for the respondent.

Karthigesu JA, delivering the collective judgment of the Court of Appeal, firstly noted that

[the appellant] relied on Eveleigh LJ’s statements in Potten Homes…, which were followed … in Royal Design… . These statements suggest that the court, in exercising its equitable jurisdiction to grant an injunction restraining a call or payment on performance bonds, should not be precluded from adopting a broad approach, if the facts warrant it, to examine disputes relating to the underlying transaction as well. It was suggested that there was a distinction between the

applicable principles in cases where the injunction sought to restrain banks from making payment, and those where the intended injunction was on the beneficiaries under the bond.13 [emphasis mine]

Reacting strongly to these arguments, Karthigesu JA bestowed judicial imprimatur to the following principles:

The respondent undertook a comprehensive and judicious survey of the relevant case law on the restraint of calls or payment on bonds from a variety of common law jurisdictions. Of the various propositions of law suggested by the respondent, four principles may be extracted:

1. (a) The ‘autonomy’ principle — the guarantee constitutes a separate contract from the underlying transaction. The appellants are not privy to the guarantee.

2. (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.

3. (c) The ‘fraud’ exception — the sole exception to the ‘autonomy’ and ‘cash in hand’ principle arises where the plaintiff can establish fraud in the circumstances of the call or payment. This permits injunctive relief.

4. (d) There is no distinction between cases where an injunction is to restrain a bank (n 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. … [C]ontrary 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 calls from calling for payment. This principle has been consistently endorsed by English authorities … and was similarly endorsed by our Court of Appeal in Brody, White & Co Inc v Chemet Handel Trading (S) Pte Ltd.14 [emphasis mine]

Thus, the extract above makes it is very clear that Karthigesu JA rejected the broad approach suggested by the appellant to look at the underlying transaction based on Potten Homes and Royal Design. His Honour clearly held that ‘fraud’ was the sole exception which permitted injunctive relief.

Karthigesu JA then went on to clarify Donaldson MR’s views in Bolivinter Oil SA v Chase Manhattan Bank,15 which were relied upon by the appellant to support its contention that, besides ‘fraud’, a ‘substantial challenge’ as to the validity of the guarantee would be a sufficient basis for an injunction. His Honour said:

Donaldson MR was not suggesting that there...