06 April 2020

Performance Bonds: Courts exercise restraint in not restraining bond calls

Hong Kong SAR, Singapore, Australia and England

Authors: Donovan Ferguson and Charlie Bruce

In these distressed times, we have seen an increase in companies considering recourse to performance bonds in light of financial difficulties, so it was opportune that the position in Hong Kong* on the circumstances in which a bond call will be restrained was revisited last week in the High Court’s decision of West Kowloon Cultural District Authority v AIG Insurance Hong Kong Limited.[1]

The decision concerned an on demand bond (HK$297,198,000) obtained by Hsin Chong Construction Company Limited (Contractor), in favour of the West Kowloon Cultural District Authority (Owner) from its financial provider, AIG Insurance Hong Kong Limited (AIG), as required under a construction contract for the development of the M+ Project in West Kowloon Cultural District.

In respect of the on demand bond, the two issues to be decided were whether the Owner’s demand upon the bond was invalid on the basis that the demand:

(a)  failed to identify the amount of damages or loss sustained by the Owner, instead relying on an unidentified amount of future or prospective damages (Formality Issue); and

(b)  was made fraudulently, as the Owner could not have formed a bona fide opinion that the Contractor was in default of its obligations under the contract, or consequently that the Owner had incurred damages exceeding the bond sum (Fraud Issue).

The Honourable Justice Peter Ng rejected AIG’s arguments on the validity of the Owner’s demand, on the basis that the demands, when read as a whole, were compliant with the terms of the bond and to take an overly strict or hypercritical approach to compliance would be contrary to the importance of preserving the certainty and reliability of on demand bonds.  His Lordship found no evidence of fraud.

You can read more about this case and a consideration of the position in other jurisdictions below.




Performance Bonds issued by a financial institution on behalf of a contractor to their employer are commonplace in all major construction projects across the globe. 

In their most common form, a bond will be ‘on demand’ simply requiring a written demand be made to the financial institution in a particular documentary form, stating that the contractor is in default under the contract and the amount of loss or damages sustained by the employer as a result of the default.  The bond will often contain wording that statements as to default and damages shall be conclusive evidence and the bank shall have neither right nor obligation to challenge the accuracy or sufficiency of such statements. 

These bonds play an important role in providing security for the performance of contractual obligations and have been described as the lifeblood of international commerce.  However, once a call is made on a contractor’s bond, the timeframe to consider your position and whether there are grounds to seek (or defend) an injunction restraining the call is a matter of days.

The High Court’s decision in Hong Kong

In West Kowloon, his Lordship, Justice Peter Ng noted that the essential first step in considering an application to restrain a call on a bond is the true construction of the bond in question.  In this case it was a clear ‘on demand bond’ with the relevant clause being worded as standard to the construction industry:

If, in the [Owner’s] opinion, the Contractor is or has been in default in respect of any of its obligations under the Contract, [AIG] shall upon demand made by the [Owner] in writing and without conditions or proof of the said default or amount demanded, pay the amount identified in the demand in respect of the damages, losses, charges, costs or expenses sustained by the [Owner] by reason of the default, up to the amount of the Bonded Sum.[2]

In refusing to find the Owner’s demand on the bond was invalid, his Lordship considered the key circumstances in which an injunction will be granted to restrain such a call, being a non-compliance with the terms of the bond or the existence of fraud.

On the Formality Issue, his Lordship stated that as a matter of construction he was satisfied that the Owner’s demand had set out all that it was required to under the relevant clause, being:

(a)  A demand made by the Owner in writing.

(b)  In the Owner’s opinion, the Contractor is or has been in default in respect of any of its obligations under the contract.

(c)  The amount stated in the demand is in respect of the damages, losses, charges, costs or expenses sustained by the Owner by reason of the Contractor’s default.

Counsel for AIG’s argument that the demand was invalid as it failed to identify the amount of damages or losses, was rejected by the Court on the basis that the demand did refer to damages having been incurred and that no further particularisation of breach and damages was required,[3] citing Nishimatsu Construction Co Ltd v AHA Co.[4]

In respect of a claim for future damages, which was also included within the demand, his Lordship determined that this additional reference to future damages and losses was redundant given the earlier statement of damages sustained by reason of the Contractor’s default. 

However, in obiter, his Lordship stated that where a demand only referred to future damages and losses (and omitted to mention damages already sustained) then an argument that the bond was defective would have more force. 

One nuance of this case was that the default upon which the demand was predicated was the insolvency of the Contractor.  The Contractor’s Fraud Issue alleged that the Owner could not have formed a bona fide view that the Contractor was insolvent and therefore in breach of the contract, this allegation raised issues of the substantiation of such claims and the requirement in Enka Insaat Ye Sanayi A.S v Banca Popolare Dell’Alto Adige SPA[5] that “particularly cogent evidence” is required to establish the fraud exception when resisting summary judgment based on a performance bond. 

In dismissing the Fraud Issue on the basis that the court was not satisfied that the demands were made mala fide, his Lordship addressed AIG’s evidence, which took the form of several paragraphs in affidavit from its solicitors, and concluded:

In this court’s view, such evidence is little more than a mere assertion, rather than cogent evidence, let alone particularly cogent evidence of fraud.[6]

Implications

This is a useful decision in providing confirmation of the position in Hong Kong that the courts will be very reluctant to restrain a call on an on demand bond.  Reasons for restraint that are overly pedantic or an unreasonably strict compliance with the wording of a bond are unlikely to succeed.  As his Lordship’s concluding remarks on the Formality Issue highlight:

[A]s long as the demand states in substance what is required in the bond, and is understood by its recipient as such, the demand will be treated as a valid one.  This approach is wholly consistent with the importance of preserving the certainty and reliability of on demand bonds, which, as emphasized in the authorities, are their essential and defining characteristics.  Being hypercritical of the wording of a demand and an overzealous insistence of strict compliance would only serve to undermine the certainty and reliability of on demand bonds.  This should be rigorously resisted.[7]

Position around the Globe

As more and more of our clients begin to work on international construction projects, it is important to be mindful of the law regarding performance bonds in each of the jurisdictions they operate.

Hong Kong SAR

The leading High Court decision of Grande Cache Coal LP & Another v Marubeni Corporation & Another[8] sets out the circumstances in which an injunction will be granted to restrain a call on a performance bond.

The first step in any analysis will be the proper construction of the bond, that is, whether it is an “on demand” or “conditional” bond.  This will involve careful attention of the bond’s wording and the relevant contractual clauses to determine whether the bank’s obligation to pay is conditional upon any event.

The next consideration is whether circumstances exist that should compel the court to act to restrain the bank from making payment on the bond.  In Hong Kong, the courts have held that restraint of payment under a bond will normally only be made in circumstances of fraud.[9]  However, it appears that the courts are open to a consideration of a second circumstance, being where the terms of the underlying contract preclude the beneficiary from making the call.[10]

In seeking to restrain payment on the basis of an exception, a plaintiff will be required to meet a higher threshold than merely showing that there is a serious question to be tried:

A higher threshold is required to be met – that threshold has variously been described as "it is positively established that the party was not entitled to draw down", or "a strong case" has been shown, or "the ‘serious issued to be tried’ threshold is in practice a more difficult one to overcome", or "it has been clearly established that the beneficiary is precluded from making a call by the terms of the contract".[11] 

In the recent Court of First Instance decision in CLA Engineering Ltd v DBS Bank (Hong Kong) Ltd and Another[12], the Court confirmed that unconscionability is not recognised by the courts of Hong Kong as a sufficient basis to restrain payment due under a performance bond.[13] 

To secure an interlocutory injunction on the basis of the fraud exception:

The claimant must show clear evidence of fraud by the beneficiary, and show that it is obvious that the fraud is being carried out by the beneficiary to the knowledge of the bank.[14]

As in Marubeni, the CLA Engineering decision is a timely reminder that a party bringing an ex-parte application is under an obligation to make full material disclosure on both the facts and law to the Court.  A failure to do so may, in and of itself, be grounds to later discharge an injunction granted at that interim stage.[15]

Singapore

In contrast to Hong Kong, the position of the courts in Singapore is that an injunction restraining a call on a performance bond may be granted in circumstances of either unconscionability or fraud.

The Court of Appeal’s decision in BS Mount Sophia Pte Ltd v Join-Aim Pte Ltd[16] is regularly cited as the leading authority on this position.  The reasons for judgment state that where facts support a finding of unconscionability, but falling short of fraud, an injunction may still be granted.

The availability of unconscionability acknowledges that conduct exhibited by the beneficiary other than fraud might be sufficiently reprehensible to justify relief on the part of the obligor.[17]

In contrast to this extension of the exemptions to include unconscionability, the Court made statements to effectively warn lower courts against granting injunctive relief on this basis, without proper regard to the high threshold required for a finding of unconscionability. 

If calls on this security by the beneficiary are too liberally subject to injunctive relief from the courts, this security loses its efficacy and the raison d’être of performance bonds would be eroded or even wholly undermined.[18]

Further, the Court stated that there ought to be a high threshold to the grant of an injunction, which requires a strong prima facie case of unconscionability to be established.  The evidence on which this case is to be based must also be taken in its full context and with consideration of all relevant factors.[19]

Australia

In a similar position Singapore, the Federal Court of Australia held in Clough Engineering Limited v Oil & Natural Gas Corporation Limited[20] that the principal exceptions to the rule that a court will not prevent the issuer of a performance bond from performing its unconditional obligation to make payment are where the party in whose favour the performance bond is given:

(1)  is acting fraudulently;

(2)  is acting unconscionably; or

(3)  has made a contract not to call upon the bond.

In construing the terms of the underlying contract to determine whether they restrict a call on the bond, the Court noted the importance of performance bonds to the construction industry, citing their need to provide security for valid claims and the allocation of risk between the parties as to who shall be out of pocket pending resolution of the dispute, as relevant factors in interpreting the terms.[21]

What the authorities emphasise is that the commercial background informs the construction of the contract. In particular… the court ought not too readily favour a construction which is inconsistent with an agreed allocation of risk as to who is to be out of pocket pending resolution of the dispute about breach.

Their Honours stated that given the commercial importance of performance bonds to the industry, it follows that clear words will be required to support a construction which inhibits a beneficiary from calling on a performance guarantee where a breach of contract is alleged in good faith, that is, non-fraudulently.[22]

England

The English courts may restrain payment under a demand on a bond where (1) there is the existence of fraud on behalf of the beneficiary or (2) the underlying contract expressly prohibits the making of the demand.  These principles were clearly articulated in Justice Akenhead’s reasons for judgment in Simon Carves Ltd v Ensus UK Ltd.[23]

The decision of Justice Edwards-Stuart, sitting as the Technology & Construction Court in Doosan Babcock Ltd v Comercializadora de Equipos y Materiales Mabe Limitada[24] offers a potential incremental development to the English legal position on injunctive relief for bond calls.

The Court considered an application of the principle in Alghussein Establishment v Eton College[25] that a party should not be permitted to benefit from its own wrong.

In the light of the principle established or recognised by the House of Lords in the Alghussein case, I cannot see how it would be just to refuse interim relief in a case where the defendant can only make a call on the bond by setting up a state of affairs which, on the material before the court, has a strong likelihood of being shown to be the direct result of his own deliberate breach of contract.[26]

In the case before Justice Edwards-Stuart, the beneficiary was only able to make a call on the guarantee as a result of their own breach of the contract, being a failure to issue certain certificates which were a pre-condition to the expiry of the relevant guarantee, the failure to issue having the effect of extending the validity of the guarantee.

In respect of threshold for cases involving an interim application to restrain payment under a bond, as in other jurisdictions, the position in England requires the claimant to show a strong case that there has been either fraud or a breach of contract by the defendant.

In Doosan it was discussed that where the principles set out in the Alghussein case are at play, it may be sufficient for the claimant to demonstrate only that its case has a realistic prospect of success.[27]  Although only an incremental development, caution should be shown towards this line of authority until further tested in the English courts.

What you need to know – Your checklist

kwm-hk-performance-bonds

In short, timeliness and jurisdictional knowledge is critical in seeking to restrain an urgent bond call.   

King & Wood Mallesons has retained its market-leading position in the 2020 Chambers Asia Pacific rankings for legal services to the construction industry.


*Any reference to “Hong Kong” or “Hong Kong SAR” shall be construed as a reference to “Hong Kong Special Administrative Region of the People’s Republic of China”.


[1] [2020] HKCFI 569 (West Kowloon).            

[2] Ibid, [11].

[3] Ibid, [37].

[4] Unreported, HCA 10416 of 1999, 20 September 1999,

[5] [2009] EWHC 2410 (Comm), [24]-[25].

[6] West Kowloon, [49].

[7] Ibid, [40].

[8] HCA 2136/2015 (Grande Cache).

[9] Ibid, [29].

[10] Ibid, [30].

[11] Ibid, [32].

[12] [2018] HKCU 989 (CLA Engineering).

[13] Ibid, [24].

[14] Gee on Commercial Injunctions (6th Edition) [15-022].

[15] CLA Engineering at [29].

[16] [2012] SGCA 28.

[17] Ibid, [23].

[18] Ibid, [24].

[19] Ibid, [39].

[20] [2008] FCAFC 136.

[21] Ibid, [79].

[22] Ibid, [83].

[23] [2011] EWHC 657 (TCC).

[24] [2013] EWHC 3010 (TCC) (Doosan).

[25] [1991] 1 All ER 267 (Alghussein).

[26] [2013] EWHC 3010 (TCC) at [39].

[27] Doosan, [40].

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