The changing attitudes to the use of on-demand bonds
Vanessa On
On-demand bonds (also known as unconditional performance bonds) are used in the construction industry as a form of guarantee given by the contractor to the employer, which is issued by a third party (usually a bank or insurer). The employer needs only to submit a valid demand to the bondsman in order to receive payment. The bondsman cannot question the validity of the call on the bond, as any disputes regarding the legitimacy of the employer’s call would need to be settled between the contractor and employer.
The difficulty in challenging a request for payment (with fraud being the only established defence in the UK) has meant that in the UK they have been viewed with apprehension by the construction industry, the courts and the government. This is exemplified by HM Treasury, Central Unit on Procurement (No. 48 Bonds and Guarantees) advising that: “Unconditional on-demand bonds are essentially unfair and Ministers have said that they should not be used in government procurement”. Nonetheless, in other countries, especially across the Middle East and Asia[1], they remain commonplace. This paper will consider the English and Hong Kong courts’ conservative approach in restraining a call on a bond, compared to a more progressive approach in Singapore that allows unconscionability as a means of resisting payment.
England
On-demand bonds came into popular usage in the 1970s, mirroring the trend of providing letters of credit in international sale and supply contracts[2]. Kerr J in RD Harbottle (Mercantile) Ltd v National Westminster Bank Ltd[3] first described the performance guarantee as “astonishing” in that the bonds could be drawn on “without any or any apparent justification” [4]. It is for this reason the UK courts and the construction industry have viewed the bonds with apprehension[5], as they are seen as “onerous” on both the contractors and the bondsmen, even referred to as a “suicide bond” by the Privy Council[6].
Due to the fact on-demand bonds are viewed as akin to letters of credit[7] it means that the English courts take a more non-interventionist approach when a party calls on the bond, only allowing the bondsman to resist payment on the limited grounds of fraud[8]. The high (close to impossible) standard of proof necessary to establish fraud, as established by Ackner LJ in United Trading Corp v Allied Arab Bank[9], has made it even more challenging for the bondsman to resist payment, with the bondsman required to establish on the evidence available, “the only realistic inference is that [the beneficiary] could not have honestly have believed in the validity of his demands on the performance bonds”[10].
The courts have held that fraud in this context also includes common law fraud, for example, where the employer knowingly makes an invalid demand for payment on the bond, and even extends to a situation where there is a bona fide demand for payment but the bondsman knows that it is bad[11].
It could be argued that there is some relaxation of the court’s attitude as seen in TTI Team Telecom International Ltd v Hutchinson 3G UK Ltd[12] where the court suggested that a party may be able to restrain a bond on the grounds of a “lack of good faith”. Nonetheless, the language used by Thornton J to define a lack of good faith is, in reality, very similar to the language used by Ackner LJ in United Trading Corp, with Thornton J describing a lack of good faith as including “unconscionable ulterior motive” or a “lack of honest or bona fide belief by the beneficiary” in its ability to call on the bond. Furthermore, the high evidentiary threshold that bad faith “must be both significant and clearly established”[13] perhaps indicates the court’s apprehension towards introducing a new defence. This uneasiness towards introducing a new defence is further reflected in the fact TTI Team Telecom has not been followed, and the courts returned to the traditional rigorous approach last year in MW High Tech Projects UK Ltd v Biffa Waste Services Ltd, where it was held there were only two established defences to restraining a call on an on-demand bond: fraud, or the contract itself provided a term preventing the beneficiary from making a claim[14].
Hong Kong
Similarly, in Hong Kong the courts have approached on-demand bonds cautiously, describing them as “oppressive documents” in Tins’ Industrial Co Ltd v Kono Insurance Ltd [1988] 2 HKLR 36. The Hong Kong government has generally waived on-demand bonds on public works projects with the exception of projects with tight deadlines, high risks or co-funding with China[15], however, many other minor and major private employers, including the Hong Kong Airport Authority and the MTR Corporation, still insist on on-demand bonds. A notable example is the Hong Kong Housing Authority which requires all its contractors to supply on-demand bonds for all new works[16], on the pretence they are used to pay their employees’ wages in case of contractor default.
The Hong Kong courts, like the English courts, have also approached defences to calling on the bond conservatively, confirming more recently in Hyundai Engineering & Construction Co Ltd v UBAF (Hong Kong) Ltd [2012] 5 HKLRD 620 that fraud was the only way to resist payment on the bond. The Hong Kong court’s strict approach is perhaps due to its belief that it was, and remains, “most important, in the interests of Hong Kong as a commercial centre, that international performance guarantees should be certain of fulfillment”[17]. Nonetheless, the Hong Kong construction industry has not shied away from addressing the punitive nature of the bonds, and the Construction Industry Council in its Procurement Alert No. 001/14 noted and highlighted that employers often abuse the bonds and suggested that employers should only request bonds in a “responsible manner”[18]. Perhaps the worries of the industry will be addressed by the courts in due course, and Hong Kong will follow the more liberal tack taken by its East Asian neighbour, Singapore.
Singapore
In Singapore, the courts have departed from the English position that clear fraud is the only defence to a call on a bond, and have diverged in two main ways. Firstly, the court in Chartered Electronics Industries Pte Ltd v Development Bank of Singapore [1992] 2 SLR(R) 20 suggested that clear fraud need not be shown, and “a strong prima facie case of fraud” (at [40]) would suffice to defeat a call on a bond. Secondly, the courts introduced the doctrine of unconscionability as a ground for restraining unfair calls in Bocotra Construction Pte Ltd v Attorney General (No.2) [1995] 2 SLR(R) 262, which was later confirmed in GHL Pte Ltd v Unitrack Building Construction Pte Ltd [1999] 3 SLR(R) 44.
The Singaporean courts were able to introduce this new defence primarily because they disagreed with Lord Denning MR’s contention that on-demand bonds were like letters of credit, and gave rise to a primary obligation to pay on the bondsman’s part. Rather Chan Sek Keong CJ in JBE Properties Pte Ltd v Gammon Pte Ltd [2010] SGCA 46 described a performance bond as “merely security for the secondary obligation of the obligor to pay damages if it breaches its primary contractual obligations to the beneficiary”. This allowed the court to introduce the doctrine of unconsciability because they could find that “a less stringent standard (as compared to the standard applicable vis-à-vis letters of credit) can justifiably be adopted for determining whether a call on a performance bond should be restrained”[19].
The court later clarified the defence of unconscionability in Raymond Construction Pte Ltd v Low Yang Tong & Anor [1996] SGHC 136 as “conduct of a kind so reprehensible or lacking in good faith that a court of conscience would either restrain the party or refuse to assist the party”[20]. Further, when making a decision as to whether it is unconscionable the court takes a more holistic approach and will consider the party’s conduct within the circumstances of each individual case[21].
Although the Singapore courts have expanded the law in this area, one should not consider this development to be excessively lenient, as a strong prima facie case of unconscionability is still needed to injunct a call on the bond[22], and a high evidentiary threshold remains[23].
Conclusion
In conclusion, in light of the economic climate and increasing number of multinational construction projects it is likely on-demand bonds will continue to be widely used in the construction industry. Whilst it can be harsh on the party providing the bond, they provide the employer with a means to ensure that the contract is performed, and vital security in the event of default. Perhaps, the English and Hong Kong courts have lessons to learn from Singapore, as the varied means of resisting a call on the bond helps to not only relieve the acrimonious nature of on-demand bonds, but also to foster a commercial environment that acknowledges the practicalities of doing business. Singapore’s progressive approach is perhaps a reason why Singapore has become a major commercial centre in recent times, and in a short period of 25 years the Singapore International Arbitration Centre has risen rapidly as a hub for dispute resolution worldwide, and is one of the five most used arbitration centres in the world[24].
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[1] King & Wood Mallesons remark that on-demand bonds are “used on just about every construction and engineering project in the Gulf region” (King & Wood Mallesons (2016, 12 February), “Dealing with “Bad Calls” on Bonds”, retrieved from http://www.kwm.com/en/ae/knowledge/insights/dealing-with-bad-calls-on-bonds-20160212
[2] Dennys N. and Clay, R (eds.), Hudson’s Building and Engineering Contracts, 13th Ed., London: Sweet and Maxwell, pg
[3] [1977] 2 All ER 862
[4] Ibid., at [865]
[5] Construction Manager Magazine described how on-demand bonds were making an “unwelcome comeback” due to the economic downturn (“’On-demand’ bonds make unwelcome comeback” (2011, 11 March), retrieved from http://www.constructionmanagermagazine.com/news/-demand-bonds-make-unwelcome-comeback/
[6] Frischmann Engineering v Bow Valley Iran & Anor [2009] UKPC Case Ref 45 at [13]
[7] Lord Denning MR in Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] QB 159 at [169]
[8] The English courts’ approach has been described as “rigorous” by Goode in “Unconditional Bonds: the Common Law” in Lloyd (ed), The Liability of Contractors (Longman, 1986), pg 107
[9] [1985] 2 Lloyd’s Rep 554
[10] at [561]
[11] GKN Contractors Ltd v Lloyds Bank plc (1985) 30 BLR 48 at [63]
[12] [2003] 1 All ER (Comm) 914
[13] at [37]
[14][2015] EWHC 949 (TCC) at [33]
[15] Danny Chung (2013, 23 December), “The Name’s Bond, Performance Bond”, Construction Post, Retrieved from http://www.construction-post.com/names-bond-performance-bond/
[16]“On-demand bond requirement extended” (2006, October 13), Retrieved from http://archive.news.gov.hk/isd/ebulletin/en/category/atschool/061013/html/061013en02008.htm
[17] Guangdong Transport Ltd v Ancora Transport N.V. and Another [1987] HKCU 215
[18]Procurement Alert No. 001/14 – Use of On-Demand Performance Bonds in Construction Contracts
[19] at [10]
[20] at [5]
[21] Dauphin Offshore Engineering & Trading Pte Ltd v The Private Office of HRH Sheikh Sultan bin Khalifa bin Zayed Al Nahyan [2000] 1 SLR (R) 117 at [42]
[22] Leighton Contractors (Singapore) Pte Ltd v J-Power Systems Corp [2009] SGHC 7
[23] Hudson, pg.115
[24] Queen Mary University (2015), International Arbitration Survey