England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION, COMMERCIAL COURT
Mr Justice Christopher Clarke
[2012] EWHC 1715

		Royal Courts of Justice Strand, London, WC2A 2LL
		19/12/2013

Lord Justice Tomlinson :

1. A bank, "the Bank", is properly called upon by a shipbuilder beneficiary, "the Seller", to make a payment under an on demand performance guarantee issued at the request of the Buyer. The Bank guaranteed due and punctual payment by the Buyer of the second instalment of the price of a vessel under a building contract. The Seller's demand for payment by, firstly, the Buyer, and secondly, in default, the Bank was made in all good faith. However by the time payment was made by the Bank pursuant to the guarantee, it had been conclusively determined by an arbitration award which had become final and subject to no further challenge that the second instalment had not in fact fallen due. Is the money paid over by the Bank pursuant to its obligation under the guarantee held by the Seller on trust for the Bank, alternatively on trust for the Buyer who would in turn hold the money on trust for the Bank?
2. The answer to this question is in my view no. It is only the very unusual facts of this case which have enabled some plausibility to be given to what is essentially a heretical proposition which, if accepted, would be subversive of the basis upon which international trade is routinely financed. At the outset I pay tribute to the attractive, skilful and tenacious submissions advanced to us by Mr Sean O'Sullivan for the Bank.
3. Most of the underlying facts out of which this application arises emerge from our judgment delivered on 7 December 2012, [2012] EWCA Civ 1629, in which we decided, differing from the judge below in the Commercial Court, that the guarantee here in question, described in the documents as the "Payment Guarantee", is indeed an on demand guarantee in the nature of a performance bond, as opposed to a traditional guarantee in the sense that the Bank undertakes to see to it that the Buyer performs its obligations. It is however worth restating the chronology, which takes the case out of the ordinary.
4. The shipbuilding contract for the construction of a bulk carrier was concluded on 29 November 2006. The second instalment under the building contract was, putting it broadly, payable within five banking days of receipt by the Buyer of (i) a "refund guarantee" issued by the Seller's Bank in a prescribed form and (ii) a certificate of confirmation of cutting of the first steel plate in the Seller's workshop. It is said that first cutting of steel occurred in April 2009.
5. On 11 May 2009 the Seller demanded payment of the second instalment from the Buyer. It is accepted that it did so in good faith. The Buyer contended that the second instalment was not in fact due, and did not pay it.
6. Demand for payment by the Bank under the Payment Guarantee was not made until 22 June 2011, i.e. over two years after the demand made of the Buyer. We were told that the delay was as a result of discussions between the parties. The Bank declined to pay, contending that the Payment Guarantee was a traditional guarantee of the Buyer's obligation rather than an on demand performance guarantee, and that the Buyer's obligation to pay the second instalment had not been determined to have accrued due.
7. On 28 June 2011, i.e. shortly after demand had been made of the Bank, the shipbuilding contract came to an end, although the parties were in dispute as to whether it did so because the Buyer exercised a contractual right of cancellation for late delivery or because the Seller accepted the Buyer's repudiatory breach, in purportedly cancelling, as terminating the contract.
8. The Seller sued the Bank, claiming payment under the Payment Guarantee of the amount of the second instalment. By a judgment dated 22 June 2012 the first instance judge, Christopher Clarke J as he then was, agreed with the Bank and refused the Seller summary judgment on its claim. The Seller lodged an appeal to this court.
9. On 12 October 2012 the arbitration tribunal appointed by the parties pursuant to the shipbuilding contract issued its award in relation to the dispute between Seller and Buyer. It concluded that the second instalment had not in fact fallen due from Buyer to Seller because the Refund Guarantee provided by the Seller's bank was not in the prescribed form. The tribunal also concluded that the third instalment under the shipbuilding contract had fallen due, that the Seller had contractually extended the time for delivery as a result of the Buyer's default in paying the third instalment and that the Buyer's purported cancellation of the contract was a repudiatory breach which the Seller had accepted as terminating the contract. The tribunal held that the Seller was entitled to retain the first instalment, which had been paid, and to recover the third instalment from the Buyer.
10. On 18 October 2012 we heard argument on the Seller's appeal against the order of Christopher Clarke J refusing summary judgment against the bank. As I have already indicated, we reversed the judgment below. We handed down judgment on 7 December 2012. Longmore LJ, with whose judgment Rimer LJ and I agreed, added the following postscript to his judgment:-

"34. We had some argument as to the legal position if, on the assumption that the bank is liable to pay and does pay the amount guaranteed, the underlying position turns out to be that the Buyer never was obliged under the shipbuilding contract to pay the second instalment. Would the Seller hold the amount paid by the bank on constructive or resulting trust for the Buyer? That is better considered when finality is reached in the arbitration."

11. In December 2012 the Bank paid the amount of the second instalment, together with interest, an amount just over US$ 10.5 million, into an escrow account in the joint names of the Bank's and the Seller's solicitors.
12. On 21 January 2013 Cooke J refused the Buyer and the Seller permission to appeal against the arbitration award of 12 October 2012 which thereby became final.
13. On 24 April 2013 the Supreme Court refused permission to appeal against our decision of 7 December 2012.
14. In May 2013 the Bank agreed to the release of the amount in the escrow account to the Seller's solicitors, Messrs Reed Smith. Before doing so it issued an application for an order declaring that in the event that it made payment, the Seller would hold the money on trust either for the Bank or for the Buyer who would in turn hold it in trust for the Bank. When releasing the money to Reed Smith the Bank asserted that it would be held on trust by the Seller.
15. The summit of Mr O'Sullivan's ambition before us was to persuade us that the money is held by the Seller either on trust for the Bank or on trust for the Buyer. However as Mr Jonathan Hirst QC for the Seller pointed out the Bank has no locus to seek declaratory relief to the effect that the money is held by the Seller on trust for the Buyer. That is a matter which arises as between the Seller and the Buyer and is in any event, as it seems to me, a matter to be decided by the arbitrators.
16. I turn then to the question whether the money has since its receipt by the Seller been held on trust for the Bank. I should note that the Bank asserts that the trust arose in May 2013 when the money was released from the escrow account to Reed Smith. It is not in fact known, or at any rate it is not known by the Bank and we were not told, what has become of the money since it was released to Reed Smith. However nobody suggests that anything will turn on this. I will simply assume that the money was then paid to the Seller. I will also assume in the Bank's favour that the question whether a trust arises is to be determined as at May 2013 rather than by reference to the earlier date on which the money was paid into escrow.
17. The starting point of Mr O'Sullivan's argument is to note that the Bank guaranteed "due and punctual payment" of the second instalment and that the guarantee requires the Seller to state in the demand that the Buyer has been in default of the payment obligation and that such default has continued for a period of twenty days. The Seller so stated in its demand of 22 June 2011.
18. The second step in the argument is to assert that once the arbitration award became final, the Seller knew that the second instalment had not in fact become due from the Buyer. From that it is reasoned that when payment was ultimately made to the Seller by the Bank in May 2013 the Seller knew that it was money to which it was not entitled. That knowledge is said to give rise to a trust on receipt of the money. It is said to be the effect on the conscience of the recipient which gives rise to the trust. An analogy is sought to be made with the position of a recipient of money who has been paid that money by reason of a mistake. It is suggested that such a recipient holds such money on constructive trust, at any rate from the point in time at which he learns of the mistake and ought to act on that knowledge. The foundation for that suggestion is a well-known and much discussed passage in the speech of Lord Browne-Wilkinson in Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 at pp 714C-715C. In the relevant passage Lord Browne-Wilkinson seeks to defend the result although not the reasoning in Chase Manhattan Bank NA v Israel-British Bank (London) Limited [1981] Ch 105. It reads as follows:-

"In that case Chase Manhattan, a New York bank, had by mistake paid the same sum twice to the credit of the defendant, a London bank. Shortly thereafter, the defendant bank went into insolvent liquidation. The question was whether Chase Manhattan had a claim in rem against the assets of the defendant bank to recover the second payment.

Goulding J. was asked to assume that the monies paid under a mistake were capable of being traced in the assets of the recipient bank: he was only concerned with the question whether there was a proprietary base on which the tracing remedy could be founded: p. 116b. He held that, where money was paid under a mistake, the receipt of such money without more constituted the recipient a trustee: he said that the payer "retains an equitable property in it and the conscience of [the recipient] is subjected to a fiduciary duty to respect his proprietary right": p. 119d-e.

It will be apparent from what I have already said that I cannot agree with this reasoning. First, it is based on a concept of retaining an equitable property in money where, prior to the payment to the recipient bank, there was no existing equitable interest. Further, I cannot understand how the recipient's "conscience" can be affected at a time when he is not aware of any mistake. Finally, the Judge found that the law of England and that of New York were in substance the same. I find this a surprising conclusion since the New York law of constructive trusts has for a long time been influenced by the concept of a remedial constructive trust, whereas hitherto English law has for the most part only recognised an institutional constructive trust: see Metall & Rohstoff v. Donaldson Inc. [1990] 1 Q.B. 391, 478-480. In the present context, that distinction is of fundamental importance. Under an institutional constructive trust, the trust arises by operation of law as from the date of the circumstances which give rise to it: the function of the court is merely to declare that such trust has arisen in the past. The consequences that flow from such trust having arisen (including the possibly unfair consequences to third parties who in the interim have received the trust property) are also determined by rules of law, not under a discretion. A remedial constructive trust, as I understand it, is different. It is a judicial remedy giving rise to an enforceable equitable obligation: the extent to which it operates retrospectively to the prejudice of third parties lies in the discretion of the court. Thus for the law of New York to hold that there is a remedial constructive trust where a payment has been made under a void contract gives rise to different consequences from holding that an institutional constructive trust arises in English law.

However, although I do not accept the reasoning of Goulding J., Chase Manhattan may well have been rightly decided. The defendant bank knew of the mistake made by the paying bank within two days of the receipt of the monies: see at p. 115a. The judge treated this fact as irrelevant (p. 114f) but in my judgment it may well provide a proper foundation for the decision.
Although the mere receipt of the monies, in ignorance of the mistake, gives rise to no trust, the retention of the monies after the recipient bank learned of the mistake may well have given rise to a constructive trust: see Snell's Equity p. 193: Pettit Equity and the Law of Trusts 7th edn. 168: Metall and Rohstoff v. Donaldson Inc. [1990] 1 Q.B. 391 at pp. 473-474."

19. This is not the occasion to discuss the soundness of Lord Browne-Wilkinson's analysis which was itself offered only tentatively – "the retention of the monies after the recipient bank learnt of the mistake may well have given rise to a constructive trust". I referred to some of the problems to which this analysis gives rise and to the manner in which those problems have been discussed in the authorities in my judgment in Fitzalan-Howard v Hibbert [2009] EWHC 2855 QB, [2010] PNLR 11 at paragraph 49. To that discussion there should now be added paragraph 37-22 of the current 8^th Edition of Goff and Jones on The Law of Unjust Enrichment at which the soundness of Lord Browne-Wilkinson's analysis is doubted. I note also paragraph 118 of the judgment of Rimer J, as my Lord then was, in Shalson v Russo [2005] Ch 281 at 320 which I read as sharing that doubt. Finally, I should refer to an article written by Lord Millett, Restitution and Constructive Trusts, (1998) 114 LQR 399. In that article Lord Millett is critical of the notion that notice of the existence of a ground on which a claim to personal restitution may be founded is sufficient to found a proprietary remedy.
20. In my judgment Mr O'Sullivan's argument founders at an earlier hurdle. There is here no analogy with cases of mistake, where by definition no obligation to pay ever arose. Here, on making its demand of the bank on 22 June 2011 the Seller acquired a complete and immediately enforceable cause of action against the Bank. The Bank was obliged to pay immediately, as paragraph 4 of the Payment Guarantee spells out in terms. Thereafter the Seller's right to payment from the Bank was indefeasible, and it is of no relevance that the Seller subsequently discovers that his demand, although made in good faith, was in fact made upon an incorrect premise. The position is clearly analysed by Staughton LJ in his judgment in Group Josi Re v Walbrook Insurance Co Ltd [1996] 1 WLR 1152 at pages 1160-1161 in this way:-

"It is, however, worth looking into the question somewhat further.

United City Merchants (Investments) Ltd. v. Royal Bank of Canada   [1983] 1  A.C.  168 was not an interlocutory dispute; it concerned the liability at trial of a bank under a letter of credit, when documents had been presented and payment refused. The letter of credit incorporated the self-styled Uniform Customs and Practice for Documentary Credits 1974. It required presentation of a bill of lading showing that goods had been shipped from Felixstowe on or before 15 December 1976. The bill of lading did say that, but it was not true; the goods were in fact loaded on the following day. The bank refused to pay on the ground that they "had information in their possession which suggested that shipment was not effected as it appears in the bill of lading." However the judge found that there was no fraud on the part of the sellers or their assignee.

Subject to another point which will be considered later, the claim against the bank succeeded. Lord Diplock said, at p. 183:

"If, on their face, the documents presented to the confirming bank by the seller conform with the requirements of the credit as notified to him by the confirming bank, that bank is under a contractual obligation to the seller to honour the credit, notwithstanding that the bank has knowledge that the seller at the time of presentation of the conforming documents is alleged by the buyer to have, and in fact has already, committed a breach of his contract with the buyer for the sale of the goods to which the documents appear on their face to relate, that would have entitled the buyer to treat the contract of sale as rescinded and to reject the goods and refuse to pay the seller the purchase price. The whole commercial purpose for which the system of confirmed irrevocable documentary credits has been developed in international trade is to give to the seller an assured right to be paid before he parts with control of the goods that does not permit of any dispute with the buyer as to the performance of the contract of sale being used as a ground for non-payment or reduction or deferment of payment. To this general statement of principle as to the contractual obligations of the confirming bank to the seller, there is one established exception: that is, where the seller, for the purpose of drawing on the credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representations of fact that to his knowledge are untrue."

As the decision in that case shows, it is nothing to the point that at the time of trial the beneficiary knows, and the bank knows, that the documents presented under the letter of credit were not truthful in a material respect. It is the time of presentation that is critical."

21. As explained by Lord Diplock, the rationale for this well-understood and long-hallowed approach is that the guarantee is intended to be an autonomous contract, independent of disputes between the seller and the buyer as to their relative entitlements pursuant to the different contract between themselves. That same rationale underlies the equally well-established analysis that the underlying contract between seller and buyer, or between beneficiary and the party at whose instance the guarantee is procured, is subject to an implied term that the beneficiary will account to the other party to the underlying contract to the extent to which the beneficiary has been over-compensated by the guarantor. Again the matter is put succinctly by Staughton LJ in Cargill SA v Bangladesh Sugar Corporation [1998] 1 WLR 461 at 471F:-

"The general situation as to performance bonds is that they provide that the bank or the other party giving the bond has to pay forthwith, usually on demand. But subsequently there has to be an accounting between the parties to the commercial contract."

See also per Potter LJ in Comdel Commodities Ltd v Siporex Trade SA [1997] 1 Lloyd's Rep 424 at 431:-

"Comdel submit that they have a strong case on the merits in their claim against Siporex. The substantive issue between the parties is whether, as Siporex contends, Siporex are entitled to keep the full amount paid under the performance bonds regardless of the amount of damage which Siporex suffered as a result of Comdel's breach of the original contracts of sale.

The law in this respect has recently been the subject of an illuminating decision of Morison J. in Cargill International SA -v- Bangladesh Sugar and Food Industries Corporation [1996] 2 Lloyd's LR 524 in which the authorities are reviewed, most notably decisions in two Australian cases and dicta of Lord Denning MR in State Trading Corporation of India Limited -v- E.D. & F. Man (Sugar) Limited , July 17th, 1981, transcript.

Those authorities are to the effect that it is implicit in the nature of a performance bond that, in the absence of some clear words to a different effect, when the bond is called, there will at some stage in the future be an "accounting" between the parties to the contract of sale in the sense that their rights and obligations will finally be determined at some future date. The bond is a guarantee of due performance; it is not to be treated as representing a pre-estimate of the amount of damages to which the beneficiary may be entitled in respect of the breach of contract giving rise to the right to call for payment under the bond. If the amount of the bond is not enough to satisfy the seller's claim for damages, the buyer is liable to the seller for damages in excess of the amount of the bond. On the other hand, if the amount of the bond is more than enough to satisfy the seller's claim for damages, the buyer can recover from the seller the amount of the bond which exceeds the seller's damages."

22. As I indicated at the outset, these principles underlie the basis upon which international trade is routinely financed. They are completely inimical to the implication of a trust impressed upon the monies in the Seller's hands by reason of circumstances arising after accrual of the Seller's completed cause of action under the guarantee. It is critical to the efficacy of these financial arrangements that as between beneficiary and bank the position crystallises as at presentation of documents or demand as the case may be, and that it is only in the case of fraudulent presentation or demand by the beneficiary that the bank can resist payment against an apparently conforming presentation or demand.
23. I also have to say that I can detect no unconscionability in the Seller's retention of the sum. The purpose of requiring prompt payment pursuant to the guarantee is to ensure that the Seller has available to it funds with which to conduct its business which includes construction of the vessel. The payment, if made on time, is plainly intended to enure to the immediate and unencumbered benefit of the Seller to use in its business. It is only by reason of the Bank's breach of contract in failing to make prompt payment when demanded that circumstances have arisen in which it could be said that the money was not in fact due from the Bank. That could not have been said if the money had been paid when it should have been paid and it would be surprising if the Bank can rely upon its own wrongdoing as giving rise to unconscionability on the part of the Seller. The Seller merely seeks to be put in the position it would have been in had the contract of guarantee been properly performed. In any event, it is not correct to say that the money was not at the time of receipt due from the Bank. True, it has been decided that the Buyer had not at the time of demand come under an obligation to pay the second instalment. But payment of the amount represented by the second instalment did fall due from the Bank under the guarantee in June 2011 because the Seller in good faith asserted that the Buyer was in default of due and punctual payment under the Shipbuilding Contract. That rendered payment due under the guarantee, and once due it remained due. Indeed, I do not know pursuant to what principle of law it could have ceased to be due. What is more, payment was required by clause 11 of the Payment Guarantee to be "made without any set off or counterclaim".
24. It is also worth reminding ourselves of clause 7 of the Payment Guarantee, which is in the following terms:-

"Our obligations under this guarantee shall not be affected or prejudiced by any dispute between you as the Seller and the Buyer under the Shipbuilding Contract or by the Seller's delay in the construction and/or delivery of the Vessel due to whatever causes or by whatever variation or extension of their terms thereof or by any security or other indemnity now or hereafter held by you in respect thereof, or by any time or indulgence granted by you or any other person in connection therewith, or by any invalidity or unenforceability of the terms thereof, or by any act, omission, fact or circumstances whatsoever, which could or might, but for the foregoing, diminish in any way our obligations under this Guarantee."

25. Whilst it is true that no case has decided that a trust is unavailable in the circumstances which here arise, all attempts to construct some other remedy for the guarantor have failed. This is unsurprising, since it is contrary to all principle that the guarantor should have a remedy. The guarantor has simply done, or is being required to do, that which it has promised to do. Thus in Uzinterimpex JSC v Standard Bank plc [2008] EWCA Civ 819 this court rejected the argument that a performance bond might contain an implied term pursuant to which the beneficiary would be obliged to repay to the bank any amount by which, subsequently, the demand was shown to be excessive. At page 463 Moore-Bick LJ said this:-

"20. In my view there is no basis for saying that a term of that kind is to be implied by law and Mr. Gruder did not seriously pursue that aspect of the argument. Indeed, he expressly disavowed any suggestion that such a term is to be implied into every performance bond, which effectively rendered the argument untenable. Nor, in my view, can it be said that it is necessary to imply a term of that kind in order to give business efficacy to the contract. The guarantee stands as an independent contract between NBU and the Bank and is capable of operating effectively without the need for such a term. If a demand under the guarantee resulted in the wrongful refund of part of the price due to the seller, the seller would have a remedy against AMJ under the contract of sale. It is well established, as indeed Mr. Gruder recognised, that in the ordinary case a performance bond is intended to provide a provisional remedy and that in the absence of clear language in the contract pursuant to which it is issued either party can seek to recover from the other the additional amount of its loss or the amount by which the amount paid under the bond exceeds its true liability. There will, in other words, usually be room for an accounting between the parties to reflect their rights and liabilities under the underlying contract: see Cargill International S.A. v Bangladesh Sugar & Food Industries Corp. [1996] 2 Lloyd's Rep 524 and Comdel Commodities Ltd v Siporex Trade S.A. [1997] 1 Lloyd's Rep 424. That provides the answer to the 'windfall' argument, despite the fact that in this case the remedy may be of little practical value because AMJ is insolvent."

26. In Pan Ocean Shipping Co and Credit Corp Ltd [1994] 1 WLR 161 time charter hire was payable in advance to an assignee of shipowners. The contract spelled out a regime pursuant to which overpaid hire could be recovered by the charterers from the shipowners. The House of Lords, including significantly Lord Goff of Chieveley, regarded the existence of this contractual regime as rendering both unnecessary and inappropriate the imposition by law of a remedy in restitution exercisable by the charterer against the assignee. The assignee was not intended to supply the consideration for which the hire was paid, the use of the vessel, and nor, reasoned Lord Woolf in his speech, could he be liable to make a repayment in the event that that consideration was not provided – see at page 170.
27. That reasoning is applicable here by analogy. If it were relevant to have regard to matters arising after accrual of the cause of action, which in my judgment it is not, the existence of the Seller's contractual obligation to account to the Buyer for the sum paid to it by the Bank in respect of the second instalment is of itself diametrically inconsistent with the notion of the Seller holding the money on trust for the Bank. The Seller cannot at one and the same time hold the money on trust for the Bank and yet be obliged to account for it to the Buyer.
28. I would therefore decline to make a declaration to the effect that the Seller holds the money on trust for the Bank. That is sufficient to dispose of this application.
29. I do not consider it appropriate to express a concluded view on the question whether the Seller holds the money on trust for the Buyer. I can only observe that it is difficult to see why the principles to which I have already referred do not militate conclusively against the creation of any trust affecting the money in the hands of the Seller. In particular, I see great force in Mr Hirst's submission that the creation of a trust for the Buyer is inconsistent with the obligation to account which envisages the payment of the balance due on striking the account as between Seller and Buyer. The existence of a trust in favour of the Buyer might, and I emphasise might, affect the ability of the Seller to bring into account the unpaid third instalment which the arbitral tribunal has held to be due and owing as between Seller and Buyer. It is presumably at the instance of the Buyer that the Bank seeks to raise the point, but the Buyer is not before the court and it is unnecessary to say anything further on a point which it is not for us to decide.

Lord Justice Rimer :

30. I agree.

Lord Justice Longmore :

31. I also agree.