England and Wales High Court (Technology and Construction Court) Decisions

IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
TECHNOLOGY AND CONSTRUCTION COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		23rd March 2011

 


Mr Justice Akenhead:

1. This case relates to an "on demand" performance bond and raises issues, rarely addressed in the past, as to the extent to which, if at all, a party may be prevented from seeking payment under the bond by the terms of the very contract in respect of which the bond is provided by way of security.

The Facts and Background

2. I preface these findings by commenting that they are made only for the purpose of the applications with which I have to deal and are not intended to be binding on any tribunal which in the future has to resolve the underlying disputes between the parties.
3. By a written contract ("the Contract") dated 6 October 2006, Simon Carves Ltd ("SCL") as Contractor was employed by Ensus UK Ltd ("Ensus") as Purchaser to carry out and complete the Works as defined in the Contract at a site at Teesside. The Works related to the provision of a process plant to produce bioethanol. The Contract incorporated the General Conditions of Contract for Lump Sum Contracts published by the Institution of Chemical Engineers in 2001, known as the "Red Book", albeit that it was amended with special conditions agreed between the parties.
4. Under the Red Book requirements, when the project comes to completion, there are various steps which have to be taken. The first one is what is called a Take-Over certificate, which broadly means what it says. The Purchaser takes over the works when it has reached a certain level of completion. Following that, at least in this case, there is a period during which various performance and other type of tests are done or may be done and certain further work may be done, leading to a stage which is called Acceptance. For one year after the issue of the Take-Over Certificate, there follows the Defects Liability Period during which the Contractor is required by Clause 37.2 to make good defects in respect of which the named Project Manager has given it notice. If the Contractor fails to make good such defects, Clause 37.7 entitles the Purchaser to proceed to do the relevant remedial work. Clause 36.3 of the Red Book indicates that, as soon as the plant has passed all the performance tests, the Purchaser's project manager shall issue the Acceptance Certificate, which states that the plant is accepted by the Purchaser as from the date of that acceptance certificate. Clause 36.3 goes on to say that:

"The Acceptance Certificate shall list any known Defects which the Contractor is bound to make good under the provisions of Clause 37 (Liability for Defects) and any minor items still remaining to be completed following the issue of a Take-Over Certificate."

5. Some of the Special Conditions are of importance, relating as they do to the Bond which was to be provided:

"3.1 It is intended that the Contractor shall have delivered to the Purchaser…the Performance Bond prior to or on the Effective Date…

3.2 …the Performance Bond shall be provided as security for any and all of the Contractor's obligations and liabilities under the Contract…

3.5 The Performance Bond shall initially be for an amount equivalent to …12% of the Contract Price

3.7 Upon the issue of the Acceptance Certificate the Performance Bond shall become null and void (save in respect of any pending or previously notified claims).

3.8 The Performance Bond shall be returned to the Contractor immediately after it becomes null and void, save where there are pending claims (including previously notified claims) at such date, in which case it shall be returned following final determination and (if applicable) payment of such claims and shall in the meantime remained valid.

3.9 Where the Performance Bond is subject, pursuant to its terms, to a fixed expiry date, the Contractor shall, not less than…14 days prior to such expiry date, amend or replace the relevant bond with a duly executed amended or replacement Bond if the date upon which the Purchaser will be obliged to return the said bond to the Contractor is not certain to occur prior to such expiry date…

3.10 If the Contractor fails to provide an extension to a Performance Bond or replacement Performance Bond pursuant to clause SC 3.9, the Purchaser shall have the right to call the outstanding balance of the Performance Bond and hold the same on security for compliance by the Contractor with its obligations and liabilities under the Contract. The Purchaser shall be entitled to make deductions against any amounts so held in respect of any claim for which it would have been entitled to call against an extended or replacement Performance Bond…but shall otherwise return to the Contractor the remaining balance of such amounts (without any interest) if the Contractor provides the relevant extended or replacement Performance Bond or, if no extended or replacement Performance Bond is provided, following the date on which the relevant Performance Bond becomes null and void."

6. There is no reference to the word "claim" in the definitions clause (Clause 1 (as supplemented by Special Condition 1). However, Clause 19.5 states:

"Any claim made by either party under the Contract, whether covered by Sub-clause 19.1 or otherwise, shall be supported by a written statement of grounds and a summary of material facts upon which it is based."

7. SCL duly procured from Standard Chartered Bank a performance bond in the due amount (£18,480,000). It was very much in the standard form of such documents:

"2. The Bank hereby irrevocably and unconditionally undertakes to pay to the Purchaser upon the fifth business day immediately following that on which it receives a written demand from the Purchaser in accordance with Clause 4 below an amount equal to the lesser of:

2.1 the amount specified in such demand and

2.2 the Bond Amount less the aggregate of all amounts previously paid under this Bond.

3. The Bank's obligation to make payments under this Bond shall arise on receipt of a demand made in accordance with the provisions of this Bond without any further proof or condition and without any right of set-off or counterclaim, and the Bank shall not be required or permitted to make any other investigation or enquiry. For the avoidance of doubt this Bond is not a guarantee and the bank's obligations hereunder do not have the character of suretyship…

6. This Bond is irrevocable. This Bond will be valid up to the earlier of:

6.1 14.00 hrs London time on 31 August 2010…

6.2 the date on which all payments under this Bond equal the bond amount.

The Bank shall be liable to pay the Bond Amount or any part thereof under this Bond only if the Purchaser serves a written claim or demand on the Bank (and which should be received by the bank) on or before 14.00 hrs London time on 31 August 2010, after which time this Bond shall cease to be ineffective in all respects whether or not the original of this Bond is returned to the bank…"

8. The Take-Over Certificate was issued on 17 February 2010 and Ensus has been operating the plant since then. In March 2010, Ensus received complaints from individuals in the area that the Plant was producing foul smelling emissions, whereupon it embarked upon analysis and sampling which confirmed that certain emissions exceeded the specification requirements. The Environment Agency issued an Enforcement Notice on 26 March 2010 on Ensus which imposed nine conditions. On 16 March 2010, Ensus issued to SCL a Defect Notice (DN072) pursuant to Clause 37.2 (b) of the Red Book Conditions; this identified the odour problem and suggested that it might be a breach of certain statutory requirements. Ensus called for a solution from SCL. There is evidence that Ensus issued a Variation Order (VO152) on 26 April 2010, agreed to by SCL, whereby the emissions stack would be doubled in height to 80 metres, amongst other things; there was some agreement that at least temporarily each party would bear its own costs in achieving this work with subcontractors being paid by Ensus and SCL bearing its own costs. On 1 June 2010, Ensus re-issued DN072 pointing out that the defect was a problem for which SCL was responsible and stating that, if SCL did not remedy the defect within a reasonable time, Ensus would proceed to do the requisite remedial work; it then went on to say:

"Ensus would recover its costs under clause 37.9 and keep contemporaneous substantiating records in compliance with clause 4.3 and submit a claim in accordance with clause 19.5."

9. It is not absolutely clear what work if any SCL did in relation to the Defect Notice DN072 or to the Variation Order VO152 but the inference is that it did not do much or enough to satisfy Ensus. On the evidence put before the Court, nothing happened which is of significance to these court proceedings before 19 August 2010 when Ensus' Project Director, Mr Henniker Major, issued the Acceptance Certificate under Clause 36.3 of the Contract, in these terms:

"Ensus certifies that the Plant, as described in the EPC Contract and the Variations to the Contract passed the 5 Day Performance Test as defined in Schedules 16 and 17 of the Contract on 5^th August 2010.

In accordance with clause 36.3 of the Contract, as of the 19^th August 2010, the Plant is accepted by the Purchaser subject to outstanding defects being rectified as per the attached schedule and subject to resolution of liability of certain of the rectification works…"

The "attached schedule" contains a list of some 45 "defects" which had been the subject matter of Defect Notices. One of these was Defect Notice DN072 as revised on 1 June 2010 which related to "Stack Odour".

10. On the following day, the Environment Agency issued an enforcement notice to Ensus to the effect that Condition 3.3.1 ("Odour") of the Environmental Permit was being contravened:

"because odour at levels likely to cause annoyance outside the site has been identified by an authorised officer and the operator has not used appropriate measures to prevent, or where that is not practicable to minimise the odour."

11. Issues arose or had arisen between the parties as to responsibility for the problem. On the one hand, Ensus complained that the problem was a contractual fault and risk of SCL whilst SCL argued that the problem had been caused by Ensus running the plant inefficiently, ineffectively or otherwise inappropriately. It appears in any event that, after August 2010, Ensus embarked upon a remedial process and have, for instance placed orders for two "Regenerative Thermal Oxidisers". Some £2.6 million has already been spent, it is said, by Ensus and a total cost possibly exceeding £10 million is anticipated in relation to what Ensus suggests will be the appropriate remedial works.
12. Shortly after the issue of the Acceptance Certificate, SCL began to assert the arguments which they put forward before the Court now to the effect that, once the Acceptance Certificate is issued, the Bond was to be considered as null and void as between the parties (save in respect of any pending or previously notified claims) and is to be returned to SCL. It asserted that there had been no "claim" as such. This was an important issue at this stage because the Bond was due to expire at 2 p.m. on 31 August 2010. This appears to have been discussed on the telephone between Mr Walsh, a solicitor but then also Vice- President Legal and Commercial and company secretary of SCL, and Mr Botterill, a director of Ensus. Mr Walsh confirmed SCL's position in his e-mail to Mr Botterill on 24 August 2010. The e-mail averted to the fact that Ensus had an additional £7.7 million by way of money retained. The e-mail called for the return of the Bond but asked for an explanation of Ensus' position. This e-mail was copied to SCL's solicitors who wrote openly on 25 August 2010 to Ensus' solicitors reiterating the argument in the three-page letter.
13. The response from Mr Botterill seems to have come the following day, 25 August 2010, in the following terms:

"Following our discussion last Thursday, and as agreed, I approached the banks yesterday regarding the release of the performance bond.

They instigated a check of all the documentation to confirm that all the conditions relevant for the release of the bond had been met. As you know, there is a long list of defects attached to the acceptance certificate, which could add up to a very significant value. The question that is being pondered is whether Special Condition 3.8 means that the bonds should be left open to cover the costs should this be required.

We are clearly tight on time - best answer would be to extend the bond to allow this to be worked through properly. There is no wish to call the bond at this time, but the banks will clearly want to be satisfied that the appropriate security is in place."

14. Mr Walsh responded later that day wondering whether Mr Botterill had seen his e-mail of the previous day, referring to the fact that Mr Botteril's e-mail did not address a number of the key issues. He then, over a page, spells out SCL's position that the Bond is null and void and should be returned concluding:

"Please cease and desist your ponderances and return the original of the bond to us forthwith without the need for this matter to be escalated to full legal confrontation."

15. What happened then was that there were "without prejudice" discussions between the parties, this being in part an explanation as to why Mr Botterill did not respond in detail to Mr Walsh's open e-mails. Although Ensus has put before me the without prejudice communications which took place over the next two days, to great protest from SCL, I have found it unnecessary to base any conclusions on the content of that material. I make no finding as to whether it was legitimate to put this material before the Court.
16. Following the without prejudice attempts to resolve their differences, some accommodation was reached between the parties in relation to the Bond. This is recorded in an e-mail in the form of a note from Mr Botterill to Mr Walsh, apparently amended by agreement, on 27 August 2010:

"This is a note to record the solution we have reached over the phone on the performance bond. I would be grateful if you could e-mail back to confirm this is agreed.

Simon Carves agrees to provide, as soon as practicable, an extension to the existing bond, in the amount of £2.3m and with an initial expiry date of 31^st December 2010 which will subsequently [be] extended to 28^th February 2011, should we not have reached the final solution regarding defects by 31 December 2010.

I know you are doing your best to get this in place by 31^st August, however we recognise it may take a few days longer and would imagine it should be possible to get the new Bond not later than end of next week, but certainly by 14th September - please confirm if you agree that is a reasonable backstop.

In return Ensus, with the support of its lenders, agrees not to make any demand under the existing £10.8m performance bond before its current expiry date…."

17. Suffice it to say, Mr Walsh has unequivocally said in evidence that during the discussions he "made it very clear to Ensus' representatives, particularly David Botterill, that this extension in no way was to prejudice or impeach the emphatic position SCL took on the contractual position…" (Paragraph 19 first statement). He says in his second statement (Paragraph 16) that he at all times reserved SCL's position.
18. It is important to see how Mr Botterill in his witness statement responded to the evidence about a reservation being made. He simply does not challenge the evidence that Mr Walsh made the reservations which he says that he made. All that he does say in Paragraph 14, having indicated that Mr Hughes of Ensus and Mr Bhattacharya of SCL had without prejudice discussions leading to the figure of £2.3m being arrived at in relation to the value of the continuing Bond:

"It was my clear understanding that all £10 million was a protection to Ensus against the defects we had notified to [SCL], and Ensus entered into this agreement (and lost the opportunity to enforce against the much larger bond amount of £10.8m with the retention remaining in place) on the understanding that the new £2.3 million Bond was valid and enforceable."

The reference to the £10 million figure in context is the £7.7 million retention plus the £2.3 million value of the bond as it was to be extended. The reason that this is important is that Mr Botterill, advised by well-known solicitors, was the person charged with recording the "solution" referred to in the e-mail note of 27 August 2010 set out above and had the opportunity in his witness statement to challenge Mr Walsh's evidence relating to reservation of rights; but he did not challenge it.

19. The Bond was duly extended to the end of 2010 in the sum of £2.3 million and thereafter, as anticipated in the note, it was extended until 28 February 2011.
20. On 9 February 2011, Mr Walsh e-mailed Mr Botterill in the following terms:

"SCL's performance bond to the value of £2.3M will expire on 28 February 2011.

SCL provided that Bond in August 2010 under duress; reserving its rights and generally and specifically as to its position; and did not accept Ensus' ponderances at that time. You are well aware of our position as we clearly explained it at that time. We fully expect that this bond will expire by effluxion of time on 28 February 2011.

You are hereby put on notice that any attempt to make a call on the same, prior to or up to its expiry, would be unfounded and will be met with an application (which we consider will be successful) for injunctive relief, together with an application for an order for costs against Ensus.

We await your confirmation of the above by return and, in any case, no later than Tuesday 15 February 2011."

It is again of some relevance that the reference in this e-mail to SCL having reserved its rights generally and specifically in August 2010 was not challenged in the correspondence which followed.

21. It can not be wholly coincidental that, on 15 February 2011, Ensus gave a notice "under clause 19.5 of the EPC Contract" to SCL. In terms it made specific written claims against SCL in relation to the stack odour problem, specifically complaining that the stack as provided by SCL was of an inadequate height and should have been 80 m high rather than the 40 m provided by SCL. The stack heightening remedial works totalled to date £1,920,180 whilst the provision of two regenerative thermal oxidisers would cost at least £7.5 million. Details were given in this four-page letter of the alleged defects and why it was that Ensus was asserting that SCL was liable.
22. SCL responded on 18 February 2011 reserving its position on liability but asserting that, even if it was liable, any liability would be subject to a monetary cap under the Contract of £795,000. It gave notice of its intention to adjudicate in relation to the cap issues. On the same day a notice of adjudication was served on Ensus. Also on 18 February 2011 Mr Walsh wrote to Mr Henniker Major reiterating in some detail SCL's position on the bond which in broad terms was to the effect that absent any "pending or previously notified claims", there not being any, prior to the issue of the Acceptance Certificate, the effect of Special Conditions 3.7 and 3.8 was that the Performance Bond was and was to be treated as null and void and had to be returned to SCL. SCL indicated that it would seek to adjudicate on that issue as well but also applied for an interim injunction in the TCC. It also indicated that it would be prepared to extend the Performance Bond subject to all reservations of right of action. Mr Henniker Major responded in an e-mail dated 21 February 2011 to Mr Walsh stating that lawyers have been instructed to consider matters relating to the bond and would respond in due course about Ensus would expect SCL to inform it of any further legal proceedings to be set in motion; it was hoped that meetings could resolve the matter in a reasonable manner "avoiding precipitate action by either party". This was repeated in another e-mail on 22 February 2011.

These Proceedings

23. SCL sought on Friday, 25 February 2011 an injunction to restrain Ensus from making any demand under the Bond. Unbeknown to it and the Court Ensus had submitted a written demand to the Bank on 23 February 2011. SCL gave some notice at night on 24 February 2011 of its intended injunction application at this Court but, unfortunately the person to whom the relevant e-mail was addressed had been taken seriously ill. Thus it was that Ensus did not appear at the first hearing. Having heard argument and considered extensive evidence, and applying Cyanamid principles, I granted the injunction on the afternoon of 25 February 2011; SCL gave an undertaking to the Court that it would extend the Bond, due to expire on 28 February 2011 for some two months. Notice was given to Ensus and its solicitors later that day.
24. It emerged on the weekend following that the bond had been called and, so it was, that the parties appeared before me on Monday 28 February 2011 with SCL seeking a variation in the injunction to the effect that Ensus should withdraw its demand on the Bank. It would be fair to say that, although I heard from the parties all that they wished to put before me, it cannot be said that there was a full and thorough examination of the law and, of course, at this stage, Ensus had not submitted any substantive evidence other than from a solicitor (Mr Hooker) setting out what had happened over the previous few days. The thrust of the argument of Mr Rowlands, Counsel for Ensus, on this occasion was, certainly in the circumstances of this case, that no interim injunction could be granted even if the making of the demand was in breach of contract on the part of Ensus. My decision was set out in my judgement:

"11. It seems to me that I should be primarily concerned today with the best way of preserving the status quo pending a full argument. Mr Rowlands has made it clear, and it is not surprising, that he and indeed his solicitors have not yet had a full opportunity to review all the evidence put before this court last week and all that Mr Hooker's witness statement deals with is logistics and what was said and done as between the parties between Wednesday of last week and Saturday or Sunday. He has not had time to review the merits of the application. The argument which is relied upon by the respondent, Ensus, through counsel is effectively that the court in effect in practice cannot and certainly should not grant any further injunctive relief and such injunctive relief as has been granted should be discharged.

12. I am very reluctant on the basis of an argument that has run for no more than about 45 or 50 minutes from both parties to make any final findings of law about this. I do not think that it would be appropriate to do so because both parties have put limited authority before me. I suspect that there is more helpful authority which would cast light on the matter. I am going to proceed on the following basis, at least at this stage. It is certainly the case, and the law and practice establishes this over many years, that a bank or surety which has provided an on demand bond, sometimes called an unconditional bond, cannot be enjoined against paying against a valid demand unless there is the clearest at least prima facie evidence of fraud, either fraud at the bank or fraud by the giver of the demand. I am not going to go into what may constitute fraud because fraud is not alleged to take place here. But I am, at least on the authorities that have been put before me, not satisfied on the argument as it is run so far that the only ground of granting an injunction in bond cases is fraud.

13. There are two scenarios to consider. One is the case where a bank is being enjoined and the other is when the beneficiary under the bond is being enjoined from either making a call or enjoying the proceeds of the call. As the bank is not involved in these proceedings, I do not really need to consider its position in this case. But what I am concerned to consider is the relationship between the Contractor and the Purchaser, which is a contractual one, and the extent to which under the terms of the contract in the light of the facts which are said to have happened (or not happened, as the case may be) whether this call, this demand, could legitimately have been made. In the ordinary course of events and historically a court of equity, and indeed now any court, can act by way of injunction to enjoin a party who is about to commit or is committing a breach of contract to prevent that occurring. Of course I cannot decide today whether there is a breach of contract. All I can decide is as to whether there is at least a reasonably good or good arguable case or, at least on the argument as it is run today, a serious issue to be tried for Cyanamid purposes, whether there is a sufficiently good argument.

14. It seems to me that, and I am not going to put it any higher than this at this stage for obvious reasons because I have not heard full argument, but there is a reasonably good arguable case in relation to whether or not as between the two contractual parties the performance bond has become null and void and as to whether it should have been returned before any demand was made on it. As I have said, I am not going to go any further than that. I look forward, if the argument comes back, to considering any argument that under the contract that must be wrong. In those circumstances, in accordance with ordinary contractual principles and ordinary principles relating to an injunction, subject to any further argument I may hear next week, it seems to me that the court should act in appropriate circumstances to prevent breaches of contract which can be shown to cause or to be likely to cause serious and significant commercial upset to the purportedly innocent party to this alleged breach.

15. I do not see that any of the authorities put before me suggest that the court does not have jurisdiction, to be exercised properly of course, in the circumstances said to exist in this case and it seems to me that, if the bank has not yet paid, then steps should be taken by way of injunctive relief to preserve the status quo between the parties, at least until full argument can take place. It seems to me that full argument has not taken place today, and the respondent is not in any way to be criticised for that, it simply has not had enough time. Therefore I would be minded to continue some injunctive relief to preserve the status quo at least until next Monday when I have set aside at the moment an hour and a half, but that can be extended if necessary, to hear the parties in full on this.

16. I have not heard any argument about any temporary inconvenience to the respondent, Ensus, if that were to happen, but any further injunctive relief would have to reflect the need for the bond to be extended for some reasonable period of time at least pending the resolution by the court of inter partes injunctive proceedings next week, so that, if need be and if the decision of the court permits, the respondent, Ensus, would still have time to make an effective call under the bond and to secure payment from the relevant bank. What I propose to do in those circumstances is just to give you five or ten minutes to talk about the best way of achieving that."

25. The injunction was continued but subject to an order that the demand be recalled, given that the Bank had not yet paid. In line with the undertaking from SCL, the Bond in the sum of £2.3 million was extended until the end of April 2011. The matter was adjourned for a full hearing an argument which is what happened on 15 March 2011.
26. By the time of this latest hearing, Ensus had submitted two witness statements, one from Mr Botterill and the other from Mr Sopp. The latter dealt with the history relating to the odour and stack problem, much of which I have summarised in the factual background above. Mr Botterill's evidence, to which I have already referred, broadly deals with the history in August 2010 and thereafter. He also goes in some detail into without prejudice discussions in August 2010 and at least by general reference to further such discussions in February 2011. SCL responded with three witness statements, the first being from Mr Skadorwa who addressed the merits in relation to the complaints. The second statement was from Mr Bhattacharya primarily addressing the without prejudice matters. Mr Walsh put in two alternative "second" statements, one dealing with the without prejudice matters and one not. From all these statements, I have referred in the factual background above to that which I consider to be primarily relevant.
27. Broadly, Mr Rowlands argues that English jurisprudence over the years has established that there is really only one ground upon which a call on an on demand bond can be restrained and that is fraud; furthermore he said that the Courts have historically required the clearest or very clear evidence of fraud to justify intervention by injunction. He accepted that there might be one very limited exception, namely that adumbrated in the Court of Appeal in Sirius International Insurance Co v FAI General Insurance Ltd [2003] 1 WLR 2214. He argued that the Cyanamid principles did not apply to interim injunctions relating to restraining calls being made on on demand bonds but that, even if it did, significantly more than a "serious issue to be tried" had to be established. Mr White QC argued that there was no reason in principle or practice why the Court could not and should not restrain any breach of contract by way of injunction on ordinary Cyanamid principles, that there was no authority that it was only fraud that would ground a restraining injunction in relation to demands made on a bond and his clients had still made out the good and proper case as to why the injunction should be continued.

The Law

28. There have been many cases over the years relating to injunctions being sought often against the bank, surety or other organisation which has provided the bond or letters of credit as the case may be. In practice, there is little difference in the approach of the courts as between bonds and letters of credit. The Court of Appeal in Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] QB 159 which involved a performance guarantee said that the same principles apply as applied to letters of credit. At page 171 Lord Denning MR adopted what Mr Justice Kerr (as he then was) said in RD Harbottle (Mercantile) Ltd v National Westminster Bank Ltd [1978] QB 146 at pages 155-6:

"It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by bank. They are the life-blood of international commerce. Such obligations are regarded as collateral to the underlying rights and obligations between the merchants at either end of the banking chain. Except possibly in clear cases of fraud of which the banks have notice, the court will leave the merchants to settle their disputes under the contract by litigation or arbitration…The courts are not concerned with their difficulties to enforce claims these are risks which the merchants take. In this case the plaintiffs took the risk of the unconditional wording of the guarantees. The machinery and commitments of banks are on a different level. They must be allowed to be honoured, free from interference by the courts. Otherwise, trust in international commerce could be irreparably damaged."

Lord Justice Browne at page 174 referred to a passage from the judgement again of Mr Justice Kerr at first instance:

"'I am not saying that in such cases [that is, cases where parties have entered into confirmed that a credit] the courts would not again assume jurisdiction. Indeed, as was said in some of the authorities, in cases of obvious fraud to the knowledge of banks, the courts may preclude banks from fulfilling their obligations to third parties. But in the present case there is simply a contractual dispute between the plaintiffs and their customers in Libya, in which the rights and wrongs are not clear, though as mentioned above I assume that the rights are on the side of the plaintiffs. They will unfortunately have to pursue those rights against the buyers as best they can.'"

In the Edward Owen case, Lord Denning MR talked of the necessity of demonstrating "established or obvious fraud" at page 169; Lord Justice Browne said at page 172 "the bank knows when the documents are presented that they are forged or fraudulent" and Lord Justice Geoffrey Lane talked at page 175 of it being "clear and obvious to the bank that the buyers had been guilty of fraud".

29. Whilst many of these cases involve attempts to enjoin the provider of the bond, usually banks, the same principles and practice broadly apply where an injunction is sought against the beneficiary under the bond from seeking to make a demand or call on the bond. It will not be enough to stop the beneficiary calling on the bond that its case or claim against the other contractual party is a weak one. However, almost all the decided cases have related to allegations of fraud. There has been little jurisprudence on the circumstances which arise in which there are contractual provisions between contractor and purchaser/employer which impose restrictions or which prevent calls being made on bonds or letters of credit.
30. The most important case in this latter category is the Sirius case which was a letter of credit case in which the defendant, who wished to reinsure the liabilities of a Lloyd's syndicate with the claimant, was required to provide a $5m letter of credit, which was itself subject to an express negative covenant that the claimant would neither pay a claim by the syndicate nor draw down without the defendant's consent in writing. The syndicate made a claim but the claimant without the defendant's consent acknowledged that the syndicate had a reasonable case. The defendant disputed the coverage provided by the reinsurances and arbitration proceedings commenced in the claimant's name on behalf of the syndicate were settled by an agreement between the parties by which the defendant agreed indebtedness to the claimant for $22.5m. It was also agreed that the letter of credit be drawn down and held in an escrow account and that the positions of the parties in respect of the proceeds of that account were unaffected by the settlement. The claimant sought the determination of a preliminary issue as to who was entitled to the proceeds of the escrow account.
31. Lord Justice May gave the leading judgement, dealing initially with how the judge at first instance dealt with the relevant argument, the cross-appeal on which was dismissed:

"8. Sirius contended in the alternative that the letter of credit was an autonomous contract not affected by the conditions as to its draw down agreed between themselves and FAI. They were entitled to draw the letter of credit according to its terms. Even if Sirius resorted to it in breach of those conditions, the remedy would be a claim for damages and an injunction would not be granted. Sirius further contended that, in the light of the terms of the Tomlin order, any damages would be nominal.

9. The judge rejected this submission. He referred to Deutsche Ruckverscherung AG v. Walbrook Insurance Co Ltd [1995] 1 WLR 1017 1030, where Phillips J (as he then was) declined on the facts of that case to imply a term in an underlying contract preventing recovery under a letter of credit which did not itself contain such a term. But in the present case there was an express term that Sirius would not draw down the letter of credit except in certain circumstances. The judge did not see why such a contract should not be enforced. He accepted that the principle of autonomy was of vital importance, but it was not undermined in the very special case where a party expressly agreed not to draw down unless certain conditions were met. To seek to draw down in breach of those terms would be breach of an express negative covenant which could be restrained by injunction. Sirius could also be restrained by injunction from disposing of the proceeds held in escrow. The fact that the letter of credit was an autonomous contract between Sirius and Westpac did not determine the entitlement as between Sirius and FAI to the money now held in escrow. Sirius, if necessary, seek to appeal this decision."

32. May LJ and then went on to consider the cross appeal:

"24. The Sirius accepted that the second condition of the 3^rd September 1999 agreement was not fulfilled when the letter of credit was drawn down and that it is not now fulfilled. The case proceeded before the judge on the basis that it could never have been fulfilled once the terms of the Funding Agreement disabled Agnew from proceeding against Sirius. The cross-appeal arises on a finding by this court that the first condition was not fulfilled either. As between Sirius and FAI, Sirius were not entitled to draw down the letter of credit. To do so would have been a breach of contract. Sirius maintain nevertheless that they would have been entitled to draw down the letter of credit even though to do so would have been a breach of contract. They point to the autonomous nature of letters of credit and say that the court would not have restrained them by injunction from drawing down, notwithstanding their breach of contract. The judge was wrong to decide otherwise. They say that the terms of the underlying agreement which purport to regulate draw down could at best give rise to a personal obligation sounding in damages. They alternatively say that in the circumstances of this case, the grant of an injunction would have been discretionary only, and that the court would not have granted an injunction because FAI's damages in the alternative would have been nominal. FAI were admittedly liable to Sirius. Sirius were liable to Agnew. Payment from each to the other was due. Realising the security of the letter of credit would result in no loss to FAI. I observe parenthetically that it would result in a diminution of any dividend payable to FAI's creditors in liquidation, if, as this issue has to acknowledge, Sirius were not, as against FAI, entitled to realise their security…

Cross-appeal – discussion and decision

26. Letters of credit are an important commercial means of providing cash or security for those who in return provide goods or services. Typically a seller agrees to sell goods to a buyer. The buyer establishes a letter of credit with a confirming bank in favour of the seller. The terms of the letter of credit spell out the circumstances in which the beneficiary – the seller – is entitled to draw it down. The terms will typically include presentation to the bank of specified shipping and insurance documents and the like. The bank's concern is to be satisfied that the terms of the letter of credit are fulfilled, whereupon the bank is obliged to pay the beneficiary. Because the letter of credit is, subject to its terms, the equivalent of cash, the bank is not concerned with any disputed question, not within the terms of the letter of credit itself, which may arise under the underlying sale contract between the seller and the buyer, as for instance, if the goods were said to be defective or to have arrived late – see generally United City Merchants (Investments Ltd) v. Royal Bank of Canada [1983] 1 A.C 168 183. This is also the effect of Article 3(a) of the ICC Uniform Customs and Practice for Documentary Credits (1993 Revision) which was incorporated in the letter of credit in this case. Absent fraud by the seller presenting documents to the confirming bank seeking payment, the court will not restrain a bank from paying a letter of credit which is payable according to its terms, nor a beneficiary from seeking payment: see Group Josi Re (formerly Groupe Josi Reassurance SA) v. Walbrook Insurance Co Ltd [1996] 1 Lloyd's R. 345 at 360-1. Nor, again absent fraud, will the court restrain a beneficiary from drawing on a letter of credit which is payable in accordance with its terms on the application of a buyer who is in dispute with the seller as to whether the underlying sale contract has been broken – see for both these propositions the Deutsche Ruckverischerung case [1995] 1 WLR 1017, 1030 where Phillips J considered the authorities. This is the autonomous nature of letters of credit. By means of it, banks are protected and the cash nature of letters of credit is maintained. There is no authority extending this autonomy for the benefit of the beneficiary of a letter of credit so as to entitle him as against the seller to draw the letter of credit when he is expressly not entitled to do so.

27. The present case is in more than one important respect a variant of the more typical. Here the relevant underlying agreement is, not the commercial transaction that the letter of credit was intended to support, as in the typical case the contract of sale or in the present case the retrocession treaties, but a related agreement regulating as between FAI and Sirius terms on which the letter of the credit would be established. The terms included express contractual restrictions on the circumstances in which Sirius would be entitled to draw on the letter of credit. To that extent the letter of credit was less than the equivalent of cash and Sirius's security was correspondingly restricted. Although those restrictions were not terms of the letter of credit, and although the bank would have been obliged and entitled to honour a request to pay which fulfilled its terms, that does not mean that, as between themselves and FAI, Sirius were entitled to draw on the letter of credit if the express conditions of this underlying agreement were not fulfilled. They were not so entitled. I reject Mr Vos's submission that in the present case the parties must be taken, as between themselves, to have afforded Sirius the right to draw on the letter of credit in defiance of the conditions of this underlying contract.

28. In my judgment, this analysis without more answers the question who is now entitled to the money in the escrow account. The letter of credit was drawn down by an agreement – the Tomlin order agreement – which changed the circumstances in which it could be drawn while preserving each party's position and arguments in relation to it. Sirius are not entitled to the money because the conditions of the 3 September 1999 agreement have never been fulfilled so as to entitle them to draw the money. They did not draw the money in breach of the agreement and did not try to do so. The question whether the court would have granted FAI an injunction never arose and a hypothetical answer to that hypothetical question is not, I think, determinative of the issue before the court. Whether in other circumstances the bank would have been obliged and entitled to pay is not in point. What determines the issue against Sirius is the fact that, as between themselves and FAI, the protagonists on the issue who is entitled to the proceeds of the letter of credit, they were never entitled to draw the letter of credit. I rather think that strictly the money should revert to the bank, but we were told that, if it did, it would get back to FAI.

29. I should add that, had it been necessary to do so, I should have been very strongly inclined to agree with the judge's implicit finding that, had the question arisen out of the facts in the present case, the court would have granted an injunction restraining Sirius from drawing on the letter of credit in breach of conditions of the 3^rd September 1999 agreement: see Doherty v. Allman (1878) 3 App. Cas. 709, 719-20, modified perhaps as explained in Insurance Co. v. Lloyd's Syndicate [1995] 1 Lloyd's Rep. 273, 277 and see also Meagher, Gummow & Lehane, Equity – Doctrines and Remedies, 3^rd Ed (1992).

30. This analysis accords with the judgment of Phillips J in the Deutsche Ruckverischerung case [1995] 1 WLR 1017, 1030. He was concerned that the commercial effectiveness of letters of credit would be eroded if a claimant could prevent a beneficiary from drawing on the letter of credit by doing no more than to persuade the court that there was a seriously arguable case that the claim under the underlying contract was invalid. He did not consider that it was correct to imply a term into the underlying contract that the beneficiary would not draw on the letter of credit unless payment under the underlying contract was due. In the present case there is an unusual underlying contract and an express term restricting the circumstances in which Sirius were entitled to draw on the letter of credit. There is no need for implication. Further, FAI do not have only a seriously arguable case. They have in my judgment positively established that Sirius were not entitled to draw on the letter of credit when its proceeds were placed in the escrow account."

33. In my judgement one can draw from the authorities the following:

(a) Unless material fraud is established at a final trial or there is clear evidence of fraud at the without notice or interim injunction stage, the Court will not act to prevent a bank from paying out on an on demand bond provided that the conditions of the bond itself have been complied with (such as formal notice in writing). However, fraud is not the only ground upon which a call on the bond can be restrained by injunction.

(b) The same applies in relation to a beneficiary seeking payment under the bond.

(c) There is no legal authority which permits the beneficiary to make a call on the bond when it is expressly disentitled from doing so.

(d) In principle, if the underlying contract, in relation to which the bond has been provided by way of security, clearly and expressly prevents the beneficiary party to the contract from making a demand under the bond, it can be restrained by the Court from making a demand under the bond.

(e) The Court when considering the case at a final trial will be able to determine finally what the underlying contract provides by way of restriction on the beneficiary party in calling on the bond. The position is necessarily different at the without notice or interim injunction stage because the Court can only very rarely form a final view as to what the contract means. However, given the importance of bonds and letters of credit in the commercial world, it would be necessary at this early stage for the Court to be satisfied on the arguments and evidence put before it that the party seeking an injunction against the beneficiary had a strong case. It can not be expected that the court at that stage will make in effect what is a final ruling.

34. It is possible to get into an academic debate as to whether the proposition which I raise at Paragraph 33 (d) reflects a type of fraud in that the beneficiary is seeking to call on the bond when it knows or can be taken to know that the underlying contract forbids it from doing so or whether the proposition reflects another exception to the practice that the Courts will only rarely intervene to restrain calls being made or honoured. It is unnecessary to decide this but in my view it represents a second type of exception. One can pose this example: on a commercial contract in which there is a bond in favour of the beneficiary party, the parties reach a full and final settlement which expressly requires the bond to be returned to the other party and no further calls to be made on the bond. If the beneficiary party in those circumstances seeks to call on the bond, in breach of the settlement terms, the Court could properly restrain the beneficiary from doing either because it is committing a straight breach of contract or because it is or should be taken to be clear fraud by the beneficiary.
35. Reliance was placed by Ensus on the case of Permasteelisa Japan KK v Bouyguesstroi and Banca Intesa SpA [2007] EWHC 3508 (TCC) which related to a bond and whether the Defendant should be enjoined from calling on the bond. This was a case about alleged fraud in relation to a subcontract which stated by Clause 20.2.1 that, if the subcontractor continued in breach of contract for more than 10 days after being given formal written notice to remedy such a default, the main contractor could call on the bond. It was said that there was no such continuing default or written notice. Mr Justice Ramsey accepted that the non-compliance with Clause 20.2.1 raised a serious issue but that the calling of the bond did not amount to conduct sufficient to draw the inference of fraud so as to justify the Court's intervention. He went on:

"51. In my judgment, whilst, as the Court of Appeal indicated in Sirius, a court might grant an injunction where there is an express term restricting the circumstances in which a party can draw on a letter of credit and where it is positively established that the party was not entitled to draw down, the same will not apply where there is only a serious, arguable case to that effect. Otherwise, the commercial effectiveness of letters of credit would be eroded: see paragraph 31.

52. If those principles are applied here, then I consider that the court should not intervene in the manner the claimant seeks. First, in relation to an order preventing Bouygues calling the Bond, no case of fraud has been made out and there is only a seriously arguable case that there has been a breach of the contractual requirements under clause 20.2.1, which form preconditions to the call of the Bond."

I do not consider that this conflicts with the views which I expressed above. The case is somewhat different from the current case in that the current case is concerned with a bond which at least apparently was, as between the parties, to be considered as null and void in certain circumstances and returnable.

36. Finally, as to the issue in relation to the applicability of Cyanamid, I follow the view adopted by Lord Justice Staughton in Group Josi v Walbrook Insurance Co Ltd [1996] 1 WLR 1152 (at page 1161F-H) following that expressed by Lloyd LJ in Dong Jin Metal Co Ltd v Raymet Ltd (unreported-13 July 1993):

"I do not think it makes much difference whether one says that letter of credit cases are special cases within the American Cyanamid guidelines, because of the special factors which apply in such cases (see American Cyanamid Co v Ethicon Ltd. [1975] A-C 396, 409C-D, per Lord Diplock) or whether one says that such cases fall outside the guidelines altogether. I prefer the former view."

I also prefer and follow this view simply as a matter of pragmatic practicality that it is not sensible to have more than one set of rules in relation to interim injunctions. In bond and letter of credit cases, the "serious issue to be tried" threshold is in practice a more difficult one to overcome.

Discussion

37. I preface that what follows this reflects my views based on the evidence presented and on the arguments deployed. It is not intended to give rise to a res judicata or issue estoppel. However, I have formed the clear view that at the very least at this stage SCL has established a strong case that, as between it and Ensus, the bond is to be treated as null and void and is returnable. This is not simply a serious issue which merits resolution. My reasons are as follows:

(a) Special Conditions 3.7 and 3.8 are clear. Upon the issue of the Acceptance Certificate the Bond shall "become null and void" in respect of "any pending or previously notified claims". The bond is to be mandatorily returned to SCL after it becomes null and void.

(b) Of course, as a matter of commercial common sense and practice, the bond on its face and as between Ensus and the Bank remains valid but as between Ensus and SCL, they must treat it as "null and void" and Ensus must return it to SCL. Once the original has been returned to SCL, Ensus can not call on it.

(c) The remaining issue is partly factual and partly legal and concerns whether or not a "claim" within the meaning of Special Conditions 3.7 and 3.8 has been made before the Acceptance Certificate was issued on 19 August 2010.

(d) Although the word "claim" is not defined in the Definitions clause of the Red Book as amended, Clause 19.5 makes it clear that "any claim by either party" should be "supported by a written statement of grounds and a summary of material facts upon which it is based". It would be commercially sensible, particularly in relation to the impact of claims upon the bond but also generally, that each party knows where it stands, if each party knew that the other one was making a claim against it. It must be clear that a claim both as a matter of substance and intent is being made.

(e) There should be a distinction between a claim and the operation by one party simply of contractual machinery. In my view, what Ensus was doing in relation to Defect Notice DN072 was operating Clause 37.2 to try to get SCL to put right the defects under the contract. It was not trying to claim as such and indeed it expressly said in a later revision on 1 June 2010 that it would "submit a claim". I do not see at least on the arguments and evidence advanced to date that this Notice can be said to be a "claim" as such.

(f) Nothing else has been advanced as such by way of a "claim" and it therefore follows on the evidence and argument to date that there appears to have been no claim before the Acceptance Certificate which could be described as "pending or previously notified" within the meaning of Special Conditions 3.7 and 3.8.

(g) It follows that, if that is correct, as between the parties, the bond was null and void as between the parties and should have been returned by Ensus to SCL.

(h) One must then turn to the events leading up to the extension of the bond beyond its expiry date at the end of August 2010. If there was no reservation of rights by SCL at that stage, there would be some real force in the assertion that the parties were in practice agreeing that the bond was not null and void and therefore could be called upon. However there is unequivocal and unchallenged evidence before the court at this stage that Mr Walsh did reserve SCL's general and specific position with regard to whether the bond was and remained null and void. That evidence was not challenged in the witness statements before the court and indeed it was not challenged when it was raised in e-mail correspondence in February 2011 before proceedings were issued.

(i) Accordingly there is a strong case on the evidence that, although the parties reached an accommodation that the bond would be extended albeit in a lower sum than before, SCL reserved its rights to argue at any stage that the bond was and remained null and void and should have been and should be returned.

38. It follows from the above that I am satisfied for the purposes of Cyanamid that not only is there merely a serious issue to be tried but that on the evidence and argument put before the Court, SCL's case is a strong one.
39. Another argument put forward by SCL was that the effect of Special Condition 3.8 is that, even if there had been a claim made before the Acceptance Certificate, Ensus has no right to make a call on the bond unless and until it has been determined that SCL is liable for that claim. It will suffice to say that, whilst I consider that this gives rise a serious issue to be tried or otherwise resolved, I can not place it in the sufficiently strong category called for in cases like this.

Balance of Convenience and Damages as an Adequate Remedy

40. It is well known that bonds are regularly called for on substantial and public procurement projects. These bonds can be conditional bonds or as in this case, unconditional or on-demand bonds. Contractors are required to provide them from an acceptable bank or surety. The banks are not uncommonly the main banks which fund the contractors (albeit that it is not clear that this was the case here); the banks providing the bonds will usually have security and counter-indemnities so that they are secured when and if they have to pay out on the bond to the beneficiaries. It is often the case that banks will not provide more than a certain numbers of bonds or bonds beyond a certain value to any one contractor. If a bond is called, it may be difficult for the contractor to have that bank provide another equivalent bond for another job at that time.
41. I have formed the view that damages would not be an adequate remedy. My reasons are the same as set out in my earlier judgements on this matter which I will not again set out in detail. Broadly, they are that the calling of the bond as in this case gives rise to a very real risk of damage to the commercial reputation, standing and creditworthiness of SCL which would be very difficult to quantify; there would be a very real risk that SCL would not pre-qualify for tenders because often tenderers have to disclose whether there have been recent calls on the bonds and if so on what grounds. There was evidence that there had been an earlier call on the bond but I attach little importance to that in commercial terms because the unchallenged evidence is that it was done by agreement to secure speedy payment; in those circumstances, the call could be readily explained. An added factor is that if, as I have held, SCL does have a strong case on the continuing validity of the bond as between it and Ensus, the commercial advantage of not having the bond actually called or the loss of that advantage is unquantifiable.
42. The balance of convenience favours the continuing of the injunction in my view. This is supported by the strength of SCL's position in this case as set out above. The status quo is preserved by the £2.3m bond being continued to be provided which will provide a continuing security to Ensus so that, if its case on the defects is not only good but the quantum exceeds the £7.7m retention which it has in hand, it will be as protected by the bond as it ever would have been. There is no reason why with co-operation the parties can not have a final resolution of the issues which I have addressed in this judgement within a few weeks. I have suggested Part 8 proceedings albeit that there is an arbitration clause; even if arbitration is embarked upon, particularly a legally qualified and experienced construction lawyer arbitrator would be well able to deal with this within weeks. Even an arbitration to address liability for the defects would not have to take more than a few months. Thus, the parties can have a resolution of the issues between them within a sufficiently short time so that whatever prejudice is thought to be continued to be experienced need not continue for a long period of time.

Decision

43. As a consequence, the injunction should continue broadly in its current form although I will hear the parties as to any consequential amendments.