REUTERS |

Nearly, but not quite: the difficulties of resisting payment of an on-demand guarantee

It is notoriously difficult to resist payment following a call on an on-demand guarantee or bond. Generally, nothing less than a seriously arguable case of fraud by the beneficiary will suffice. The stringency of this test is backed by strong policy arguments militating in favour of protecting the integrity of the banking system. However, even where a seriously arguable case of fraud is made out, the balance of convenience may weigh against injunctive relief, as demonstrated recently in Tetronics (International) Ltd v HSBC Bank plc.

Resisting a call

Many construction and engineering projects include some form of guarantee and/or bond in the contractual arrangements, which provide an assurance of performance, payment or compensation in the event of default.

An on-demand guarantee or bond is payable on demand without proof of any breach of the underlying contract or damage suffered by the beneficiary (see Vossloh v Alpha Trains for a summary of the different types of contract). If a valid call is made, the bank must pay out regardless of any underlying dispute as to the beneficiary’s entitlement (Edward Owen Ltd v Barclays Bank International Ltd; Howe Richardson Scale Co v Polimex-Cekop [1978] 1 Lloyd’s Rep 161; RD Harbottle (Mercantile) Ltd v National Westminster Bank Ltd [1978] QB 146; Caja de Ahorros de Mediterraneo v Gold Coast Ltd [2002] 1 All ER (Comm)).

The grounds on which a bank may be injuncted from paying are very limited (summarised in Simon Carves Ltd v Ensus UK Ltd). One such ground is if a seriously arguable case of fraud by the beneficiary is made out. There are two elements to the test:

“… whether it was seriously arguable that on the material available the only realistic inference was that the beneficiary could not honestly have believed in the validity of its demands under the letter of credit and that the bank was aware of such fraud.”

In Tetronics v HSBC, Fraser J summarised the test Tetronics had to meet as follows:

“1. It must be seriously arguable on the material available that the only realistic inference is that Blue Oak could not honestly have believed in the validity of its demands under the guarantee.

2. The Bank must have been aware of the fraud.

3. The balance of convenience must favour granting Tetronics an injunction. This must require ‘extraordinary facts’ and Tetronics faces very considerable difficulty in having that balance found to be in favour of injunctive relief.”

These were very high hurdles for Tetronics to overcome.

The court also noted Tetronics’ duty of full and frank disclosure when first making the application, given it was made without notice (see Memory Corporation plc v Sidhu (No 2) and Millhouse Capital UK Ltd and Abramovich v Sibir Energy plc and others).

Tetronics v HSBC

Tetronics (International) Ltd carried out work for Blue Oak Arkansas LLC at an untreated electronics waste recovery plant owned and operated by Blue Oak in Arkansas, USA. The primary purpose of the plant was to retrieve small quantities of precious metals contained in the electronics waste. An advance payment made to Tetronics was secured by an on-demand guarantee held with HSBC Bank plc in the sum of £3.8 million. The guarantee was subject to the law of England and Wales.

The contract between Tetronics and Blue Oak provided that Blue Oak could terminate the contract for breach and, after satisfying various notice requirements, call on the guarantee to compensate Blue Oak for damages or to set off payments.

The plant commenced operation in June 2017, with commissioning works continuing into the second half of the year.

The original guarantee expired in June 2017. The Bank wished to ensure that any further guarantee was not being used as a mechanism to obtain immediate payment by Blue Oak. Therefore, on 13 November 2017, Blue Oak wrote to the Bank confirming that it was not aware of any current circumstances that would give rise to a demand for breach of the underlying contract between Blue Oak and Tetronics. The Bank duly issued a new on-demand guarantee covering an extended period.

On 11 December 2017, Blue Oak issued a notice to Tetronics stating a range of matters it had become aware of which it contended amounted to breaches of the contract that justified termination.

On 11 January 2018, Blue Oak made a call on the on-demand guarantee. The original documents (required for a valid call) were received by the Bank on 17 January 2018.

On 18 January 2018, Tetronics successfully obtained an ex parte injunction to restrain the call, which was re-considered on notice to Blue Oak. Tetronics argued the call on the guarantee was invalid and that there was a seriously arguable case of fraud against Blue Oak.

After distributing a draft judgment, two events arose:

  • The parties served nine further witness statements.
  • The court became aware that, in parallel ICC proceedings concerning the contract between Tetronics and Blue Oak, Tetronics had sought emergency injunctive relief to prevent the call on the guarantee. In the course of submissions, Tetronics had conceded that it would not be made insolvent if the Bank paid out (because its shareholders would be able to make additional contributions). This directly contradicted the witness evidence relied on by Tetronics in support of the injunction before the TCC.

The judgment

Fraser J held that the call itself was valid (some concerns about the validity of a signature required by Blue Oak’s bank were addressed by a witness statement served after circulation of the draft judgment).

The court also held that the allegations of fraud were sufficient to meet the test in United Trading Corp. Blue Oak had been given an opportunity to answer the allegations and had failed to do so by not entering any evidence for the injunction return date. Furthermore, the court was satisfied that Tetronics had made out a seriously arguable case that the only realistic inference was fraud, and it was supported by contemporaneous documents. To take one example, if the matters Blue Oak complained of to justify the call arose prior to its letter of 13 November 2017, either the letter or the call was knowingly or recklessly false. If the letter was false, the guarantee itself was procured by fraud. Tetronics claimed that nothing had changed since 13 November, and Blue Oak had not filed any evidence to contradict Tetronics. These were “extraordinary facts”.

The bank was aware of the fraud by material sent to it by Tetronics in seeking to resist the call.

In its draft judgment, the court had also considered that the balance of convenience was in favour of granting the injunction. Tetronics’ witness evidence suggested that following a call the Bank would immediately demand the same sum from Tetronics, which would make Tetronics immediately insolvent, and the Bank unable to recover any of the sums paid out. Tetronics also claimed that even if it could pursue Blue Oak, that company as a SPV may no longer exist. At the time of the draft judgment, Blue Oak had served no evidence to contradict this suggestion. This would mean that the shareholders of Blue Oak would benefit from the fraud, and the other parties would be financially damaged (the Bank) or destroyed (Tetronics). These were “extraordinary facts”.

However, the insolvency development led the court to reconsider its view after distribution of the draft judgment. Fraser J held that, as a matter of discretion, the court would discharge the injunction on the basis of Tetronics’ failure to comply with its duty of full and frank disclosure “regardless of whether it was otherwise justified to keep it in place”. Furthermore, this development weighed heavily on the balance of convenience, and favoured the discharge of the injunction. Accordingly, the court discharged the interim injunction.

The take-away messages

I think there are three key take-away messages from this case:

  • First, it serves as a useful reminder of the relevant principles governing when a bank will be restrained from payment following a call on an on-demand guarantee. In short, very rarely. Even if the applicant makes out a seriously arguable case, the only realistic inference is a fraudulent call, of which the bank was aware, an injunction will not be granted unless the balance of convenience favours granting the injunction on “extraordinary facts”.
  • Second, parties should ensure consistency in any parallel court and arbitration proceedings. Here, different counsel had represented Tetronics in the TCC, and in the ICC proceedings. Materially different factual evidence had been presented in the two forums, which led to the court reversing its decision to grant an injunction at the final hour.
  • Third, where an employer seeks to extend an on-demand bond or guarantee, the contractor (and bank) may gain valuable protection by insisting that the employer writes a comfort letter stating that it is not aware of any matters at that time which would justify a call. Particularly where the extension arises late into the project, such a letter narrows the grounds upon which a call might be legitimately made (i.e. to facts and circumstances arising after the letter) and may provide fruitful hunting ground for establishing the notoriously difficult fraud exception.
Keating Chambers Jennie Wild

Leave a Reply

Your email address will not be published. Required fields are marked *