Summary

The High Court has provided a useful restatement of the legal principles applicable to performance bonds, namely that the bond must be honoured according to its terms without reference to the underlying contract between the parties except where there is a clear fraud of which the surety (the guarantor) has notice. 

The November 2024 judgment in Power Projects Sanayi Insaat Ticaret Limited Sirketi v Star Assurance Company Limited [2024] EWHC 2797 (Comm) was delivered in response to an application for directions brought by the defendant Star Assurance Company Limited (Star). 

Facts

Power Projects Sanayi Insaat Ticaret Ltd Sirketi (PP), a contractor specialising in the construction of large-scale energy projects, entered into a contract with Early Power Limited for constructing a power-generation plant in Ghana, valued at approximately US$363 million. 

PP subcontracted part of the works to Glotec Engineering Limited (Glotec Ghana) and Glotec Korea Limited (Glotec Korea and collectively with Glotec Ghana, Glotec) through two separate subcontracts dated 10 May 2018 (the Subcontracts). Pursuant to the terms of the Subcontracts, Glotec was required to provide on-demand performance bonds to secure its obligations. 

Star issued an irrevocable, unconditional on-demand bond in favour of PP on 22 November 2018, securing the performance of Glotec under the Subcontracts (the Bond). The Bond was governed by English law and included, amongst other things, an undertaking from Star to pay PP within three business days of receipt of written demand and provided that:

"[Star’s] obligation to make payments under this Bond shall arise upon receipt of a demand made in accordance with provisions of this Bond, without any further proof or condition and without any right of set-off or counterclaim, and [Star] shall not be required or permitted to make any other investigation or enquiry." 

PP alleged a number of failures by Glotec under the Subcontracts; a matter disputed by Glotec Ghana on several grounds including that:

• it had successfully completed the project and was in no way indebted to PP and 
• it was PP who was indebted to Glotec Ghana in the total sum of cUS$3.54 million

Glotec Korea similarly considered that it had complied with its obligations.

Notwithstanding Glotec's position of alleged compliance under the Subcontracts (of which PP had knowledge), PP proceeded to make a written demand under the bond for cUS$6.3 million on 9 November 2021 (the Demand).

Star contended, amongst other things, that the Subcontracts had been performed and that PP had failed to comply with its obligations thereunder in respect of payment of a final 2% instalment of the contract price. It therefore expressed its surprise that PP had issued the Demand and invited PP to arrange a meeting to discuss the issue. 

On 30 November 2021, PP notified Star that it considered its refusal to honour the Demand and investigation of the claim to be a breach of the Bond and made a final demand for payment failing which it stated it would commence proceedings. 

In December 2021, Glotec issued proceedings in the Ghanian courts for the indebtedness it alleged as owing by PP although the Ghanian courts stayed proceedings on PP's application for arbitration pursuant to the mandatory arbitration terms of the relevant Subcontract.

Performance bonds: general principles 

In considering whether it was inappropriate to manage the claim in the manner contended by Star, Richard Millett K.C. (sitting as Deputy High Court Judge) set out the basic principles of performance bonds, considered well established through existing case law.

In particular it was noted that: 

• On-demand bonds and other similar instruments are the "life-blood of international commerce" (Harbottle v NatWest [1978] QB 146 at 155) to be treated as "an autonomous contract, independent of disputes between the seller and the buyer as to their relative entitlements pursuant to the different contract between themselves" (Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA [2014] 1 All ER (Comm) 870 CA) (Wuhan Guoyu).
• Liability under the bond is separate from liability under the underlying contract (Edward Owen v Barclays Bank [1978] Q.B. 159) (Edward Owen) (per Lord Denning MR):
  "A bank which gives a performance guarantee … is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions".
• Any lack of correlation between payment made under an on-demand bond and liability in the underlying contractual relationship is a matter for resolution between the parties to that relationship, not for the bond issuer and beneficiary: "By agreeing to provide a bond which is payable on demand, a party agrees that the bond may be called pending resolution of any dispute with the counterparty beneficiary. He thereby agrees to assume the risk of payment being made notwithstanding that he can subsequently establish in litigation or arbitration that the dispute is to be resolved in his favour": Ouais Group v. Saipem [2013] EWHC 990 (Comm)."

Performance bonds: exception to the general principles

• The only exception to the general rule in Edward Owen in relation to contractual obligations as between the beneficiary and issuer of an on-demand bond is: 
  "when there is a clear fraud of which the bank has notice" (Lord Denning MR). Accordingly:
• The issuer is required to plead and prove dishonesty on the part of the beneficiary, or absence of any good-faith belief that the relevant amount is due. An honest but mistaken belief will not suffice (AES-3C v. Credit Agricole [2011] BLR 249 (TCC)), nor will the fact that the underlying contractual claim is contested (per Wuhan Guoyu).
• Fraud alone does not do; the bond issuer must have notice of the fraud at the time of the demand. As Tomlinson LJ said in Wuhan Guoyu: "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."
• The rule in Edward Owen and the status of the fraud exception as the sole defence as between issuer and beneficiary had been subsequently reiterated by the Court of Appeal (National Infrastructure v. Banco Santander [2018] 1 All ER (Comm) 156): "the only realistic inference is that [the claimant] could not honestly have believed in the validity of its demands (the emphasis is mine but none the less crucial for that)."
• In the context of on-demand bonds, in applying the summary judgment test (Banco Santander, Longmore LJ and quoting Teare J in Enka Insaat Ve Sanayi AS v Banca Popolare Dell’ Alto Adige SpA [2009] EWHC 2410): "the Court must be mindful of the principle that banks … need particularly cogent evidence to establish the fraud exception". 

Decision

The Deputy High Court Judge noted that as per the cases above the only legal defence that Star could raise was that the Demand was fraudulent (ie that PP knew that it had no right to make the Demand, and that Star knew that it was fraudulent at the time when its obligation crystallised, namely on the making of the Demand). Star was not entitled to fail or refuse to pay pending investigation of the state of the underlying account or relationship between PP and Glotec. Nor was Star entitled simply to rely on Glotec’s case against PP, however confident it was that Glotec’s case was well founded.

Dismissing the arguments presented by Star it was not considered that the facts alleged by it met the threshold to refuse performance of the Demand. In particular, they were not considered facts that if true (and nor could any inference be drawn to that effect), proved that PP knew that it was not entitled to make the Demand nor that Star knew that the Demand was fraudulent. They were considered not to be inconsistent with an honest demand under the Bond.

Star's submission that PP knew Glotec's position that it had complied with its obligations under the Subcontracts (a position Star had aligned itself with) did not amount to a case that PP knew for a fact that Glotec’s position was right, and that its own position in the dispute was wrong, and that it therefore had no right to make the Demand.

Nor was the High Court satisfied that Star knew at the time of the Demand that PP’s claim was fraudulent. It was noted in any event that the terms of the Bond (as outlined above) precluded any investigation or enquiry by Star into the underlying statement of account. Glotec's alleged cross-claim was legally irrelevant unless Star knew that it was unanswerable and that PP had no right to make any claim for any amount.

Star's submission that the refusal of payment by Star was itself a basis for any inference that Star knew that the Demand had been made by PP fraudulently was also dismissed. It was considered that a refusal to pay was based on no more than Star's perception of the strength of Glotec’s case against PP.

Star also sought to rely on a decision of the Court of Appeal (Balfour Beatty Civil Engineering v Technical & General Guarantee Co Ltd (2000) CLC 252) as evidence that the issuer can rely on evidence of fraud that it obtains later than the time of the demand in order to resist payment; an argument similarly dismissed as follows:"The modern cases on performance bonds require evidence of actual knowledge on the part of the issuer at the time of the demand, even if the evidence about that knowledge is incomplete and may be augmented later." 

Key Takeaways 

• Described as the "life-blood of international commerce" premised in part on the robust reliance a beneficiary can place on its demand rights in the absence of fraud, this case serves as a helpful reminder to issuers of performance bonds and other similar instruments of the autonomous nature of their obligations. This is a point that the High Court felt had not been appreciated by Star as shown by their decision to instruct the same London solicitors as Glotec Ghana and their closely aligned relationship. The obligations of the issuer sit independent of the relationship between the underlying contracting party and the beneficiary. 
• From the point of issuance, the issuer is accepting the risk of being obliged to deliver performance on the contracting party's behalf following demand by the beneficiary. This applies notwithstanding that the issuer may hold an honest but mistaken belief as to the validity of the demand or that it considers that it would be successful in litigation were it to challenge such demand (absent fraud).
• The only legal exception to the issuer's obligation is when there is a clear fraud of which the issuer has notice – with such notice crucially being in its knowledge at the point of the demand such that it cannot subsequently establish fraud as a defence to its failure to honour the demand at the relevant time. 
• Issuers should therefore carefully consider the underlying performance obligations, the ability for the beneficiary to make demand of those obligations (and the issuer's ability to comply) and the covenant strength of the underlying contracting party whose obligations it may be required to assume.

Find out more

To discuss the issues raised in this article in more detail, please contact a member of our Banking and Finance team in London.