1 August, 2017
Debtors hoping to restrain a call on an on-demand performance bond on unconscionability grounds must be able to establish a strong, prima facie case, according to a recent decision of the High Court in Singapore.
The court's decision in a case involving Tactic Engineering may provide some comfort to contractors and other parties considering a call on an on-demand bond in respect of a claim which is not fully developed (including from quantum perspective), but which is nevertheless not excessive or markedly inflated, and is made in good faith.
Performance bonds are an important feature of construction projects, typically providing the beneficiary with security payable unconditionally on-demand. In the courts in England and Wales fraud is generally the only basis upon which a performance bond can be restrained. Singapore law has diverged from that. Since it first emerged in the early 1990s, the development in Singapore of the doctrine of 'unconscionability' as a separate ground, in addition to fraud, for restraining calls on on-demand bonds and similar instruments has excited many legal commentators.
While the Tactic Engineering decision is not a game-changer, it provides helpful insight into the court's application of the main principles of unconscionability. In particular, it provides guidance on the archetypal scenario where the beneficiary of an on-demand performance bond such as a contractor, has claims against the party which provided the bond in place, for example a subcontractor. The subcontractor refuses to pay, and contractor considers calling the bond in respect of the sums claimed. In doing so, how strong and how well developed does that claim need to be, to ensure that the bond call is not considered unconscionable?
Sato Kogyo was engaged by the Singapore Land Transport Authority as main contractor to construct a new MRT station and associated tunnels as part of the Downtown Line 3. Tactic Engineering was engaged by Sato Kogyo as subcontractor.
Tactic began to suffer financial difficulties and, in turn, faced difficulties in completing its outstanding works. To ease Tactic's cash flow, Sato Kogyo agreed to release retention monies early in exchange for an on-demand bond of the same value; approximately $1.2 million. The bond stated that the issuer "irrevocably and unconditionally agree to pay the same to you immediately on demand without further reference to the subcontractor and notwithstanding any dispute or difference which may have arisen under the subcontract." In other words, it was an on-demand bond.
Sato Kogyo subsequently claimed approximately $1.35 million from Tactic, made up of bank charges, administrative charges and monies owed under a separate contract. Tactic did not pay. After making demands, Sato Kogyo called on the bond. Tactic then successfully applied for and obtained a court injunction restraining Sato Kogyo from calling on the bond. Sato Kogyo applied to the High Court to set aside the injunction.
Unconscionability
Tactic essentially argued before the High Court that Sato Kogyo claim fell short of the bond amount as its sums were flawed and inflated. Consequently, the bond call in respect of those sums was unconscionable. In particular, Tactic alleged that Sato Kogyo was not entitled to monies which were owed under a separate project, was not entitled to impose administrative charges, and had not computed the back charges correctly.
The Court emphasised the following principles underpinning unconscionability:
- parties are expected to abide by the deal they have struck, and the courts will be slow to disrupt the allocation of risk that the parties have agreed;
- parties resisting a bond call must establish a strong prima facie case of unconscionability. This is a high threshold. A prime facie strong piece of evidence does not make a strong prima facie case;
- unconscionability imports notions of unfairness and bad faith, and is unlikely to be established if there is a genuine dispute between the parties; and
- the court should not carry out a "protracted consideration of the merits of the case", and should focus on "breadth rather than depth".
The court's decision
The court allowed Sato Kogyo's application to set aside the injunction, on the basis that Tactic had not established a strong prima facie case of unconscionability.
In particular:
- Tactic's attempts to "slic[e] off" parts of Sato Kogyo's claim to depress it below the bond amount was "artificial" – Tactic was "bringing the court through an accounting exercise";
- It was not "reasonably apparent that there was unconscionable conduct on Sato Kogyo's part" as the back charges were "not so excessive or abusive"; and
- Sato Kogyo had provided "reasoned responses" to Tactic's allegations that Sato Kogyo had inflated the amounts claimed to justify the call on the bond.
Three points arise from the Court's decision.
First, the Court clearly recognised the danger of a party inflating its claims to justify a bond call – a situation which a cynic might say is not unheard of in the construction industry. However, on the facts, Sato Kogyo's back charges were "not so excessive or abusive as to establish that it was unconscionably bloating the numbers to justify the call on the bond". In other words, the Court appears to suggest that inflating a claim alone does not necessarily amount to unconscionability. Whether unconscionability arises will turn on the scale of that inflation. However, no guidance was provided as to what would represent a sufficiently "excessive" claim.
Second, the Court would not carry out a detailed examination of the merits of the underlying claim upon which a bond call is based, nor engage in an "accounting exercise" in respect of the same. Rather, it must be "reasonably apparent" without carrying out such exercises that there was unconscionable conduct.
Third, the party calling on the bond must provide "reasoned responses" to any allegations of unconscionability. Previous cases have indicated that a beneficiary's failure to respond to such allegations is a relevant factor for the court when deciding whether the threshold of a "strong prima facie case" has been made. For example, in a 2016 case between Arab Banking Corp and Bousted Singapore, the Singapore Court of Appeal held that it could rely on a bank's "failure to answer … allegations of abusive conduct and fraud that were made against it to draw an inference that it had acted fraudulently" when calling on a bond.
Notably, the decision in Tactic Engineering appears, rightly, to go slightly further, by emphasising the importance of providing "reasoned" responses to allegations of unconscionability. This thus operates as a check on the party calling the bond – it would not be sufficient for that party to make bald denials against allegations of unconscionability, without providing a coherent explanation.
The decision has been appealed to the Singapore Court of Appeal.
For further information, please contact:
Ian Laing, Partner, Pinsent Masons
ian.laing@pinsentmasons.com
