Where an underlying contract expressly prevents the beneficiary from making a demand under the guarantee, the court can restrain a party making a demand under the guarantee

Where an underlying contract expressly prevents the beneficiary from making a demand under the guarantee, the court can restrain a party making a demand under the guarantee

Laws established over the years have held that the ground to restrain a beneficiary from making a call on an on demand bond is limited to fraud. However, in the case of Simon Carves Ltd v Ensus UK Ltd [2011] a Contractor obtained an Interim Injunction preventing the Employer making a call on an on-demand guarantee without there being any act of fraud.

Simon Carves Ltd was engaged as a Contractor by Ensus UK Ltd to construct a Processing Plant in Teesside, England under a contract dated 6th October 2006. One of the obligations under the contract was that Simon Carves Ltd was to provide an on-demand guarantee and that such guarantee would be payable to the Employer within five business days of the Employers written demand without proof or condition.

The contract contained special conditions in relation to guarantee which stated that the guarantee would become “null and void” upon issuance of an Acceptance Certificate and that the bond would be returned to Simons Carves Ltd except where there were pending claims in which case the guarantee would be returned following determination of such claims and that the guarantee would remain valid for this period.

Ensus UK took over the operation of the plant on 17 February 2010 and in March of the same year received reports of foul smelling emissions from the plant. Subsequently on 16 March 2010, Ensus UK issued a defect notice to Simons Carves Ltd requesting the defect be corrected.

A dispute arose between Simon Carves Ltd and Ensus UK as to who was liable to put right the defect. Ensus UK claimed the foul emissions were the contractual liability and risk of Simon Carves Ltd who accused Ensus UK running the plant improperly. Discussions between the parties took place but no significant remedial work occurred before the Acceptance Certificate was issued on 19 August 2010.

The Acceptance Certificate attached a schedule of defects, including that of the foul smelling odour. Shortly after the Acceptance Certificate was issued Simon Carves Ltd asserted that, as the Acceptance Certificate had been issued without any ‘claims’ being notified, the guarantee was null and void and should be returned. On 15 February 2011, Ensus UK gave notice of its claim in respect of the odour issue and on 23 February 2011, Ensus UK submitted a written demand on the bank for the guarantee. On 25 February 2011 Simon Carves Ltd sought an injunction prohibiting Ensus UK from making a demand on the guarantee.

Ensus UK asserted that under established law, fraud was only ground upon which a call on the guarantee could be restrained. Simon Carves Ltd argued that there was no legal authority to suggest that it was only in the case of fraud and the court could award an injunction to restrain Ensus calling the guarantee for breach of contract provided there was a good arguable case. The Court reviewed the relevant case law and decided:

Unless fraud is established, the court will not prevent a bank from paying out on an on demand guarantee. However, fraud is not the only ground for granting an injunction to restrain the guarantee.

There is no legal authority permitting a beneficiary to make a call on the guarantee when it is expressly disentitled from doing so.

If the underlying contract expressly prevents the beneficiary from making a demand under the bond, the court can restrain a party making a demand under the bond. In coming to this decision the court referred to an earlier case of Sirius International Insurance Co v FAI General Insurance Ltd [2003] where there was an express contractual restriction on the circumstances which Sirius could draw down a letter of credit which were not fulfilled and as this was not done, the court held that the letter of credit could not be drawn down.

At the interim injunction stage the court did not need to make a final determination on the issues as long it was satisfied that the party resisting the demand under the on demand bond had a ‘strong case’.

A real risk of damage to the commercial reputation and the ability of Simon Carves Ltd to pre-qualify for future work if the guarantee was called was also a factor to take into account.

In this case, Simon Carves Ltd was granted an injunction preventing Ensus UK making a call on the guarantee, as they had a ‘strong case’ that the guarantee was null and void by virtue of the content of the special conditions of the contract, despite it being an on demand bond and this coupled with concerns about the effect a call on the Bond would have on Simon Carves Ltd’s reputation, warranted the injunction.

Please refer also to MALCONLAW Article on unconscionability as a cause for the courts issuing an injunction preventing a bond being called.