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    12:59 PM See Kwang Guan (Practice Trainee, Drew & Napier LLC)

    Restraining Payment under a Performance Bond: Validity of Clauses Limiting the Grounds for Injunctive Relief

        

    In a landmark judgment on performance bonds, the Court of Appeal ruled for the first time in CKR Contract Services Pte Ltd v Asplenium Land Pte Ltd and another [2015] SGCA 24 that contracting parties can limit the grounds for restraining a beneficiary’s call on an on-demand performance bond to fraud. This judgment has significant implications for the construction industry where on-demand bonds are commonly provided as security for the performance of a contractor’s obligations.   

    Facts 

    A property developer (“Developer”) engaged a main contractor (“Contractor”) for the development of residential flats. Pursuant to the main contract, the Contractor procured an on-demand performance bond of S$8.8 million (i.e. 10% of the total contract sum) from a bank in favour of the Developer. 

    A clause incorporated into the main contract (“Clause 3.5.8”) states that “in keeping with the intent that the performance bond is provided by the Contractor in lieu of a cash deposit”, the Contractor shall not be entitled to restrain the calling of the bond “except in the case of fraud”. This limitation is significant in the light of the fact that, unlike English law which recognises fraud as the main exception to the general principle that courts will not interfere with the calling of on-demand bonds, Singapore law has recognised a further exception based on unconscionability.

    Dissatisfied with the Contractor’s performance under the contract, the Developer issued a notice of termination and called on the bond. The Contractor applied for an injunction to restrain the Developer on the ground that the call was unconscionable. To overcome the obstacle in Clause 3.5.8, the Contractor mounted several arguments against the validity of the clause.  

    First instance decision

    The trial judge held that Clause 3.5.8 was void and unenforceable for three reasons. First, Clause 3.5.8 was an attempt to oust the jurisdiction of the court by severely curtailing the court’s discretion to grant injunctive relief on the significant ground of unconscionability. Secondly, the court’s power to grant injunctions emanated from its equitable jurisdiction which could not be circumscribed or curtailed by contract. Thirdly, the development of the unconscionability exception was underpinned by important policy considerations, in particular the striking of a balance between the principle of party autonomy and the regulation of abusive calls, which could not be lightly brushed aside by an agreement between the parties.

    Although Clause 3.5.8 was held to be void and unenforceable (with the consequence that the Contractor could rely on the unconscionability exception), the trial judge ultimately dismissed the Contractor’s application for injunctive relief as the Contractor had failed to establish a strong prima facie case of unconscionability on the part of the Developer. The Developer was therefore entitled to call on the performance bond. 

    Both parties appealed against the decision. The Contractor appealed against the trial judge’s finding that the Developer did not make the call unconscionably. The Developer cross-appealed against the trial judge’s holding that Clause 3.5.8 was void and unenforceable.

    Appellate decision

    Allowing the Developer’s appeal, the Court of Appeal held that parties can limit the grounds for restraining a beneficiary’s call on an on-demand performance bond to fraud.

    The Court observed, as a preliminary point, that while freedom of contract is the norm, courts are prepared to override the contractual rights of the parties concerned if to do so would give effect to the greater public good. The Court cited contracts that oust the jurisdiction of the court as one category of unenforceable contracts. However, given the inherently nebulous nature of public policy, the Court noted that it is only on rare occasions that contracts will be held to be void and unenforceable on public policy grounds. Thus, the Court cautioned against applying that “particular category of illegality and public policy to every (or even most) contracts in which there are limitations placed on the rights and remedies of the contracting parties concerned”. The Court explained that a clause limiting the rights and remedies available to parties is, in effect, an “exclusion or exception clause”, as opposed to a clause seeking to oust the jurisdiction of the court. 

    Turning to the present contract, the Court held that Clause 3.5.8 was more in the nature of an exclusion or exception clause, since its effect was to restrict the availability of an equitable remedy in a specific context relating to calls on performance bonds. Clause 3.5.8 was not a clause seeking to oust the jurisdiction of the court because it had no bearing on the court’s jurisdiction to hear the matter notwithstanding the fact that it sought to limit or exclude the remedy that the court could grant. Further, such an exclusion or exception clause would be something that the parties had voluntarily agreed to and would, in applicable cases, be subject to the scrutiny of the courts pursuant to the relevant provision(s) of the Unfair Contract Terms Act (“UCTA”). For example, a clause governed by the UCTA would be set aside if it was found to be unreasonable (section 3 of the UCTA). As this argument was not canvassed, the Court declined to express a definite view, save to note that the policy underlying the operation of performance bonds points in favour of the reasonableness of such clauses. The Court added that such clauses might also be invalidated by common law principles (including the principles of incorporation or construction), although this appeared unlikely in the present case, having regard to the specific language and context of Clause 3.5.8.

    In addition, the Court highlighted the pertinent point (which in the view of the Court was an intensely practical one) that the Developer could have asked for a cash deposit instead of an on-demand bond. This point was made plain in the wording of Clause 3.5.8 (as outlined above). In the circumstances, the Court concluded that there was no pressing reason in either principle or policy why a clause such as Clause 3.5.8 should be considered as being contrary to public policy. The Court therefore rejected the first and second reasons behind the trial judge’s decision. 

    Finally, in addressing the third reason behind the trial judge’s decision, the Court clarified that the particular conception of policy that formed the basis for the unconscionability exception was quite different from the concept of public policy behind treating contracts that seek to oust the jurisdiction of the court as void and unenforceable. Thus, in the view of the Court, the trial judge’s reasoning did not support his conclusion. 

    For the foregoing reasons, the Court held that Clause 3.5.8 was enforceable and there was no further need to consider the Contractor’s arguments on unconscionability. Since there was no suggestion of any fraud, the Court allowed the Developer to call on the bond. 

    Commentary

    Some background on performance bonds must be considered to explain the significance of this decision. A performance bond is essentially an undertaking by an issuing bank or financial institution, on behalf of the obligor, to pay a specified amount to the beneficiary upon a valid call. As opposed to conditional performance bonds, on-demand bonds (which form the subject of the present case) are payable upon a simple demand with no conditions attached. Originally, fraud was the only ground in Singapore on which an injunction would be granted to restrain a beneficiary’s call on an on-demand performance bond. This mirrored the traditional non-interventionist position of English law. However, in order to address the issue of abusive calls, Singapore law departed from English law to recognise unconscionability as a separate and distinct ground (from fraud) for granting injunctive relief. 

    A call on a performance bond is considered to be unconscionable if it involves unfairness or conduct of a kind so reprehensible or lacking in good faith that a court of conscience would either restrain or refuse to assist the party. As unconscionability is not a formulaic doctrine with definite elements, the precise ambit of unconscionability has not been clearly defined by case law. However, what is clear is that unconscionability includes elements of abuse, unfairness and dishonesty which are broader than the type of conduct that would constitute fraud. Thus, according to some commentators, the courts’ recognition of an additional exception based on unconscionability and the fact of its amorphous nature have encouraged obligors to challenge the call of a performance bond (see, for example, Nelson Enonchong, “The Problem of Abusive Calls on Demand Guarantees” [2007] Lloyd’s Maritime and Commercial Law Quarterly 83). 

    Beneficiaries of on-demand performance bonds have sought to exclude the unconscionability exception in order to avoid costly litigation and preserve the raison d’être of on-demand bonds as an expeditious form of secured payment such that they are, for all practical purposes, the equivalent of cash. One method is to incorporate a clause stipulating that the bond shall be governed by and construed in accordance with the laws of England which does not recognise the unconscionability exception. The validity of such a clause was upheld in the High Court decision of Shanghai Electric Group Co Ltd v PT Merak Energi Indonesia and another [2010] 2 SLR 329. However, this method has become less attractive in view of the recent emergence of English decisions which have taken an incremental approach to extending the law on restraining a beneficiary’s call (see, for example, Simon Carves Ltd v Ensus UK Ltd [2011] EWHC 657 (TCC) and Doosan Babcock Ltd v Comercializadora de Equipos y Materiales Mabe Limitada [2013] EWHC 3201 (TCC)). Given these circumstances, Clause 3.5.8 illustrates another viable method to exclude the unconscionability exception. 

    By allowing contracting parties to limit the grounds for injunctive relief to fraud in the case of on-demand performance bonds, this decision is to be welcomed for facilitating the commercial intent of the parties. In this regard, it bears noting that the parties in the present case intended the on-demand bond to be an immediate and assured source of payment upon a valid call, since the bond was provided “in lieu of a cash deposit”. If the courts were to frustrate such intentions, this may well compel the construction industry and others (which depend on the convenience and benefits of on-demand bonds) to resort to the use of cash deposits. In the circumstances, it is no surprise that the Court declined to interfere with the contractual arrangement mutually agreed to by the parties. Obligors of performance bonds should therefore take extra care to understand the full risks and consequences of an exclusion or exception clause such as Clause 3.5.8, before entering into such contracts.    

    However, this does not mean that obligors of on-demand bonds will always be prevented from relying on the unconscionability exception in the face of such a clause. As noted by the Court, obligors may challenge the exclusion or exception clause by invoking (where applicable) the relevant provision(s) of the UCTA or common law principles (including the principles of incorporation or construction). The success of such a challenge will necessarily depend on the specific language and context of the clause itself. In this regard, parties are likely to be held to their bargain if the clause is clear and unequivocal in its intent to exclude the unconscionability exception and if the parties have negotiated at arms’ length with a full understanding of the risks and consequences of such a clause. 

    * This blog entry may be cited as See Kwang Guan, "Restraining Payment under a Performance Bond: Validity of Clauses Limiting the Grounds for Injunctive Relief ", Singapore Law Blog (13 May 2015) (http://www.singaporelawblog.sg/blog/article/110)

    ** A PDF version of this entry may be downloaded here

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