Enforcement of on-demand bond where underlying dispute

In the case of Power Projects Sanayi Insaat Ticaret Ltd Sirketi v Star Assurance Ltd [2024] EWHC 2798 (Comm), the bond issuer asserted that sums claimed under an on-demand bond were not due by virtue of the fact that the principals had a defence to the claims. Would the Court enforce payment?

Background facts

The case concerned a claim by Power Projects, a Turkish construction company, (the Employer) against Star, (Star) which had issued a performance bond in the sum of US$6.297m to secure the obligations of two sub-contractors, Glotec Ghana and Glotec Korea Ltd (the Principals).

The Principals were involved in construction works for a power generation plant in Ghana.

The issues

The Employer issued a written demand calling for the full amount of the Bond.

The Bond provided, inter alia, that Star’s obligation:

“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”.

However, the Employer and the Principals were in dispute; the Principals claimed to be owed US$3.6m. They had issued proceedings in the Ghanaian Court, which were stayed pending arbitration. The Principals subsequently made an application to arbitration.

Star contested the demand on the grounds that the Employer had failed to comply with its contractual obligations under the sub-contracts in favour of the Principals, the work which the Principals were required to do had been executed and that the Employer had failed to make payment of the contract price. That dispute, between the Employer and the Principals was ongoing. Star said that it had a defence including whether the Principals had failed to perform the sub-contracts.

Process

The application to the Court was by Star to convert the Employer’s summary judgment (“CPR Part 8”) claim into a claim where there was a substantial factual dispute (“CPR Part 7”) in order that the wider circumstances of the disputes could be considered by the Court.

The decision

Mr Millett KC decided that this was a clear example of an on-demand bond citing:

• Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA [2013] EWCA Civ 1679
• Ouais Group Engineering and Contracting v Saipem SpA [2013] EWHC 990 (Comm)

On-demand bonds were the life blood of international commerce. As such, liability under the Bond was separate from liability under the underlying sub-contract.

The only defence that Star could raise as a matter of law was that the demand itself was fraudulent – i.e. that the Employer knew it had no right to make it, and that Star knew that it was fraudulent at the time when its obligation crystallised, which was not the case here.

On the basis that: (i) Star could not refuse to pay under the on-demand bond; and (ii) there was no reasonable prospect of successfully arguing the demand was fraudulent, the Court held that the summary judgment process under CPR Part 8 was appropriate.

Star was not entitled to fail or refuse to pay pending investigation of the state of the underlying account or relationship between the Employer and the Principals.

Implications

An on-demand must be honoured, despite any underlying dispute between the contracting parties. The only exception to this is if the call is fraudulent, which was not the case here.

A principal may be in a different position to the surety. The Principals were not a party to the proceedings in this case – the on-demand bond was entered into by Star and the Employer, as is usual. However, the Judge in this case, referred to and distinguished two similar cases where the principal was seeking an injunction to restrain the issuer from paying the beneficiary:

• Doosan Babcock Ltd v Commercializadora de Equipos [2013] EWHC 3201 (TCC)
• TTI Team Telecom v Hutchison 3G UK (2003) 1 All ER (Comm) 914 (TCC)

In those cases, the principal was relying on its own contractual rights against the beneficiary under the underlying contracts. In contrast, the Principals in this reported decision had made no attempt to restrain the Employer from either making or pursuing the demand or seeking or enforcing payment.

This is a reminder that in such circumstances, the principal may be best placed to challenge the beneficiary’s claim if indeed there are grounds to do so.

The case is also a reminder of the onerous nature of on-demand obligations. If parties do not intend that payment should be made if there are underlying disputes, then a conditional guarantee should be considered.