Member Article

In JML-Craft Pty Ltd v China Ping An Insurance (Hong Kong) Company Ltd, HCCT 27/2021, the subcontractor (P) applied for an interlocutory injunction to restrain the main contractor (D2) from making any further demand under a surety bond (Advance Payment Bond) and receiving any payment under it pending disposal of the action, on the grounds that the demand was made fraudulently and/or in bad faith, knowing that it was not entitled to make the demand under the Advance Payment Agreement and/or a Variation Agreement. The Court held that P’s substantive case in respect of D2’s entitlement to the Advance Payment Bond did not satisfy the requisite legal thresholds and it declined to grant the injunction sought.

Background

D2 (the Main Contractor) awarded P a subcontract for facade glazing (Subcontract) for a construction project in Sydney (Site). P’s scope of work consisted of the design, supply and installation of a curtain wall facade system. A substantial part of the subcontract sum was for the supply and installation of “FT01 panels”.

P’s case was that the parties had entered into an “Advance Payment Agreement” in order to give D2 security for its advance payment up until the FT01 panels were delivered to the Site. Under this agreement, P was to provide D2 with an Advanced Payment Bond for AUD1.5 million. One of the terms was provision for reduction in value of the Advance Payment Bond as the FT01 panels were delivered to the Site. P’s liability for the advanced payment and the corresponding maximum guaranteed sum under the Advance Payment Bond would be extinguished after satisfactory delivery of all FT01 panels. In return, D2 was to pay P AUD1.35 million as advanced payment for the procurement of the FT01 panels after receipt of the Advance Payment Bond. The Advance Payment Agreement was said to be evidenced by a number of emails between the parties (Pre-Variation Correspondence).

The Advance Payment Bond was signed by P and delivered to D2 and payable by D1. Clause 2 provided “[D1] shall reduce the Maximum Guaranteed Sum progressively by a sum equivalent to any deduction made on the cumulative aggregate value of goods and materials supplied and/or work done by [P] in the course of the project, up to the value of the Maximum Guaranteed Sum, as evidence in a certified true copy of the Interim Payment Certificate that has been signed by [D2]’s Commercial Manager and Construction Director and that [P] has to submit to [D1]. The format of the Interim Payment Certificate shall be in the format attached in Schedule B, or such revised format which must be mutually agreed between [D1], [D2] and [P].”

The parties subsequently entered into a written Variation Agreement and a number of provisions in the Subcontract were amended. The Advance Payment Bond was attached to the Variation Agreement.

D2 provided AUD1.35 million to P as advance payment. It was P’s case that by 12 February 2021, all FT01 panels were satisfactorily delivered to the Site and that therefore according to the Advance Payment Agreement and/or Clause 2 of the Advance Payment Bond, P’s liability for the advanced payment and the corresponding liability under the Advance Payment Bond should be extinguished and D2 could not make any demand under the Advance Payment Bond.

D2’s solicitors made a written demand for the Maximum Guaranteed Sum under the Advance Payment Bond, which demand, P asserted was made fraudulently and/or in bad faith, since D2 knew that it was not entitled to make the demand under the Advance Payment Agreement and/or the Variation Agreement. P also pleaded an implied term of the Variation Agreement that P’s liability for the advance payment and corresponding Maximum Guaranteed Sum under the Advance Payment Bond would be reduced progressively by the value of FT01 panels satisfactorily delivered to the Site. P’s overall position was that the Variation Agreement should be construed to give effect to the Advance Payment Agreement, which catered for a progressive reduction mechanism. P also pleaded an alternative case that D2 was estopped from denying the terms and conditions of the Advance Payment Agreement.

Nature of on-demand bonds

It was not in dispute that, in general, on-demand bonds are independent of underlying transactions and, accordingly, courts in general will not restrain the enforcement of such bonds even though there may be disputes relating to the underlying transaction between the parties. However, there are two relevant exceptions to this rule, namely (i) the Fraud Exception and (ii) Implied Agreement Exception. In order to restrain the enforcement of an on-demand bond in the interlocutory stage on the basis of the Fraud Exception, the court must be satisfied that it is seriously arguable that the only realistic inference on the facts is that there has been fraud by the beneficiary and that the bank (payor of the bond) was aware of the fraud. The Implied Agreement Exception arises when there is an express or implied agreement between the parties that the beneficiary will not enforce the bond in certain conditions. For an applicant to succeed in obtaining an injunction on this ground, he must show that there is a “strong case” as to the existence of such an agreement.

P’s Case

Based on the Advance Payment Agreement, P’s case was that D2’s entitlement to the Advance Payment Bond was limited by two conditions:

1. The Advance Payment Bond could only be invoked as security for P’s delivery obligations in respect of FT01 panels. It could not be invoked to satisfy other claims D2 may have against P. As such, D2 could not, as it had done, rely on the Advance Payment Bond to satisfy other claims it may have against P, such as damages claims for delay (the Purpose Limitation).
   
   
2. The value of the Advance Payment Bond would be progressively reduced as FT01 panels were delivered to the Site. Since P had delivered all the FT01 panels by 12 February 2021, the Advance Payment Bond was extinguished (Satisfactory Delivery).
   
   
   

The Purpose Limitation

The Court held that:

• P’s argument that the Advance Payment Bond could only be invoked as security for P’s delivery obligations in respect of FT01 panels was inconsistent with Clause 2.7(iv) of the Variation Agreement, which provided that the Advance Payment Bond could be used as security for any claims that D2 may have against P. P and D2 may have negotiated the advanced payment arrangement around P’s obligation to deliver the FT01 panels, but it did not follow that the Advance Payment Bond could only be used as security for that narrow purpose. The effect of Clause 2.7(iv) was that the parties were free to widen the effect of the security.

• A wider reading of Clause 2.7(iv) of the Variation Agreement was consistent with other terms of the Subcontract. In particular, it was materially similar to Clause 5.2 of the Subcontract, and the default mechanism was that security provided for one purpose under the Subcontract could be used to satisfy any claims that D2 may have against P. By inserting Clause 2.7(iv) into the Variation Agreement, the parties likely intended to follow the default position in the Subcontract.

• It was inappropriate to imply a term into the Variation Agreement so as to restrict the purpose of the Advance Payment Bond as security. Such an implication was not necessary for business efficacy. The Variation Agreement was fully workable without it – it merely put P in a less advantageous position commercially.
  
  

Satisfactory Delivery

It was hotly contested as to whether the Advance Payment Bond had been extinguished/reduced because P had already satisfied the relevant delivery obligations. There were various defects relating to a host of materials, and there was therefore no satisfactory delivery. For that reason, D2 never issued any written confirmation certifying satisfactory delivery. The two main points of contention between the parties were (i) whether a progressive reduction mechanism existed in the first place; and (ii) whether the delivery of materials other than the FT01 panels had an impact on whether the Advance Payment Bond was reduced/extinguished.

The Court held:

• The starting point was to look at the relevant contractual terms. There appeared to be a conflict between Clause 2 of the Advance Payment Bond and Clauses 2.3/2.8 of the Variation Agreement. The former clearly provided for a progressive reduction mechanism, whereas the latter spoke of a 100% one-off reduction when all materials were delivered. At the interlocutory stage, the Court did not need to rest its decision on whether P or D2’s interpretation was correct. Irrespective of whether the Court relied on Clause 2 of the Advance Payment Bond or Clauses 2.3/2.8 of the Variation Agreement, it was clear that the Advance Payment Bond was not automatically reduced/extinguished when there was delivery. Instead, D2 must issue a written confirmation to certify its satisfaction with delivery. Clause 2 of the Advance Payment Bond specifically required this confirmation to be in the form of an Interim Payment Certificate and D2’s Commercial Manager and Construction Director had never issued any such written confirmation. This was fatal to P’s case. Accordingly, D2’s entitlement to the Advance Payment Bond was valid and subsisting.

• P could have argued that D2 acted in breach of contract by failing to issue written confirmation, even when there was satisfactory delivery, and that D2’s breach was the only reason why the Advance Payment Bond remained alive. However, P had not pleaded any such breach and had never asked D2 to issue any written confirmation of satisfactory delivery, in the form of the Interim Payment Certificate or otherwise.
  
  

Fraud Exception

The Court was satisfied that the Fraud Exception did not apply. It said that the Fraud Exception was closely intertwined with P’s case on the implied terms and common understandings and the Court had found that P has failed to establish a strong case in respect of the Implied Agreement Exception. Accordingly, D2 could legitimately consider that it could demand payment pursuant to the Advance Payment Bond.

Estoppel

P’s case (relying on Pre-Variation Correspondence) was that the Advance Payment Agreement reached between P and D2 formed a shared assumption which gave rise to an estoppel by convention. However, the Court held that the principle of estoppel by convention only arose when the parties had a shared assumption and it was questionable whether pre-contractual negotiations were to be given much weight. It said that when parties are negotiating to reach a final agreement, the shape of the agreement would continue to evolve. It was therefore natural that a final written agreement would depart from a previous common understanding and the court should be slow to rewrite a contract on the basis of an estoppel by convention. More importantly, the Pre-Variation Correspondence consisted of emails between P and D2’s staff instead of their legal advisers and the parties may not have chosen their words very precisely and it was dangerous to read too much into them. On the facts, the Court said, P did not have a strong case showing a common understanding that would assist its position.

In light of the above, the Court declined to grant the injunction against D2.

Comments

Contractors providing on-demand bonds in construction projects should be aware that the grounds for restraining payment by the bondsman are narrow, as explained in the above judgment. The conditions for triggering of payment under an on-demand bond are usually mechanical, such as only requiring certification by the architect or employer that the contractor is in default. No challenge will usually be allowed against the correctness of the certification. In other words, the certificate is final and conclusive for the purposes of the on-demand bond.

In contrast, if a default bond is provided by the contractor, the employer is usually required to prove default of the contractor in performing the contract before it is entitled to payment under the bond. In such case, the bondsman can raise all of the defences which are available to the contractor about poor performance under the construction contract in resisting payment and it may be difficult for the employer to obtain summary judgment against the bondsman.