Performance Bonds And Unconscionability: A Note On Cases After BS Mount Sophia

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1 ::: AUTHOR ::: LOKE Wanqing Partner Finance Performance Bonds And Unconscionability: A Note On Cases After BS Mount Sophia This June 2014, soccer fans heading to São Paulo's Itaquerao Stadium for the World Cup will probably be hoping that they don't get rained out. The Itaquerao Stadium, which will host the 2014 World Cup opener, has not yet installed glass covers on its roof. News reports have it that the missing covers, which are able to cover more people from rain than the existing roofing, will only be installed after the World Cup. Similarly, those in Singapore driving along Nicoll Highway towards the Central Business District would have seen the partially completed National Stadium, which, while boasting a retractable roof and state-of-the-art hybrid grass pitch, has had its opening delayed from April to June this year, with the possibility of even further delays. Construction delays are common. Equally common are developers calling on performance bonds given by their contractors for construction delays. A 2012 Singapore Court of Appeal case has affirmed the position that it will not be easy for contractors to enjoin such calls on their performance bonds if the events giving rise to the right to make a call has occurred (although in that case, the injunction was granted). In construction disputes, abusive calls on performance bonds could oppress the obligor by damaging its liquidity and commercial creditworthiness; but depriving the beneficiary of its right to call on the bond could be equally damaging to the beneficiary s own liquidity, which is particularly important. Furthermore, a lack of liquidity could hamper the parties abilities to defend themselves at the substantive resolution of the dispute. It is settled law that, in Singapore, an on-demand bond may be restrained on grounds of unconscionability. (There is also the recognised basis of fraud which is not discussed in this article.) The Singapore Court of Appeal in BS Mount Sophia Pte Ltd v Join-Am Pte Ltd [2012] 3 SLR 352 (BS Mount Sophia) considered the evidentiary threshold required to support an application for injunctive relief to restrain a beneficiary from calling for payment under a performance bond on grounds of unconscionability. The Court held (at [20]) that this threshold is a high one, being the demonstration of a strong prima facie case of unconscionability. Delivering the Court s judgement, Andrew Phang JA stated (at [22]) that a high bar is necessary because the prohibitive injunction essentially restricts the beneficiary of the performance bond from enforcing a substantive right which he has contracted for. It must be remembered that, typically, the performance bond is a substitute for a cash deposit placed with the employer to secure the contractual performance of the contractor. In the Court s view, the elements of unconscionability were fairly uncontroversial, and have been variously stated to include elements of abuse, unfairness and dishonesty (at [19]). It is a label applied to describe unsatisfactory conduct tainted by bad faith. If the beneficiary s call on the

2 bond is motivated by improper purposes or cannot be justified with clear evidence, or in any other situation where the beneficiary is less than certain about his entitlement to call on the bond and for what amount, the beneficiary ought to take a step back and re-examine its entitlement and conduct prior to calling on the bond. Unfairness is also an element of unconscionability. The question as to whether or not notice was afforded to the obligor of his alleged breach before the beneficiary s call on the bond would also be a relevant consideration (at [36]-[37]). The Court cited the Singapore High Court decision of Raymond Construction Pte Ltd v Low Yang Tong [1996] SGHC 136, in which Lai Kew Chai J observed (at [5]) that the concept of unconscionability to me involves unfairness, as distinct from dishonesty or fraud, or conduct of a kind so reprehensible or lacking in good faith that a court of conscience would either restrain the party or refuse to assist the party. The Court also cited the Singapore Court of Appeal decision of Eltraco International Pte Ltd v CGH Development Pte Ltd [2000] 3 SLR(R) 198 which stated (at [30]) that while in every instance of unconscionability there would be an element of unfairness, the reverse is not true: not every instance of unfairness would amount to unconscionability. While the Court has observed that it would be impossible to define unconscionability, this note looks at the cases which have been decided as at June 2014 in the wake of BS Mount Sophia to distil the factual scenarios which have led the courts to find or reject that there has been unconscionability. CAA Technologies Pte Ltd v BHCC Construction Pte Ltd and ABN Amro Bank N.V. [2014] SGDC 25 Facts The 1 st defendant engaged the plaintiff as their sub-contractor in a building project under which the plaintiff furnished an unconditional on demand guarantee (Guarantee) to the 1 st defendant as security for the advance payment made by the 1 st defendant to the plaintiff. The advance payment was to be deducted against the plaintiff s progressive claims for work done. The 1 st defendant subsequently called on the Guarantee for a sum of $200,000 on the basis, essentially, that the value of the works done by the plaintiff, less payments received, back charges and other relevant sums, was a negative value. Decision The plaintiff had not met the high threshold of a strong prima facie case of unconscionability. The court cited the Singapore High Court decision in Shanghai Electric Group Co. Ltd. v PT Merak Energi Indonesia & anor [2010] 2 SLR 329 where Justice Lee Seiu Kin held (at [47]) that the fact that the call was on an advance payment bond was a significant factor in determining whether there was unconscionability. By calling on the bond, PT Merak was only effecting the

3 return of the moneys it had paid out in advance to Shanghai Electric, and it was held not to be unconscionable for PT Merak to obtain the money it had advanced in the event of a dispute, as parties had agreed to it at the outset. The issue of back charges imposed by the 1 st defendant appeared to be genuine and not merely created or exaggerated by the 1 st defendant in a bid to call on the Guarantee. There were prior complaints from other project parties on the delay to the works performed by the plaintiff, resulting in the 1 st defendant agreeing with the plaintiff to omit certain works from the construction contract, which the 1 st defendant then subcontracted to another sub-contractor. The plaintiff was also put on notice of the issues resulting from such delay. The plaintiff did not dispute that there were back charges incurred as a result of the delay. Based on the court s calculations, the estimated quantum of the amount owed to the 1 st defendant in dispute was not far from the $200,000 called under the Guarantee. This was bearing in mind that the amount of back charges claimed by the 1 st defendant already exceeded the amount of the call and appeared greater than the outstanding advance payment for the value of the works performed by the plaintiff. As such, the 1 st defendant was drawing on the balance amount from the Guarantee to reduce the deficit, which was the purpose of having a performance guarantee in the first place. The court reiterated that the Guarantee was an advance payment bond where money had already been advanced to the plaintiff. Tech-System Design & Contract (S) Pte Ltd v WYWY Investments Pte Ltd [2014] SGHC 57 Facts The defendant was a property developer which engaged the plaintiff as its main contractor for the development of certain apartments. The plaintiff provided two performance bonds (Bonds) as security for performance of its obligations. Following soil slippage during the course of excavation works, the Building and Construction Authority issued a stop work order for eight months which in turn delayed the completion of the works. A dispute arose between the parties and, prior to commencement of arbitration, the defendant called on the Bonds. Decision The defendant s conduct was not in bad faith, abusive, dishonest or in any way unconscionable. Extension of time Claims that the architect told the plaintiff that the former had been pressured not to grant an extension of time to the plaintiff to complete construction works

4 were entirely hearsay and could not count towards making out a strong prima facie case (at [22]). While the Court of Appeal in BS Mount Sophia found unconscionable conduct on the basis that the beneficiary of the bond failed to contemporaneously allege any delay that would have entitled it to liquidated damages, in the present case, there were a number of architect s directions attesting on a prima facie level that the delay had been brought to the plaintiff s attention numerous times even before the actual completion of the works (at [24] and [25]). Bare allegation of the improper appointment of a third party to assist the architect to evaluate an extension of time was insufficient to show a strong prima facie case of abuse or dishonesty (at [25]). For the reasons above the defendant s claim for liquidated damages was not so obviously abusive or dishonest as to be unconscionable. Alleged defects The defendant s conduct in claiming for over 500 defects to be rectified was not unconscionable. The court could not find anything unconscionable or any sign of dishonest or abusive conduct in the way the claim for defects was brought about. Even if the defendant s conduct in failing to carry out an actual site inspection to ascertain defects was unconscionable, this by itself without more could not constitute abusive or dishonest behavior, and would not have the effect of rendering the calls on the Bonds unconscionable. Money owed to plaintiff While the defendant asserted that it was owed about $1m by the plaintiff, the plaintiff claimed that it was the defendant which owed the plaintiff $1.4m. The plaintiff had claimed that if the defendant was not stopped from calling on the performance bonds, the former would meet financial ruin and be penalised for acting on good faith (such as completing various variation works without a formal extension of time), such that it would be unable to claim the $1.4m which it said was owed by the defendant. The court held that there was some documentary evidence for each of the plaintiff s and defendant s accounts of the amounts they are owed, but the main source of discrepancy lay in the issue of liquidated damages. The court held that the plaintiff was unable to make out a case that the defendant s claim on this point was unconscionable. Moreover, it did not find that the defendant s accounts were false or fraudulent or so obviously wrong on a surface examination as to constitute unconscionable conduct. The court referred to BS Mount Sophia and stated that even in the event that the beneficiary was mistaken in adopting the position that it was entitled to a certain sum thus justifying a call on the Bond, the call would still be legitimate so long as the position was genuinely adopted and the beneficiary honestly

5 believed that the obligor was in breach of its obligations. The court cited the Court of Appeal in BS Mount Sophia (at [52]) that It is not the court s role in such proceedings to appraise the merits of the parties decisions; but, rather, it is the court s role to be alive to the lack of bona fides in those decisions. The court cited the Court of Appeal in BS Mount Sophia (at [39]) that it is a fact of commercial life that the tide of liquidity needs to wash both ways, and financial droughts can be equally detrimental to both the beneficiary and the obligor, and held that a beneficiary should not be prevented from calling on a bond simply because this resulted in hardship to the obligor (at [39]). Instead, the inquiry focused on the beneficiary s alleged unconscionable conduct rather than the effect on the obligor. CCM Industrial Pte Ltd v 70 Shenton Pte Ltd and another [2014] SGHC 75 Facts The plaintiff is a building contractor engaged by the defendant as the main contractor to erect a 32-storey commercial building. During the course of the project, the defendant s architect informed the plaintiff that it was of the opinion that completion of micro-piling works by the plaintiff would take eight months longer than targeted, and the plaintiff had failed to proceed with contractual works with due diligence and progress. The architect also informed the plaintiff that unless the latter took effective steps to catch up with site progress, the defendant reserved the right to terminate its construction contract with the plaintiff. The defendant subsequently terminated the construction contract and made a demand under a performance bond policy for the project. Decision The plaintiff failed to discharge its burden to establish a prima facie case of unconscionability, and Woo Bih Li J considered the fact that the plaintiff did not even respond to the architect to dispute the allegation of delay in micropiling works or assert that it would be able to catch up, or claim an extension of time. The plaintiff therefore appeared to accept that there was a delay and yet did not provide concrete evidence as to how it would catch up. The plaintiff s allegations that it was gathering evidence to support its claims that it could catch up or that it was entitled to extensions of time were inadequate to show unconscionability on the part of the defendant. Conclusion As the cases currently stand, it appears that a strong prima facie case of unconscionability is not easy to establish. Clear evidence that the amount claimed by the beneficiary is close to the actual amount called works in the beneficiary s favour, as do express notifications to the obligor of delays on which claims for liquidated damages may be founded. Appointment of third parties to assess extensions of time or failures to carry out site inspections to ascertain defects before requiring rectification do not appear to be considered

6 RODYK & DAVIDSON LLP SINGAPORE 80 Raffles Place #33-00 UOB Plaza 1 Singapore Tel Fax [email protected] SHANGHAI Unit Ocean Towers No. 550 Yan An East Road Shanghai , China Tel +86 (21) Fax +68 (21) [email protected] unconscionable. Finally, the fact that an obligor would fall into financial hardship which may further impede its ability to pursue other legitimate claims does not in itself make a beneficiary s call unconscionable. Obligors come up against a very high bar to show unconscionability in order to enjoin a beneficiary s call on an on-demand performance bond. While the sanctity of contract should be protected, it is ironic that in protecting the beneficiary s substantive contractual right to recover liquidated damages in a contractor s insolvency, such protection may actually result in the latter s insolvency. Perhaps the real rationale is simply this, at least in construction cases: the performance bonds are usually substitutes for cold hard cash that have to be deposited with the developer to secure the contracted performance of the contractor. Seen in this light, it is no surprise that the bar for enjoining a call of a performance bond is or should be a high one. This article is for general information purposes only. Its contents are not intended to be legal or professional advice and are not a substitute for specific advice relating to particular circumstances. Rodyk & Davidson LLP does not accept responsibility for any loss or damage arising from any reliance on the contents of this article. If you require specific advice or have any questions, please contact the author(s). Rodyk & Davidson LLP Limited Liability Partnership Registration No. T07LL0439G.