The Gazette 1986

g a z e t t e

s e p t e m b e r 1986

Performance Guarantees

Part II

Gabriel J. McGann, B . A . (Mo d ), LL .M. (Yale), Barrister-at-law

The Potton Homes and

United Trading Corporation cases

Since the judgment of Keane J. was delivered, two

cases have come before the English Court of Appeal in

which the law relating to performance bonds has been

considered. In

Potton Homes Ltd.

-v-

Coleman

Contractors (Overseas) Ltd.

the Court considered its

jurisdiction by injunctive relief to freeze the proceeds of

a performance bond; and in

United Trading Corp. S.A.

-v- Allied Arab Bank Ltd

the Court considered several

aspects of the fraud exception.

In the

Potton Homes

case, the plaintiffs, Potton

Homes, agreed to supply the defendants with pre-

fabricated building units to be shipped to Libya. There

were altogether three contracts and the total purchase

price was £1.3 million. Provision was made for payment

at the various stages of the performance of the

contracts. In respect of each contract, the plaintiffs gave

an advance payment guarantee and a performance

guarantee. Disputes arose between the parties. The

defendants alleged a number of defects in the houses

and claimed to be entitled to retain some £89,000 which

was undoubtedly due from them. They claimed that the

plaintiffs were liable to them for sums in excess of the

amounts retained by them; and, in addition, made a

demand upon the performance guarantee which was for

£68,816. The plaintiffs obtained an interim injunction

restraining the defendants from calling on the bond.

Summary proceedings were commenced by the

plaintiffs and the matter came before a judge of the

Queen's Bench Division, who found that the plaintiffs

were entitled to judgment for the sum of £89,000. In

relation to the performance bond he held that he had no

power to restrain the defendants from making a call

upon it. He recognised, however, that he did have

jurisdiction in an appropriate case to grant a

Mareva

injunction in respect of the proceeds of the bond in the

hands of the recipient. But, having considered evidence

as to the defendants' financial position, he concluded

that the case was not an appropriate one for an

injunction based upon the

Mareva

principles. Neverthe-

less, he ordered that the money should be paid into a

joint account in the names of the solicitors of both

parties being of the opinion that, in all the

circumstances then existing, including the undoubted

entitlement of the plaintiffs to over £89,000, and the

various factors appertaining to the claim and

counterclaim it would not be right for the defendants at

that stage to be paid the sum of £68,000 and to be free to

do with it as they wished.

On appeal to the Court of Appeal, the defendants

contended (referring among other cases, to the

Edward

Owen

case) that demand performance bonds were

virtually promissory notes payable on demand and thai

similar principles applied to first demand performance

bonds and letters of credit. It was further submitted that

no set-off or counterclaim would be allowed to detract

from a first demand bond and that it was part of inter-

national law that such bonds should not be nullified by

an attachment order. In a judgment that is in places

difficult to understand, Eveleigh L.J., allowing the

appeal, accepted that the proposition as to set-off and

attachment was correct in English law in relation to

letters of credit but he could not accept that according

to international law the same rule applied to perfor-

mance bonds without authority for the proposition.

It is interesting to note that he was prepared to accept

that different considerations would apply in the case of

a claim for injunctive relief not against a bank but

against the beneficiary. Thus, he said:

"[a]s between buyer and seller the underlying

contract cannot be disregarded so readily. If the

seller has lawfully avoided the contract

prima

facie

. . . he should be entitled to restrain the buyer

from making use of the performance bond. More-

over, in principle I do not think it possible to say

that in no circumstances whatsoever, apart from

fraud, will the court restrain the buyer. The facts

of each case must be considered. If the contract is

avoided or if there is a failure of consideration

between buyer and seller for which the seller

undertook to procure the issue of the performance

bond, I do not see why, as between seller and

buyer, the seller should not be unable to prevent a

call upon the bond by the mere assertion that the

bond is to be treated as cash in hand."

He made these and other observations "in order to

sound a note of caution". He wished to leave it open for

consideration "how far the bond is to be treated as cash

in hand as between buyer and seller". However, on the

facts he concluded that because the plaintiffs had failed

to prove a failure of consideration they could not

restrain a demand upon the bond.

In a separate judgment, May L.J. was of the opinion

that, because of the irrevocable nature of the obligation

assumed by the relevant bank in the case of a first

demand bond, such bonds should be treated in the same

way as irrevocable letters of credit and thus effectively

as cash in hand. He held that the judge below was

correct in holding that, as a matter of law, the

defendants were entitled to demand payment of the

bond and that the bank was bound to pay. However, he

197