Reed Smith Client Alerts

Introduction From our previous alerts, which can be found here and here, we know that bonds and guarantees are complex instruments, the consequences of which depend not on what they are called, but their terms, the circumstances in which they are provided, the terms of the underlying contract and the manner in which they are called.

This alert looks at the recent English High Court case of MW High Tech Projects UK Limited & Anr v Biffa Waste Services Limited [2015] EWHC 949 (TCC), which considered whether the court can or should intervene if it is established that the breach of obligation under the underlying contract, upon which the beneficiary relies as the basis for demand on an on-demand bond, is unfounded.

The relevant principles The judge, Mr Justice Stuart-Smith, considered and reaffirmed the principles that determine when it is open to a party to interfere with the process by which on-demand bonds are called and paid were as follows:

  1. only in exceptional cases will a court interfere with the machinery of irrevocable obligations, such as bonds and letters of credit;
  2. such instruments are intended to be autonomous contracts, so, a beneficiary will not be restrained from calling on a bond simply because there is a dispute as to whether the underlying contract has been broken;
  3. there are two established exceptions to the rule that the judge will not intervene: firstly, where there is a seriously arguable case of fraud; and secondly, where the terms of the underlying contract, expressly or impliedly, prevent the beneficiary from making the call; and
  4. when considering whether or not to grant an injunction restraining the beneficiary from calling on the bond, the burden is a high one and it must be positively established that he was not entitled to draw down under the underlying contract.

The background Biffa Waste Services Limited (“Biffa”) was engaged under a resource management contract by a local council to manage and dispose of waste in the area. One of the requirements of the contract was that a waste treatment plant should be designed and constructed. To this end, Biffa entered into a contract with MW High Tech Projects UK Limited (“M+W”) for the design, construction, installation, commissioning and testing of the plant (the “EPC contract”). Under the EPC contract, M+W was required to procure a parent company guarantee and a retention bond.

Parent company guarantee The parent company guarantee (“PCG”) was entered into between Biffa and M+W’s parent company, M+W GmbH. It provided that if M+W committed any breach of or failed to fulfil any terms of the EPC contract, then within 10 days of receipt of a notice from Biffa setting out the details of the breach, M+W GmbH was required to perform and fulfil in place of M+W every term which M+W had breached or failed to fulfil.

Retention bond The retention bond was provided to Biffa by Euler Hermes Kreditversicherung (the “Surety”). The retention bond provided that Biffa could make a written demand upon the Surety stating that M+W had failed to perform or observe its duties and/or obligations arising under or in connection with the EPC contract.

Upon seven days of receipt of any such demand, the Surety was required to pay to Biffa the amount demanded, up to a maximum sum. It was a condition precedent to Biffa’s right to make a demand under the retention bond that it had first called upon the PCG “in respect of the same matter”.

Alleged defaults and Biffa’s demand on the bond M+W’s failure to reach the planned completion test date resulted in M+W being in default, which meant that pursuant to the EPC contract it would terminate. Biffa wrote to M+W to confirm its view that a breach under the EPC contract had occurred and that the EPC contract had terminated as of 6 December 2014.

M+W did not accept that Biffa was entitled to terminate the EPC contract, but accepted that the EPC contract had terminated, its case being that Biffa had committed a repudiatory breach. In response, Biffa maintained that the contract had terminated as a consequence of M+W’s default.

Prior to the termination, Biffa sent a letter to M+W demanding payment of liquidated damages from June 2014 up to 6 December 2014. However, it was accepted by both parties that the demand only became effective on 12 December 2014, that is, when it was served, by which time the EPC contract had terminated.

Biffa notified M+W GmbH, in accordance with the PCG, that M+W was required to have paid liquidated damages, but had failed to do so. Biffa requested M+W GmbH to perform and fulfil M+W’s obligations, namely, to pay the liquidated damages in the sum of £2,387,388.

Biffa then wrote to the Surety demanding payment under the retention bond, relying upon its assertion that M+W had failed to pay liquidated damages and M+W GmbH had additionally failed to make payment under the PCG.

M+W made an urgent without notice application to the court to restrain Biffa from making a demand on the retention bond and to require Biffa to reverse any steps it had already taken in that regard. The court issued a temporary injunction retraining Biffa from making the demand until a full hearing could take place with Biffa present.

M+W’s arguments At the full hearing, M+W submitted that Biffa should be restrained from pursuing a demand because the purported call on the PCG was not valid and, therefore, did not satisfy the condition precedent to a demand on the retention bond.

M+W argued that it was not open to Biffa to assert an entitlement to liquidated damages in justification of the purported call on the PCG, as no demand for liquidated damages had been made before the EPC contract terminated.

In addition, M+W argued that the entitlement to liquidated damages was contrary to the basis Biffa was simultaneously adopting in relation to the “automatic termination” of the EPC contract.

M+W argued that the basis upon which Biffa called the PCG was referable to an entitlement under a schedule of the EPC contract, which had superseded the liquidated damages provisions in the EPC contract on and after termination. As a result, it was inconsistent for Biffa to pursue a claim for liquidated damages when Biffa had already asserted that the schedule was operative.

Although the word “valid” did not appear anywhere in the contractual structure relating to the PCG, or how to call upon it, M+W argued that that word meant a “demand that has a basis contractually and is not being made when an opposite contractual route is being pursued”. M+W submitted that it should be implied into the condition precedent that a call on the PCG was “valid”.

The judge’s decision The judge set out the relevant legal principles referred to above.
He rejected M+W’s argument regarding the validity of the call on the PCG, finding that there was no justification for implying a term that the call on the PCG must be “valid”. This was on the basis that while the word “valid” had a “disarming air of simplicity and precision”, the proposed implied term was uncertain in its formulation and its effect.

The judge held that an implied term that a demand on the PCG must “have a basis contractually” was imprecise in failing to distinguish whether the demand is put forward in reliance on contract terms or whether the contract terms upon which the demand relies in fact justify the demand.

He additionally found that the EPC contract terms relating to the condition precedent worked adequately without the addition of the word “valid”, so that a need for business efficacy did not justify implying such a word. The requirement imposed by the express terms of the EPC contract that Biffa should “call upon the PCG in respect of the same matter” was readily comprehensible and entirely workable, since the concept of calling upon a guarantee is well known and readily understood without further elaboration.

The judge found that even if Biffa’s call could be described as “ill-founded”, there was no suggestion that it was fraudulent. There was, the judge stated, nothing new or remarkable in calls on guarantees being controversial, objectionable or misconceived. There was, therefore, no reason in favour of imposing any further qualification on the requirement that there be a call on the PCG and potent reasons against it. To do so would encourage protracted satellite litigation at short notice to try and establish whether or not the call on the PCG was not merely controversial, but misconceived. The notion that there should be a preliminary dispute about whether the underlying demand is justifiable went directly against the normal approach to on-demand bonds, that is, pay now, argue later.

Contrary to M+W’s submissions, the judge found that it was not plain that the contractual basis upon which the PCG was made was in fact misconceived or wrong. The judge held that he was not persuaded that M+W had shown clearly that no liability to liquidated damages had arisen. Therefore, M+W had shown no grounds upon which it could be right to restrain Biffa from pursuing its demand on the retention bond.
Concluding remarks This case once again illustrates the complexity of dealing with calls on on-demand bonds. While the facts of each case will be different, there are nevertheless some guiding principles parties should have in mind when either considering making a call on an on-demand bond or seeking to restrain a party making the call:

  1. a party should ensure that the terms of the on-demand bond and the substantive requirements for its call are fully understood and met;
  2. there should be adherence to the procedural requirements relating to the calling of an on-demand;
  3. due diligence on the underlying contract should be undertaken to ensure there is nothing which prevents the making of a call; and
  4. a party seeking to restrain a party from making a call on an on-demand bond should ensure there are sufficient grounds for doing so, including supporting evidence.


Client alert 2015-127