by Karen Gough

We are in the midst of a world-wide recession. So, in times when contractors’ liquidity and therefore their very survival is more at risk than usual, and employers are more than usually jittery about the ability of contractors to complete works, a recent decision on a claim to enforce an advance payment guarantee and a performance bonds is of particular interest to construction law practitioners.

The case of Enka Insaat ve Sanayi AS v Banco Popolaire Dell’Alto Adige SPA; Enka Insaat ve Sanayi AS v Cassa Di Risparmio Di Bolzano SPA delivered by Mr. Justice Teare on 6 October 2009 in the Commercial Court is just such a decision.

Enka, the Claimant, is a major Turkish construction company and Banco and Cassa, the Defendants, are banks. Enka contracted with a Russian owner to design and construct a multifunctional retail and office building in Moscow. It sublet the work of designing and installing the façade of the development to a Russian company. The subcontract provided for Enka to make advance payments and for the sub-contractor to provide an Advance Payment Guarantee (“APG”) and a Performance Guarantee (“PG”) which it duly provided through the Defendant banks, Banco and Cassa respectively. The guarantees were governed by English law and were subject to the exclusive jurisdiction of the English Courts. They both provided that a demand on the guarantee had to state that the sub-contractor had failed to perform its obligations under the sub-contract and accordingly Enka was entitled to receive payment under the guarantee.

Under the sub-contract, in the event of non-performance or other breaches, Enka had the right unilaterally to terminate the sub-contract. The main contract between the Russian owner and Enka was terminated. Under the APG and PG, Enka made demands in the necessary form against Banco and Cassa and subsequently terminated the sub-contract. Both banks rejected the demands as fraudulent stating that they had been made by Enka without any honest belief that the sub-contractor was liable to Enka in the sum claimed. Subsequent demands on the APG were also rejected on the basis that the APG had been discharged by Enka’s first (earlier) fraudulent demand (A formal requirement of the APGs had not been complied with at the date of the first demand, hence the need for a subsequent demand after compliance with the formality) and therefore Banco was not obliged to respond to Enka’s otherwise valid subsequent demands.

Enka commenced proceedings before the Commercial Court in London and sought summary judgment on its claims under CPR Part 24, arguing that the Banks had no real prospect of successfully defending its claims for payment and, that there was no other compelling reason why the case should proceed to trial. In essence Enka’s case was advanced on the premise that its obligation was simply to meet the requirements of CPR Part 24.2.

The Court reviewed earlier authorities on the test to be applied to determine the CPR part 24 application and concluded that they were not entirely clear. The Judge considered the following:

In Safa Ltd v Banque de Caire [2000] 2 LLR 600, Waller LJ said [p. 608]:

“If a bank can establish a claim with a real prospect of success… that the demand was fraudulent at the time of the demand… it may also be unjust to enter summary judgment against the bank… because the bank has a reasonable prospect of succeeding in a defence of set- off…”

Waller LJ’s statement in Safa was discussed by Mance LJ in Solo Industries UK Ltd v Canara Bank [2001] 1 WLR 1800. He said that “real prospect” was a low test and that such a low test was not appropriate as between a bank and the beneficiary of a letter of credit or a performance guarantee. Mance LJ said:

The courts in the Harbottle ([1978] 1QB 146) and Edward Owen ([1978] 1QB 159) cases emphasised this, and, in my view, set a higher standard than “a real prospect of success” in relation to all these situations. Short of “established fraud”, a bank will not normally be allowed to raise any defence of set-off based on alleged impropriety affecting the demand.” [my emphasis]

Mance LJ also referred to earlier remarks made by Rix J in the Czarnikov-Rionda case in 1999 where he said: “on any view… the court should be careful not to allow too extensive a dilution of the presumption in favour of the fulfilment of independent banking commitments.” His brother judges agreed with these comments.

In the event, the actual decision in the Solo case did not concern the application of the general principle that performance bonds, bills of exchange and letters of credit, should be treated as the equivalent of cash where the issue between the parties related to the enforcement of those obligations. The Court of Appeal concluded in Solothat different principles applied where the issue was the validity of the instruments themselves. It held that the so-called “fraud exception” which had been developed to mitigate the effect of the general principle, had no role to play where the Defendant bank sought to avoid the bond on the basis that it had been procured by a fraudulent conspiracy and/or misrepresentation to which Solo was alleged to be a party.

In this case, Mr. Justice Teare also reviewed the decision of the Court of Appeal in the case of Banque Saudi Fransi v Lear Siegler Services Inc [2007] 2 LLR 47. In that case, the Court of Appeal considered the test to be applied where the claim was against a party (a subsidiary of Lear Siegler) who had given the bank a counter-indemnity in relation to a performance bond issued by the bank. There the employer had made a demand under the performance bond which had been met by the bank. When the bank sought to recover the money paid under the bond from Lear Siegler (as guarantor of its subsidiary’s obligations under the counter-indemnity), the claim was resisted on the basis that the demand under the performance bond was dishonestly made and that, at the time of payment, the bank knew or must have known that the employer had no entitlement to make the demand. Here the Court of Appeal held that it had to ask itself whether the test in CPR Part 24.2 was met and whether Lear Siegler had shown that there was a “real prospect” that it would prove that the fraud exception applied at trial? It decided that Lear Siegler had not met the test and so its appeal against the order for summary judgment was dismissed.

In the instant case, Mr. Justice Teare decided that he was not bound to apply the “heightened test” or follow the earlier cases because the question before him was different. He was being asked to consider a claim against a bank under a guarantee where the defence was that the demand was said to be fraudulent. He decided that the test to be applied in these circumstances was that of a “real prospect”, i.e. he applied only the test required by CPR Part 24.2. The test was whether there was a real prospect that the Banks would establish at trial that the only realistic inference is that the fraud exception applied, i.e. that Enka could not honestly have believed in the validity of its demands under the APG and PG.

However – there is always an “however” with these things – in reaching his decision, the judge was mindful also to pay due deference to the general principle that banks, when sued on a letter of credit, or performance bond or guarantee, need particularly cogent evidence to establish the fraud exception.

To conclude therefore, what in truth we may be looking at here is a subtle distinction, without any great difference.


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