The Gazette 1986

g a z e t t e

s e p t e m b e r 1986

Performance Guarantees Part II by Gabriel J. McGann, B . A . (Mo d ), LL .M. (Yale), Barrister-at-law

The Potton Homes and United Trading Corporation cases

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

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. 2 * 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 21 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

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