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24 May 2004
In Ekovest-KMZ-Dragages Sdn Bhd v HSBC Bank Malaysia ((2003) MLJU Lexis 177) the Kuala Lumpur High Court considered an application for an interim injunction to restrain payment under a performance bond where the beneficiary had yet to make any demand under the bond.
The plaintiff was the main contractor employed by the second defendant to design and build Kuala Lumpur Central Station and the infrastructure works related to it. The terms of the main contract between the parties required the plaintiff to furnish a performance bond in the form of a bank guarantee as security for the due execution of the works. HSBC, the first defendant, issued the performance bond in favour of the second defendant on the instructions of the plaintiff.
Disputes arose between the plaintiff and second defendant relating to delays in completion and the quality of the works. Anticipating a possible call on the bond by the second defendant, the plaintiff filed an action to restrain the bank from making (and the second defendant from receiving) any payment under the performance bond.
The plaintiff submitted that it had a right to restrain payment under the bond based on the principles of American Cyanamid Co v Ethicon Ltd ((1975) AC 396) as there were six serious issues to be tried. The plaintiff also alleged dishonesty, bad faith and fraud on the part of the second defendant.
"The judge found that the performance bond was unconditional, and was a separate and independent contract as opposed to a contract collateral to the main contract. After considering the six serious issues to be tried, the judge found that the plaintiff had failed to prove any of them and had failed to show fraud substantively. Further, the application was premature as the second defendant had yet to make any demand on the bond. Thus, the plaintiff's application for an interim injunction was dismissed with costs.
The Esso Petroleum Case
The leading Malaysian decision with regard to performance bonds is that of the Supreme Court (the highest appellate court at that time, now known as the Federal Court) in Esso Petroleum Malaysia Inc v Kago Petroleum Sdn Bhd ((1995) 1 MLJ 149). The Supreme Court held that where a performance bond is an 'on-demand' bond, its issuer must unquestionably pay on demand except in case of fraud. However, the position in respect of parties to the underlying contract is different than it is in respect of the issuer of the bond.
The Supreme Court in Esso Petroleum rejected submissions that American Cynamid principles had no application in a situation of restraint of payment on a performance bond. The court went on to apply these principles in considering the application for an interlocutory injunction, including the balance of convenience test, and noted Lord Diplock's reference to special factors to be taken into consideration in the particular circumstances of individual cases.
This aspect of the Esso Petroleum decision was explained by Justice Talalla in Bains Harding (Malaysia) Sdn Bhd v Arab-Malaysian Merchant Bank Bhd ((1996) 1 MLJ 425) as follows:
"The Esso Petroleum case, being a decision of the Federal Court, binds me. Therefore, I need to examine that decision for its effect. I see it as being dichotomous, envisaging on the one hand a situation between the issuer of a pure on-demand performance bond on the one part and the beneficiary of the bond on the other part, where the issuer should unquestionably pay the beneficiary on demand except in the case of fraud; and on the other hand, a situation between a person on whose order such a bond is issued on the one part and the beneficiary from receiving any money under the bond the principle in the American Cyanamid case is to apply. This principle includes a consideration of any special factors as referred to by Lord Diplock in that case, and that a pure on-demand guarantee constitutes such a factor which operates against the applicant. It must be remembered that Lord Diplock, in reference to the factors in that case, reiterated that in addition there may be many other special factors to be taken into consideration in the particular circumstances of an individual case."
The applicability of the American Cyanamid principles means that even if there is no fraud, a beneficiary's call on a performance bond can still be restrained if the applicant satisfies the court that it has fulfilled these principles.
Examples of special factors that may move the court to grant an interlocutory injunction to restrain a beneficiary's call on a performance bond include evidence where:
The LEC Contractors case
However, in a later Court of Appeal case, LEC Contractors (M) Sdn Bhd v Castle Inn Sdn Bhd ((2000) 3 AMR 2625), it was held that the American Cyanamid principles did not apply to injunctions restraining the call of an on-demand bond. The court was of the view that on-demand performance bonds were on a similar footing as a letter of credit. Based on the Singapore case of Bocotra Construction Pte Ltd v Attorney General (No 2) ((1995) 2 SLR 733), the American Cyanamid principles were not applicable to an irrevocable letter of credit. Since an on-demand performance bond is of the same status as irrevocable letters of credit, the tests in American Cyanamid were equally not applicable to an on-demand performance bond.
Unfortunately, the Court of Appeal failed to refer to or explain the decision in Esso Petroleum on the point of whether the American Cyanamid principles were applicable to an on-demand performance bond. The decision in Esso Petroleum was directly on point as the performance bond in Esso Petroleum was also an on-demand performance bond and the Supreme Court, being a court superior to the Court of Appeal in LEC Contractors, found that the American Cyanamid principles were applicable.
It is still open to a litigant to seek relief on the basis of Esso Petroleum from a call on a performance bond, although the chances of successfully doing so are diminished by LEC Contractors. Stare decisis principles (ie, whereby precedent decisions are to be followed by the courts) should result in the dicta in Esso Petroleum prevailing, although the matter remains inconclusive.
For further information on this topic please contact Vinayak Pradhan at Skrine by telephone (+60 3 2094 8111) or by fax (+60 3 2094 3211) or by email (email@example.com).
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