Performance Bonds: A Chink In The Armour?

Described as the "life-blood of international commerce", irrevocable payment obligations undertaken by banks through the issue of performance bonds appear potentially less immune from interference by the courts following the Technology and Construction Court's ruling in Simon Carves Ltd v Ensus UK Limited1.

This ruling challenges the established view that a court will only interfere in a beneficiary's right to make a demand under a performance bond where there is clear evidence of fraud by concluding that a court can also intervene where it feels that there is a "strong case" that a call on the performance bond would amount to a breach of an underlying contract.

Nature of a Performance Bond

On-demand performance bonds provide comfort to a party (the "beneficiary") that, if its counterparty under a contract breaches that agreement, the beneficiary need only inform the provider of the performance bond (usually a bank) in writing of the default and the bank will pay out.

Facts

In 2006, Simon Carves Ltd ("SCL") was engaged by Ensus UK Ltd ("Ensus") to construct a bioethanol processing plant. The contract incorporated the industry standard Red Book2, which lays down specific procedures for the completion of applicable projects and required that SCL provide an on-demand performance bond (the "Performance Bond") to Ensus (which was duly procured from Standard Chartered Bank (the "Bank") with an initial expiry date of 31 August 2010). Additionally, the contract provided that:

upon the project approaching completion, Ensus would take over the works by issuing a Take-Over Certificate (and SCL would, for the next 12 months, be required to make good any defects of which Ensus had given it notice); in the event that SCL failed to remedy any such defects, Ensus would be entitled to perform any necessary remedial work on its behalf; as soon as the plant had passed all relevant performance tests, Ensus would issue an Acceptance Certificate listing any known defects which SCL would be bound to make good; and upon the issue of the Acceptance Certificate, the Performance Bond would become "null and void" and Ensus would be unable to make any calls under it save in respect of any pending or previously notified "claims" (a term which was undefined in the Red Book). The Take-Over Certificate was issued on 17 February 2010, following which Ensus took over the operation of the plant. In March 2010, Ensus issued two "defects notices" and a "variation notice"...