Of Good Conscience and Commercial Sense

 

Serene Hiew reviews a landmark case on performance bonds

 

INTRODUCTION

The Federal Court in Sumatec Engineering and Construction Sdn Bhd v Malaysian Refining Company Sdn Bhd [2012] 3 CLJ 401 has recently decided and recognised unconscionability, apart from the traditional ground of fraud, as a separate and distinct ground to restrain a beneficiary from making a call on, or receiving monies under, an on-demand performance bond.


BRIEF FACTS

Malaysian Refining Company Sdn Bhd (“MRC”) awarded Sumatec Engineering and Construction Sdn Bhd (“Sumatec”) a contract to design, supply, fabricate and erect certain structural steel for a refinery in Malacca. The contract price was RM47,846.688. Pursuant to the contract, Sumatec provided an on-demand bank guarantee to MRC for RM4,784,688.80 for the due performance of the contract.

Disputes arose between the parties. Sumatec contended, inter alia, that MRC had reduced the works to be performed by Sumatec under the contract by removing certain aspects of the works from the original scope of works. As a result, the value of the remaining works had been reduced to about RM13 million. The bank guarantee, however, remained in force despite the reduction in the value of the works.

Sumatec claimed that they had by 31 May 2009 completed all works required of them under the reduced scope of contract by delivering all the agreed steel structure. However, MRC made a claim for ‘back charges’ for rectification works without giving any prior notice to Sumatec to rectify the defects in the works. The parties held several meetings to try to resolve the issue but to no avail.

MRC then made a demand for payment of the bank guarantee. Sumatec applied for an injunction to restrain MRC from calling on, or receiving monies under, the on-demand performance bond on grounds that MRC’s call on the bank guarantee was unconscionable.

Sumatec succeeded in the High Court in obtaining the injunction but the decision was reversed on appeal to the Court of Appeal. The Court of Appeal applied the American Cynamid test (also known as the balance of convenience test) and held that on the facts of the case, the balance of convenience tipped in favour of MRC and that damages would be a sufficient remedy for Sumatec should it eventually succeed in its claim against MRC. Sumatec appealed to the Federal Court.

 

FINDINGS OF THE FEDERAL COURT

The question before the Federal Court was whether “unconscionable conduct” on the part of a beneficiary of an on-demand bank guarantee or a performance bond is a distinct ground, apart from “fraud”, that entitles the Court to restrain the beneficiary from calling on or demanding and receiving monies under the on-demand bank guarantee or performance bond.

The Federal Court answered the question cited in the affirmative. In coming to this decision, the Federal Court considered the decisions in Esso Petroleum Malaysia Inc v Kago Petroleum Sdn Bhd [1995] 1 CLJ 283, LEC Contractors (M) Sdn Bhd v Castle Inn Sdn Bhd & Anor [2000] 3 CLJ 473, Kejuruteraan Bintai Kindenko Sdn Bhd v Nam Fatt Construction Sdn Bhd & Anor [2011] 7 CLJ 442, and the legal position adopted by the courts in Singapore, Australia and the United Kingdom. The Federal Court held that the principle recognising unconscionability as a separate and distinct ground to restrain a beneficiary from making a call on a performance bond accords with good commercial sense and unconscionability may now be raised as a distinct ground.

Whilst acknowledging the importance of the fundamental principle behind a bank guarantee, it being a contract that is separate and independent of the underlying contract between the disputing parties and the contract between the account party and the bank, the Federal Court recognised that the rigidity of the autonomy principle could sometimes lead to injustice. It was further observed that the courts, both in Malaysia and other common law jurisdictions, are now more willing to look beyond the fraud exception and to consider unconscionability as a separate and independent ground to allow for a restraining order on the beneficiary.

Their Lordships agreed with the “seriously arguable and realistic inference” test cited by Mohamad Ariff bin Md Yusof JC in Focal Asia Sdn Bhd & Anor v Raja Noraini Raja Datuk Nong Chik & Anor [2009] 1 LNS 913. This test was adopted by the Court of Appeal at the intermediate stage of the present case (see: [2011] 7 CLJ 21, 33-34) and expressed by Ramly JCA in the following terms:

As in the case of fraud, to establish “unconscionability” there must be placed before the court manifest or strong evidence of some degree in respect of the alleged unconscionable conduct complained of, not a bare assertion. Hence, the Respondent has to satisfy the threshold of a seriously arguable case that the only realistic inference is the existence of “unconscionability” which would basically mean establishing a strong prima facie case … “unconscionability” should only be allowed with circumspect where events or conduct are of such degree such as to prick the conscience of a reasonable and sensible man.”

Whether or not unconscionability is found to exist would depend largely on the facts of each case.

On the facts of this case, it was held that although Sumatec had raised several incidences of the alleged unconscionable conduct on the part of MRC, it had not proven unconscionability. Therefore, their Lordships could not find any reasons to justify an interference with the Court of Appeal’s decision to set aside the injunction. Accordingly, the decision of the Court of Appeal was upheld by the Federal Court.


COMMENTARY

It is important to note that the Federal Court emphasised the distinction between an injunction to restrain a beneficiary from making a demand on, or receiving monies under, an on-demand performance bond and an injunction to restrain the issuing bank from making payment out on a performance bond. The principles laid down in the Sumatec Case only apply to the former case. In the latter case, an injunction would ordinarily not be granted unless the applicant is able to show that there is fraud on the part of the beneficiary in making the call on the performance bond and that the fraud has been brought to the attention of the issuing bank.

The Federal Court’s decision in the Sumatec Case is a very important decision on this area of law as it is now clear that ‘unconscionability’ is recognised as a separate and distinct ground to restrain a beneficiary from making a call on a performance bond.

Concerns that the decision in the Sumatec Case will open the floodgates for plaintiffs to challenge the conduct of the beneficiary calling upon a bond in any particular case are largely allayed as the Federal Court has set a high threshold to prove “unconscionable conduct”. The Court has emphasised that a bare assertion will not suffice and that the party alleging unconscionable conduct must provide manifest or strong evidence of some degree in respect of the alleged unconscionable conduct.

 

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