THE LANGUAGE OF PERFORMANCE BONDS
In AXA Insurance Pte Ltd v Chiu Teng Construction Co Pte Ltd [2021] SGCA 62, the Court of Appeal made clear that while it is open to the issuer to define its risk appetite by the terms of the performance bonds, the court cannot rewrite the bargain between the parties.
Facts. The respondent, Chiu Teng Construction Co Pte Ltd (“CTC”), was the main contractor for a project for upgrading and refurbishment works at the Nanyang Technological University (“the Project”) (at [3]). QBH Pte Ltd (“QBH”), presently in liquidation, was engaged by CTC as a subcontractor for the Project under a subcontract (“Subcontract”). The appellant, AXA Insurance Pte Ltd (“AXA”), is an insurance company. At QBH’s request, AXA issued a performance bond (“the Bond”) in favour of CTC. Therefore, CTC was the “beneficiary”, QBH was the “account party”, AXA was the “issuer”, and the Subcontract was the principal or underlying contract (at [4]).
QBH and CTC were engaged in an adjudication under the Building and Construction Industry Security of Payment Act (Cap 30B, 2006 Rev Ed). On 5 October 2018, the adjudicator determined in an Adjudication Determination that CTC owed QBH a sum (at [6]).
The dispute in this case centred on AXA’s obligation to pay under the Bond in response to CTC’s call on the Bond, which in turn was predicated on CTC’s claims for breaches of the Subcontract by QBH (at [5]).
QBH was put into liquidation on 23 April 2019 (at [7]).
On 13 March 2020, CTC made a second call (“the Second Call”) on the Bond, where CTC claimed that QBH had failed to complete the works required under the Subcontract and/or had carried out defective works, and had therefore breached the Subcontract (at [8]-[9]).
AXA replied on 31 March 2020 that the Second Call was defective and that it was not obliged to make payment, leading to CTC making an application to the High Court on 19 June 2020 for an order that AXA make payment.
The High Court held that CTC was entitled to payment of the amount secured under the Bond (at [11]).
On appeal, AXA maintained its argument that QBH’s breach of the Subcontract and any loss suffered by CTC had to be established by a determination or admission before CTC could call on the Bond (at [15]-[17]). This issue will be the focus of this article.
Proper characterisation of performance bonds. It was common ground between the parties that the Bond was an indemnity performance bond (at [15] and [19]). The Court of Appeal nevertheless made some observations about the terminology and proper characterisation of performance bonds.
Firstly, the Court of Appeal highlighted that the term “performance bond”, in and of itself, does not say anything about the instrument’s legal character. This is because the legal character of such instruments depend on the construction of their terms and effect, and the phrase “performance bond” “… unnecessarily complicates the issue as it risks giving the impression that such bonds are always tied to performance of the underlying contract …” (at [23]).
Secondly, a performance bond may be an on-demand performance bond or a conditional performance bond ([24] – [25]). On-demand performance bonds are just demand bonds – i.e. bonds payable on demand, which can be said to be distinct from both guarantees and indemnities (at [24]).
However, the classification of conditional performance bonds – i.e. where the obligation to pay is conditional on something other than a mere demand or presentation of documents – has not always been clear (at [25]).
The Court of Appeal then reviewed various authorities and identified certain issues. As the Court of Appeal made clear at [34] that the outcome of the appeal did not turn on any of those issues, we will say no more, save to highlight that the Court of Appeal at [35] – [36] highlighted two key issues that may warrant a re-visit.
Turning to the present case, as the Court of Appeal stated at [37], this was a case where “the distinction between a guarantee and an indemnity would not be significant, given that breach and loss would need to be established either way… The distinction [between a guarantee and an indemnity] may only be relevant in a case where the principle of co-extensiveness would affect the issuer’s liability, for example, if the issue is whether the issuer’s obligation to pay can be restricted by reference to a limitation or exclusion clause in the underlying contract… or where the issue turns on the specific rules relating to guarantee, or where the underlying contract is found to be void or discharged.”
The terms of the Bond. In contrast to an on-demand performance bond, this was an indemnity performance bond “conditioned upon facts” (at [33(c)]). Hence, the merits of the underlying dispute between the beneficiary and the account party become relevant (at [33(b)]) and it was necessary for CTC to establish breach and loss to compel payment under the Bond (at [38]) (though the Court of Appeal re-iterated that there was no difference in the appeal whether AXA was under a primary liability or a secondary liability).
In this regard, the proper construction of the terms of the Bond had to be the first port of call (at [38] and [40]). The material provisions of the Bond were as follows:
“1 In the event of the Sub-Contractor failing to fulfil any of the terms and conditions of the said contract, we shall indemnify [CTC] against all losses, damages, costs, expenses or otherwise sustained by [CTC] thereby up to … the ‘Guaranteed Sum’ ... upon receiving your written notice of claim for payment made pursuant to Clause 4 hereof.
...
5 We shall be obliged to effect the payment required under such a claim or direction within 30 business days of our receipt thereof. We shall be under no duty to inquire into the reasons, circumstances or authenticity of the grounds for such claim or direction and shall be entitled to rely upon any written notice thereof received by us (within the period specified in Clause 4 hereof) as final and conclusive.
… ”
Clause 1 of the Bond. The Court of Appeal found that Clause 1 of the Bond made clear that “It would suffice for CTC to establish that QBH had failed to fulfil any of the terms of the Subcontract and that CTC thereby sustained losses” (at [41]). Accordingly, “… from the language of the Bond, the obligation to pay is conditional on the facts of breach of the underlying contract and loss … [not] with the proof of those facts [but] AXA was concerned primarily with a question of proof instead of the actual, substantive facts to which the Bond responded to...” (at [42]; emphasis by Court of Appeal)
Since there was “no reference anywhere in the Bond to a determination by a court or tribunal or an admission from QBH” (at [41]), the Court of Appeal agreed with the High Court that it was not necessary for the beneficiary to present a determination or admission before a valid call on the Bond could be made; it was open for an issuer to accept proof less than a determination or admission under the Bond (at [39]).
In addition, in considering AXA’s obligations under the Bond, the only relevant question was whether CTC could prove QBH’s breach and its loss as against AXA (at [43]). There was “no rule of evidence requiring CTC to first prove its case against QBH”.
Clause 5 of the Bond. The Court of Appeal also found it relevant that under Clause 5 of the Bond, AXA had in fact contracted to protect itself – it had “no duty to inquire into the reasons, circumstances or authenticity of the grounds for such claim or direction”, and it “could not now argue that it was unable to assess the beneficiary’s claim on the Bond as a reason for reading the sought-after requirement into the Bond” (at [44]). This clause “ensured that AXA’s recourse against QBH would remain unaffected even if AXA did not undertake an independent evaluation of the facts underlying the call on the Bond and accepted a written notice from CTC as final and conclusive.”
Therefore, the Court of Appeal found no room to read the proposed limitation on the means of proof into the Bond (at [46]).
Risk allocation under the Bond. The Court of Appeal also stated that the importance to be given to the terms of the Bond becomes clear when considering how risk is structured under such bonds (at [47]):
“When an issuer issues a performance bond, it assumes a certain credit risk. That risk is managed at two levels. First, the issuer will ensure that it is indemnified by the account party in the event that the bond is paid out. That is a matter to be arranged and agreed between the issuer and the account party. Whatever the arrangement or agreement might be, it has no bearing on the enforceability of the bond vis-à-vis the beneficiary. In this regard, the issuer also takes on the risk that the account party might become insolvent, and it is for the issuer to protect itself against that eventuality, for example, by obtaining a cross-guarantee from the directors. Second, the risk is also managed by defining the precise circumstances under which the bond is payable. That is achieved by a precise drafting of the terms of the bond. …”
Since there was no express condition for QBH’s breach and CTC’s losses to be determined by a court or a tribunal, the Court of Appeal found no basis for implying any such requirement into the Bond (at [48]) and this was seen as “an insurmountable hurdle in AXA’s appeal” (at [51]). As the Court of Appeal stated, “If an issuer’s intention is to issue a bond which is only payable upon a determination by a court or tribunal or an admission by the account party, then it is for the issuer to expressly spell that out in the terms of the bond. ... What is impermissible is for the issuer to advance such an argument ex post facto after the insolvency risk of the account party has materialised (as it has here). ... on the present terms, the insolvency risk of the account party lay squarely with the issuer where, on the face of things, there does not appear to be any viable recourse by AXA against QBH for recovery of the sum payable under the Bond.” (at [49])
Therefore, “[i]t is for the party who wishes to stipulate more restrictive conditions on how a bond may be called to do so” and “[t]he parties to such commercial instruments must be entitled to rely on the language of the bond to conduct their affairs.” (at [50])
Parties’ bargain. An argument raised by AXA was that a requirement for a determination or admission was justified on account of “practical considerations”, because “[g]uarantors, like banks, ‘do not have the means or the inclination to check facts, at any rate for the modest commission which they charge on a … performance bond’.” (at [63]; emphasis in original)
The Court of Appeal was not convinced because “[t]hat was a matter which [AXA] had chosen to take on by issuing, for a fee, the Bond under which payment was conditional on those facts. … AXA could have, if it had so intended, provided for conditions precedent requiring certain forms of proof. It would also have been open to AXA to determine what rights it wished to have against QBH or its directors to require their assistance in making the necessary assessments of the facts or in resolving any difficulties with any call on the Bond. Not having done so (or having done so inadequately), the alleged practical difficulties faced by AXA could not justify the court intervening to rewrite the bargain between AXA and CTC.” (at [64])
In fact, the Court of Appeal found that “the net effect of AXA’s arguments, if accepted, would be to completely rewrite the terms of the Bond. … In the absence of such a condition precedent in the Bond itself, it was not for this court to rewrite the terms of the Bond simply because certain risks, which ought to have been anticipated, have materialised.” (at [66]) Therefore, there was no requirement in the Bond for CTC to present a determination or admission before making the Second Call.
Application to the facts. In summary, the Court of Appeal agreed with the High Court that CTC did establish QBH’s breach of the Subcontract to justify the Second Call. In particular, at [76], the Court of Appeal stated that “the evidence adduced by CTC raised a sufficient case to call for a response from AXA. AXA offered no response. Therefore, AXA had not met the evidential burden which had shifted to it, and CTC’s claim against AXA was established”. Further, at [77], the Court of Appeal stated that “for the avoidance of doubt, we considered whether CTC had satisfied its burden of establishing the breach by QBH and the resultant losses. On a review of the documents presented by CTC, we were satisfied that there was enough objective evidence of losses caused by QBH’s non-performance or defective performance of the Subcontract which gave rise to a prima facie case that QBH had breached the Subcontract and had caused CTC to suffer loss of an amount that exceeded the sum secured by the Bond. As there was no evidence or submission to the contrary, we accordingly upheld the Judge’s finding that the legal burden had been discharged and the requisite breach and loss proved.”
Significance. This decision is an important reminder that merely calling an instrument a “performance bond” does not shed light on its legal character: it is the terms and conditions of the instrument which does so, and those terms record the parties agreement on how risks are contractually allocated.
Hence, if the issuer of the bond has taken on the insolvency risk of the account party by the express language of the bond, it would not be open for the court to interfere with the bargain of the parties and rewrite the terms of the bond. Like all contracts, readers should ensure that the terms of the bond reflect the bargain and intention of the parties before entering into a bond on those terms.
For insurers in the position of AXA, if you are called upon to issue a conditional performance bond, you will need to think carefully if you want to issue one on the same terms as AXA did in the present case. You should consider if it is necessary to make clear as part of the instrument a condition that the beneficiary would need to first establish the account party’s liability either by way of admission or an award or judgment. Of course, there is always the question of whether such terms would be acceptable by the beneficiary if they are sought to be included into the instrument, but it does not mean that you should not think about this issue.
In addition, if you are called upon to satisfy a conditional performance bond, you should consider the terms, and ask whether the beneficiary has adduced sufficient documents to “prove” the entitlement to call upon the instrument. If not, it is likely that it would be prudent for you to respond substantively in rejecting the call, lest you fall foul of the Court of Appeal’s finding at [76].
This publication is not intended to be, nor should it be taken as, legal advice; it is not a substitute for specific legal advice for specific circumstances. You should not take, nor refrain from taking, actions based on this publication. Chancery Law Corporation is not responsible for, and does not accept any responsibility for, any loss or damage that may arise from any reliance based on this publication.