Power projects: the autonomous nature and commercial importance of on-demand bonds

In Power Projects Sanayi Insaat Ticaret Limited Sirketi v Star Assurance Company Ltd [2024] EWHC 2798 (Comm), the English Commercial Court has reinforced the pivotal role of on-demand performance bonds in international commerce, particularly within the power industry. The Commercial Court’s ruling underscores the autonomous nature of on-demand bonds, which require payment upon demand without further proof or investigation, barring clear evidence of fraud. In turn, this underscores the benefits of a carefully drafted performance bond that emphasises the stringent obligations on, and limited defences available to, bond issuers.

Facts

Power Projects Sanayi Insaat Ticaret Limited Sirketi (“PP”), a contractor specialising in large-scale energy projects, entered into a contract for the construction of a power-generation plant in Ghana. It entered into a subcontract with Glotec Engineering Limited (“Glotec”) for part of the works. Pursuant to the subcontract, at the request of Glotec, Star Assurance Company Limited (“Star”) issued a performance bond in favour of PP to secure Glotec’s performance under the subcontract. Under the terms of the bond, Star was obliged to make payments under the bond on demand, “without any further proof or condition and without any right of set-off or counterclaim” and Star was not “required or permitted to make any other investigation or enquiry”. PP made a demand for payment under the bond, which Star refused, leading to a claim by PP for the sum of USD 6.3mn. To justify its refusal, Star tried leading evidence before the Commercial Court to suggest that, among other things, the work covered by the subcontract was ready for commissioning but PP had failed or refused to commission the works and that the ultimate beneficiaries of the project had accepted it and the project has been in operation for a number of years.

Decision

The Commercial Court emphasised that the performance bond was an on-demand bond, which is an autonomous contract independent of the underlying contractual disputes between PP and Glotec. The bond required Star to pay upon receipt of a compliant demand without any further proof. The only defence available to Star was fraud, which required proof that PP knew it had no right to make the demand and that Star was aware of this fraud at the time of the demand. The Commercial Court found that none of the facts presented by Star established that PP’s demand was fraudulent or that Star had knowledge of any fraud at the time of the demand.

It is settled law that on-demand bonds are crucial in international commerce, functioning as autonomous contracts independent of disputes between the seller and buyer. The issuer’s liability under the bond is separate from the underlying contract. Any discrepancy between bond payment and underlying contract liability is resolved between the contracting parties, not the bond issuer and the beneficiary. The sole exception to the issuer’s obligation to pay is clear fraud, which must be proven and known to the issuer at the time of demand. The law has been summarily explained by the Privy Council in Alternative Power Solution Ltd v Central Electricity Board [2014] UKPC 31 as that two facts are to be satisfied if the issuer is to refuse payment: “(a) that the beneficiary could not honestly have believed in the validity of its demands under the letter of credit and (b) that the bank was aware of the fraud.”

The facts identified by Star did not satisfy these tests. It was insufficient for Star to make a factual case that Glotec had a good defence to PP’s claim.

Nor did Star show that the facts relied upon had been known to it at the time of the demand. Star had relied on an earlier Court of Appeal decision in Balfour Beatty Civil Engineering v Technical & General Guarantee Co Ltd (2000) CLC 252 which suggested that a surety may be able to rely on evidence arising after a demand was made. However, in the court’s view, that case did not allow Star to simply “wait to see what evidence of fraud emerged later”. Rather, “the modern cases on performance bonds require evidence of actual knowledge on the part of the issuer at the time of the demand, even if the evidence about that knowledge is incomplete and may be augmented later.”

Comment

Performance bonds are an essential component of many power industry infrastructure transactions. One of the key benefits of an on-demand performance bond is its autonomous nature, which is crucial to its effectiveness.  It allows the beneficiary to have assurance that it need not wait until after a dispute is resolved before availing itself of security for performance. It may make a demand immediately. That can be of particular importance where issues of cash flow, solvency or enforcement may be a concern. This case underscores several critical points for drafters:

1. An issuer is required to pay upon receipt of a demand without further proof. The only defence available to it is fraud, which requires proof that the beneficiary knows that it has no right to make the demand and that the guarantor is aware of that fraud at the time when the demand is made.
    
2. In relation to specific drafting:
   1. The performance bond should explicitly state whether it is an on-demand bond or a conditional bond.
   2. If the bond is conditional, then the bond should expressly state those conditions, preferably autonomously or by reference to the underlying contract.
   3. It is useful to reiterate the autonomous nature of the bond, making it clear to the issuer that the bond is independent of the underlying contract and that it has no obligation to make the principal’s case against the party making the demand.