Challenging calls under on-demand securities: varying common law approaches to the fraud exception

Those rare cases where the fraud exception has been upheld under English law often involve statements by the beneficiary directly undermining its ability to make a call under the instrument in question. In HLC Engenharia E Gestao de Projectos SA v ABN Amro Bank NV [2005] EWHC 2074, the fraud exception was satisfied where a performance bond assignee had called the bond notwithstanding that the original beneficiary had written stating that it did not consider the contractor to be in default and that a call under the bond was not justified. Similarly, in Tetronics (International) Ltd v HSBC Bank Plc [2018] EWHC 201 (TCC) a renewed on-demand guarantee was issued on the faith of beneficiary assurances that it was not aware of any circumstances which would give rise to a demand under the guarantee. A demand for the full amount of the guarantee made less than two months later was found to be fraudulent in the face of such assurances.

In Thales QFZ LLC v Aljaber Engineering WLL [2024] QIC(F) 55, Thales QFZ LLC (Thales) was sub-contracted by Aljaber Engineering WLL (Aljaber) to install security systems for the New Hamad Port Project, which Aljaber was carrying out for the State of Qatar. Pursuant to the terms of the sub-contract, Thales procured an on-demand Performance Guarantee (the Guarantee) from BNP Paribas in favour of Aljaber.

Thales suspended work for non-payment and eventually purported to terminate the sub-contract on 20 February 2023. It subsequently commenced proceedings before the Qatar International Court (QIC), arguing that the sub-contract had been validly terminated and claiming payment of monies owed upon termination. Aljaber filed a Defence and Counterclaim in the proceedings on 3 November 2024, denying any entitlement to payment and disputing that the sub-contract had been validly terminated.

Four days prior to filing its Defence and Counterclaim, on 29 October 2024, Aljaber demanded payment of the full Guarantee amount from BNP Paribas. Its demand asserted that Thales was “in breach of its obligations under the underlying relationship as it has failed to perform the works under the contract. As a result, the contract has been terminated”.

Thales successfully obtained an interim injunction from the QIC, relying on Aljaber’s Defence and Counterclaim to show that its demand was fraudulent. The court relied on the fact that the Defence and Counterclaim asserted the sub-contract had not been terminated, whereas the basis of the demand issued four days earlier was that the sub-contract had been terminated. The court also relied on the long delay between Thales’ purported termination and the demand. That a demand was only made after Thales had commenced proceedings indicated, in the court’s view, a tactical motivation.

One point not considered by the court was the materiality of Aljaber’s statement in the demand that the sub-contract had been terminated. The terms of the Guarantee did not appear to require Aljaber to allege termination in its demand. Aljaber could be expected to have a large claim against Thales regardless of whether the contract had been terminated (given that Thales had left site). As noted by the English Court of Appeal in NIDCO v Santander [2017] EWCA Civ 27, “It cannot be fraudulent to make a demand one is entitled to make.” Aljaber might therefore have sought to argue that the alleged fraud only pertained to its statement about the termination of the sub-contract, which was not something which could affect its entitlement to make a demand under the Guarantee.

More generally, this case shows that challenges to calls under on-demand securities on grounds of fraud are most likely to succeed where a party is able to evidence statements made by the beneficiary inconsistent with its demand. Such evidence can provide a platform for a without notice application to be brought, putting the beneficiary on the back foot and effectively forcing it to explain its demand.

A recent Singaporean Court of Appeal decision has considered whether the fraud exception should include recklessness. Singaporean law also follows the English law approach to the fraud exception, whilst allowing other grounds of challenge such as unconscionability.

In Winson Oil Trading Pte Ltd v Oversea-Chinese Banking Corp Ltd [2024] SGCA 31, a Singaporean company in the business of oil trading, bunkering and supply chain services (Winson) entered into a circular trade arrangement for the sale of gasoil. Two shipments of gasoil were to be sold by Hin Leong Trading (Pte) Ltd (Hin Leong) to Trafigura Pte Ltd (Trafigura), Trafigura to Winson, and back from Winson to Hin Leong (Winson-Hin Leong Sale). In respect of the Winson-Hin Leong Sale, Hin Leong made applications to two banks (SCB and OCBC) for letters of credits to be issued in favour of Winson to finance Hin Leong’s purchase of each of the two shipments of gas oil from Winson. SCB and OCBC issued separate letters of credit to Winson. Winson made its first presentation to OCBC under a Letter of Indemnity (LOI) for a cargo shipment on the “Ocean Voyager” and its first presentation to SCB under an LOI for a cargo shipment on the “Ocean Taipan”.

Hin Leong had encountered financial difficulties and shortly after Winson’s first presentation, OCBC received information on an all-lenders telephone conference that Hin Leong’s inventory did not include cargo on either the Ocean Voyager or the Ocean Taipan. OCBC proceeded to reject Winson’s first presentation on the basis that no physical cargo was shipped on the Ocean Voyager. The next day, Winson made its second presentation to OCBC for the Ocean Taipan instead, and explained that the second presentation for a different vessel was due to an internal mix-up. On that same day, Winson made its second presentation to SCB, this time for the Ocean Voyager. Both OCBC and SCB refused to pay under the letters of credit, contending that no cargo of gasoil pursuant to the LOIs were shipped in respect of the Winson-Hin Leong Sale.

The case against Winson was not one of direct fraud, but that the demand was made recklessly. The sureties relied on the third category of fraud in the well-known test for common law fraud set out in Derry v Peek (1889) LR 14 App Cas 337 i.e. that “fraud is proved when it is shewn that a false representation has been made (a) knowingly, or (b) without belief in its truth, or (c) recklessly, careless whether it be true or false.”

Winson accepted that its presentations contained several false representations but denied recklessness and claimed it had an honest belief in its demands, principally by reference to the fact that it had already paid Trafigura for the shipments. Winson also relied on a previous decision of the Singapore International Commercial Court (SICC) where the recklessness had been held not to be sufficient to challenge demands under letters of credit.

OCBC and SCB’s fraud challenge was upheld at first instance and again on appeal to the Singapore Court of Appeal. Both courts found that various irregularities in the underlying transactions raised “red flags” which Winson took no steps to investigate or clarify. Winson’s “abject indifference” to the truth of its presentation meant that was reckless and did not honestly believe in the truth of its representations.

The Court of Appeal confirmed that recklessness is sufficient for the purpose of challenging a demand under a letter of credit or on-demand guarantee and disagreed with the SICC decision relied upon by Winson. In the court’s judgment, that decision had confused the distinction between objective recklessness and subjective recklessness: objective recklessness is akin to negligence and does not apply under on-demand securities because a beneficiary owes no duty of care to the surety. Subjective recklessness refers to indifference to a risk of which the beneficiary is actually aware of. Accordingly, where direct evidence as to the beneficiary’s state of mind is not available, circumstantial evidence of “red flags” which were ignored by a beneficiary provides an alternative means of establishing fraud.

One point not addressed by the court is the requirement for the sureties to have had notice of the fraud at the time the demands were made. This does not pose a problem where the sureties are relying on prior statements or communications by the beneficiary itself as in the Thales case discussed above. However, the position is more complex in a case based on recklessness. For example, the judgments in this case go into great detail as to the circumstances of the transactions and various communications and statements made by the parties during the relevant periods. The sureties would have been aware of very little of this at the point the presentations were made. Their knowledge at that point appears to have been limited to the discovery that Hin Leong’s inventory did not include cargo on either the Ocean Voyager or the Ocean Taipan. However, this in itself would not have been enough to establish recklessness.

English courts will permit evidence of fraud arising after the demand to be relied upon in disputes between the beneficiary and the surety, but only on the basis of a counterclaim by the surety for fraudulent misrepresentation which can be set off against the bond claim. However, in order not to dilute the effectiveness of on-demand bonds, the fraud on which such a counterclaim is based needs to be clearly evidenced at the time of the relevant hearing. Although this poses no issue where a full trial is held, claims by beneficiaries are usually heard on a summary judgment basis, meaning that sureties can come under significant pressure to provide sufficiently cogent evidence of fraud ahead of a summary judgment hearing. The difficulties of doing so are likely to be increased if recklessness is relied on due to the much more complex factual issues which such a case gives rise to.

The above cases show the difficulties which can be arise in cases where calls under on-demand securities are suspected to have been made fraudulently. The approach to such challenges required by English law is complex and may not always be applied perfectly in any given case. Accurate and strategic legal advice taken at an early stage is crucial in such scenarios.

It remains to be seen whether the English courts will follow the Singaporean Court of Appeal’s inclusion of recklessness within the categories of fraud permitted for challenges to such a claim. Whilst the success of a recklessness defence is likely to meet both factual and procedural challenges, it may be the only effective means of challenge in some cases for sureties who are faced with insolvent clients and strong suspicions as to the legitimacy of the underlying transactions and/or the demands made against them.