When the dust settles: post-termination calls on on-demand securities

United KingdomScotland

A recent Commercial Court decision has rejected an attempt by a bank to resist payment of demands made under Standby Letters of Credit after the termination of a large construction project. The decision provides helpful guidance as to the application of the fraud exception in such circumstances and confirms that no additional exception based on unconscionable conduct exists under English law.

NIDCO v Santander

NIDCO, a government owned corporation, entered into a contract with a Brazilian contractor, OAS Construtora, for the construction of a large highways project in Trinidad and Tobago. A number of Standby Letters of Credit (“SLCs”) were procured by OAS to secure its performance under the contract and the repayment of an advanced payment.

OAS entered insolvency proceedings in Brazil and its contract with NIDCO was terminated. NIDCO made demands under the SLCs, including those provided by Santander to secure the repayment of retention money. The demands were in the form stipulated by the SLCs which required NIDCO to state that the amount demanded “is due and owing to us by the Contractor”.

The SLCs were subject to English law and the jurisdiction of the English courts. NIDCO therefore brought proceedings against Santander in England and applied for summary judgment.

We previously reported on a failed attempt by BNP Paribas, another bank providing SLCs to NIDCO, to suspend payment on the grounds of Brazillian injunctions obtained by OAS (see our Law-Now on that case here). In the present case, Santander relied on the fraud exception and claimed that NIDCO did not have an honest belief that the amounts demanded were “due and owing” to it by OAS. Santander argued that:

  • The SLCs required more than a mere statement that a breach of contract had occurred and/or that loss had been suffered as a result. The amounts demanded were required to be “due and owing”.
  • NIDCO’s claim against OAS was one for damages which pursuant to the law of Trinidad and Tobago would not become “due and owing” until liquidated by an arbitration award under the construction contract.
  • Correspondence prior to the demands showed that NIDCO’s claim against OAS was based on estimated amounts for future sums.
  • Santander contended that previous payment certificates showed that a maximum of US $31 million in retention money could be claimed by NIDCO, whereas the total it had claimed under all of the SLCs provided as retention security (by Santander and other banks) was US $35 million.

Santander argued that the above facts were sufficient to put the honesty of NIDCO’s demands in issue and to require a full trial with cross-examination of those responsible for the demands within NIDCO.

Santander separately argued that English law should be developed to recognise a different approach to on-demand securities used to secure performance obligations, such as in construction contracts, from those used to secure primary payment obligations, as in contracts for the sale of goods. It suggested that there should be an exception for unconscionable conduct in such cases alongside the existing fraud exception (as is the case in other jurisdictions such as Singapore and Australia).

Decision

The court disagreed that any of the matters advanced by Santander provided a justification for further investigating the honesty of NIDCO’s demands. The fact that under the law of Trinidad and Tobago the amounts demanded might be shown not to have been “due and owing” at the date of the demand was not directly relevant to whether NIDCO honestly believed in the validity of its demands: “what really matters is not the law of England, nor the law of Trinidad, but the belief of [NIDCO].”

For similar reasons, the court was not persuaded that the maximum retention sum of US $31 million alleged by Santander provided any basis to challenge the honesty of NIDCO’s demands. The court noted the broader context of “what was happening in this case and … under the construction contract, and the future of the construction contract”. NIDCO’s belief was not to be treated as a “function of the legal analysis urged by [Santander], save perhaps in the plainest case, of which this is not one.”

Whilst noting support for an unconscionability exception in the Singaporean cases and in academic writings, the court rejected the existence of any such exception in English law. The court emphasised that “standby letters of credit must work in accordance with their terms, and that includes working on time”.

Conclusion and implications

This case provides an important precedent for Owners wishing to call on on-demand securities after the termination of a construction contract. Difficulties can sometimes arise in such circumstances where the contract requires the Owner’s entitlement to additional costs and/or compensation to be calculated after completion of the works by a replacement contractor or the Owner itself. On-demand securities will often be due to expire before completion in such circumstances, meaning that the Owner may look to make a demand based on estimated losses. Depending on the drafting of the contract in question, an Owner may sometimes have no claim at all until the works are completed.

The present case suggests that Owners are likely to be given a certain degree of leeway in such circumstances, subject to the precise terms of the securities in question, provided they hold an honest belief as to their entitlement to the amounts demanded. The case also demonstrates the difficulty of satisfying the fraud test under English law and provides confirmation that no wider test resting on unconscionability forms part of English law.

References:

National Infrastructure Development Co Ltd. v Banco Santander S.A [2016] EWHC 2990 (Comm)