Precluding calls under on-demand security

This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.

It is often the case that employers seek to protect themselves financially in the event of a contractor’s default, seeking either a parent company guarantee (PCG) or some form of bond (or both). Of course, calling a PCG or bond, including an on-demand bond does not guarantee payment (although it is typically difficult to restrict calls on on-demand bonds), but a recent case has clarified that the actual act of calling the bond or PCG should not provide an additional hurdle in the employer’s path to the funds.

The facts of the case where these: MW High Tech Projects UK Limited (the contractor) entered into a contract with Biffa Waste Services Limited which included a provision for both a PCG and a retention bond and which required Biffa to call upon the PCG as a condition precedent to calling the retention bond.

In January last year, Biffa made a call in accordance with the terms of the PCG and, in January this year, following the contractor’s parent’s failure to make payment under the PCG, Biffa wrote to the bond provider demanding payment under the retention bond. The contractor submitted that Biffa should be restrained from making a call under the retention bond, because they had not made a ‘valid’ call on the PCG in accordance with the terms of the contract. The contractor cited several reasons challenging the validity of Biffa’s call on the PCG including that there was no substantive basis for the call.

The Technology and Construction Court in England and Wales ruled that, in line with previous case law, the courts should not interfere with the machinery of irrevocable obligations save in the following circumstances:

1. there is a seriously arguable case of fraud; or

1. it is positively established that the beneficiary is precluded from making a call by the underlying contract.

He ruled that, although the contractor had described Biffa’s call on the PCG as ‘cynical’, there was no allegation of fraud. In respect of the second limb he stated that the contractor would have to prove that Biffa’s right to draw down under the PCG had been clearly precluded by the contract (it was not sufficient that there was an arguable case that Biffa had no contractual right to draw down). He further ruled that the contract neither expressly or impliedly exempted Biffa from drawing down, that Biffa had satisfied the linguistic, formal and procedural requirements of making the call under the PCG and that the word ‘valid’ did not add a separate or higher obligation in this respect.

Clearly, there are compelling policy reasons behind this ruling: a parent company can mount a defence to the claim, but this should not preclude a beneficiary from calling under a contract which is meant to be autonomous and independent of disputes between the parties relating to another contract.

Whatever the rationale, the message is clear; provided a beneficiary follows the procedural steps prescribed by the PCG or bond and provided that they are not clearly precluded from making the call under the underlying contract, a call will always be valid and one step on the road to retrieval of monies. From a beneficiary’s perspective, it is generally preferable to either allow for some leeway in such procedures or to limit these to the bare necessities in order to reduce the likelihood that a bond call could be successfully injuncted.