Implied requirements for calling on-demand bonds

A TCC decision published earlier this month has considered the circumstances in which an on-demand security might impose implied requirements for the form of a demand made under the security. Parties should give careful consideration to the form of any demand to be made under such securities and not assume that the absence of any stated form of demand means that no specific requirements apply to the making of a demand.

Lukoil Mid-East Ltd v Barclays Bank plc

Lukoil entered into a contract with Baker Hughes Asia Pacific Limited for the drilling and completion of 23 production wells in an oil field in South East Iraq (the “Contract”). As security for performance of the contract, Baker Hughes arranged for an on-demand bank guarantee to be issued by Barclays in favour of Lukoil for USD $7,115,034. By the terms of the bank guarantee Barclays undertook to pay up to the maximum amount of the guarantee at Lukoil’s “first written request submitted to [Barclays] before the expiry date if [Baker Hughes] fails to fulfil the Contract provisions, on the condition that no amendment has been made to the Contract concluded between [Lukoil] and [Baker Hughes] impacting the timely performance of the Works under the Contract”.

Shortly before its expiry, Lukoil made a demand for the full amount of the guarantee. The demand referred to failings on the part of Baker Hughes to perform the Contract but made no reference to whether amendments had been made to the Contract. Barclays declined to honour the demand, claiming that Lukoil was required to state expressly in the demand that no amendment had been made to the contract impacting the timely performance of the Works. The guarantee itself was silent as to the form any demand was to take.

By the time Lukoil had received Barclay’s letter declining payment, the guarantee had expired. Lukoil could not therefore make a fresh demand and brought proceedings to enforce payment under its original demand.

Implied requirements

Barclays’ position was supported by previous caselaw which had held that an on-demand security drafted with conditional language carried with it an implied requirement that any demand under the security expressly state the fulfilment of those conditions. So in Esal (Commodities) Ltd v Oriental Credit Ltd a bond which required payment “on your written demand in the event that the supplier fails to execute the contract in perfect performance” required a demand to state that the supplier had failed to execute the contract. Likewise, in IE Contractors v Lloyds a bond which obliged the bondsman to pay “unconditionally, the said amount on demand, being your claim for damages brought about by the above named principal" required a demand to state that it was a claim for damages brought about by the contractors.

Barclays therefore contended that the condition stated in the guarantee as to amendments required a statement to be made in the demand that no relevant amendment had been made to the Contract. Although the court accepted that the condition in the guarantee could have this effect, it rejected Barclays case by reference an additional paragraph of the guarantee which read as follows:

“We hereby agree that no amendments nor addenda to the Contract, nor any contractual documents made by you and [Baker Hughes] shall relieve us from our responsibilities under this Guarantee, and we hereby waive the right to be notified of such amendments or addenda.”

The court considered this paragraph to be irreconcilable with the condition in the guarantee referring to amendments to the Contract and inconsistent with a suggestion that Lukoil was required to notify Barclays in its demand of the absence of any amendments to the Contract. The court noted that the condition may have been a hangover from the wording of more traditional guarantees where amendments to the underlying contract can have the effect of automatically releasing the guarantor (as the court put it, a “historical relic that has washed up in a modern Bank Guarantee”). If so, “that would not be unique and would lend support to a finding that they should be treated as surplus to modern requirement.”

Conclusions and implications

This case provides a helpful reminder that calls under on-demand securities may sometimes be required to state expressly that certain conditions have been fulfilled despite no prescribed form of demand being specified. Parties considering the making of calls under on-demand securities should give careful thought to whether any such implied requirements apply in their circumstances. The grounds on which calls under on-demand securities can be challenged under English law are very narrow, but the English courts will take a strict approach to any requirements for the making of a demand. Any failure to abide by them will invalidate the demand.

The present case also provides an interesting example of the court ultimately disregarding words in on-demand guarantee which appeared to serve no purpose and potentially to have been left over from the wording of more traditional forms of guarantee. As the court noted, such a situation is one which arises not infrequently in practice. Parties would be best advised to remove any such historical wording, or to have fresh documents drafted consistently with modern practices, so as to avoid uncertainty and reduce the scope for challenge.

References:

Esal (Commodities) Ltd v Oriental Credit Ltd [1985] 2 Lloyd's Rep 546;

IE Contractors v Lloyds [1990] 2 Lloyd's 496;

Lukoil Mid-East Ltd v Barclays Bank Plc [2016] EWHC 166 (TCC).