KYB Case Update: Performance Bonds – Judicial Intervention against the Beneficiary’s Tactical Gambit
On 12.05.2023, the High Court at Kuala Lumpur in Civil Suit No.: WA-24NCC(ARB)-57-12/2022 Syarikat Ong Yoke Lin Sdn. Bhd. v. Grand Dynamic Builders Sdn. Bhd. imposed an injunction on a beneficiary to a bank guarantee / performance bond to protect the interest of a sub-contractor where the intention to call on the bank guarantee / performance bond was riddled with unconscionability.
The potential for the call loomed large when a Notice of Self-Determination was filed by the sub-contractor. Here, the Court explained the different treatments attached to unconditional or conditional bank guarantees / performance bonds, the cumulative circumstances that gave rise to an overall inference of unconscionability and the Court’s ability to impose an injunction to protect an applicant and/or preserve a matter at arbitration.
This case update intends to discuss the key aspects of the Grounds of Judgment dated 02.07.2023 as reported in Syarikat Ong Yoke Lin Sdn. Bhd. v. Grand Dynamic Builders Sdn. Bhd.  MLJU 1490.
Material Background Facts
At the material time, Grand Dynamic Builders Sdn. Bhd. was the main contractor for the 8 Conlay Project (hereafter “the Beneficiary”) and had appointed Syarikat Ong Yoke Lin Sdn. Bhd. as sub-contractor (hereafter “the Sub-Contractor”) for the ‘Supply, Delivery, Installation, Testing and Commissioning of Air Conditioning, Mechanical Ventilation and Building Management System’ works under a Sub-Contract (hereafter “the Sub-Contract Works”). Clause 21 of the Sub-Contract required a bank guarantee to be drawn in favour of the Beneficiary for a sum of RM1,991,164.00 (hereafter “Bank Guarantee”).
On 25.11.2022, the Sub-Contractor issued a Notice of Default to the Beneficiary for (i) failure to pay six (6) Certificates of Payment for a sum of RM8,794,676.94; and (ii) unreasonably suspending Sub-Contract Works, incurring prolongation/recurring costs of RM20,166,695.33.
On 19.12.2022, the Sub-Contractor had no choice but to issue a Notice of Self-Determination, terminating the Sub-Contract due to the Beneficiary’s breaches. Concerned that the Beneficiary was going to call on the Bank Guarantee, the Sub-Contractor moved the Court under Section 11 Arbitration Act 2005 to injunct the Beneficiary from calling on the Bank Guarantee, call of which would have compounded the financial strain already suffered by the Sub-Contractor.
Grounds of Judgment
Invoking the High Court’s Limited Jurisdiction Where Arbitration Agreement Exists
Section 11 of the Arbitration Act 2005 provides an avenue for parties in arbitration proceedings to apply to Court for any interim measures that would ultimately support, aid, maintain the status quo and prevent or restrain acts that would cause current or imminent harm or prejudice to arbitration proceedings pending full and final determination of the dispute. An application can be made before or during arbitration proceedings. This means that the Courts are statutorily empowered to grant interim remedies even where parties have agreed to resolve their dispute via arbitration.
Unconditional or Conditional Bond – Examining Terms of the Sub-Contract
While a bank guarantee / performance bond is made by a guarantor as a promise to meet obligations / liabilities in business, a demand for payment is not always absolute. In this case, the High Court had to first determine whether the Bank Guarantee was unconditional or conditional. If the Bank Guarantee was unconditional, a mere demand would allow a bank to release payment. If the Bank Guarantee was conditional, a call could only be made by the Beneficiary if conditions of the Bank Guarantee have been fulfilled.
The Bank Guarantee in question was found to be a conditional bond because the express wordings of the Bank Guarantee read together with the terms of the Sub-Contract required first for:- (1) a breach to be occasioned by the Sub-Contractor with respect to their obligations and works thereunder; and (2) the Beneficiary to officially communicate the said breach, in writing, to the Sub-Contractor citing consequence thereof. As a Notice of Breach was not issued, the High Court found that the condition precedent was not satisfied, disentitling the Beneficiary from calling on the Bank Guarantee despite alleging that there were defective Sub-Contract Works. This accords with the principle that conditions precedent are the bedrock of performance contracts.
Further and in any event, the Court continued to consider the instances warranting judicial intervention against a call for a bank guarantee / performance bond – unconditional or conditional – and noted that an injunction could only be imposed if circumstances gave rise to strong evidence of fraud or unconscionability. The allegations cannot be a bare assertion.
In so dealing, the Court took into account the following factors:- (1) the Beneficiary’s failure to satisfy payment for six (6) Certificates of Payment in the sum of RM8,794,676.94 which the Beneficiary admitted to owing; (2) the Beneficiary’s failure to satisfy payment for prolongation/recurring costs in the amount of RM20,166,695.33 which is undisputed and subject to certification by the architects; and (3) that the total amount due and owing is approximately fifteen (15) times the sum of the Bank Guarantee which amounted to over-securitisation.
The circumstances made it obvious to the Court that the Beneficiary’s intention to call on the Bank Guarantee was “highly unconscionable”, to the degree that it warranted judicial protection and an injunction to avoid further injustice to the Sub-Contractor. The total sums owed to the Sub-Contractor were largely disproportionate to the unproven losses claimed to be owed to the Beneficiary following the alleged defective Sub-Contract Works. The High Court held that the Beneficiary’s intention to call on the Bank Guarantee “reeks of unfairness” and was “positively oppressive”. Even if the Beneficiary’s allegation was sustained in arbitration, the sums could be set-off against the judgment debt and as such, the Beneficiary had more than enough safeguards in place to insulate themselves from financial exposure.
It is trite that once a strong prima facie case of unconscionability is established, considerations on the balance of convenience or whether damages will be an adequate remedy are irrelevant as the arguments in support of the former test must cross a higher threshold and would likewise, indirectly answer the latter two considerations. Nonetheless, the Court held that the balance of convenience tipped in favour of the Sub-Contractor and that damages would not be an adequate remedy following the colossal sums already due and owing them.
In closing, the Court attempted to allay the Beneficiary’s concern that the Bank Guarantee would lapse on 21.12.2023 by including a term for the Bank Guarantee to be renewed, should it expire before the conclusion of arbitration proceedings.
(1) Even where parties have agreed to resolve their dispute via arbitration, the Courts are still statutorily empowered to grant interim relief before or during arbitration proceedings. This includes an injunction to restrain a bank guarantee / performance bond.
(2) The Courts may deem a call on bank guarantees / performance bonds unconscionable where there are certificates of payment and/or prolongation/recurring costs due and owing as this can amount to over-securitisation. In certain situations, bank guarantees / performance bonds can operate as an oppressive instrument.
(3) Condition precedents must be strictly adhered to. Such pre-conditions must first be satisfied before a call on a bank guarantee / performance bond can be made and the right to demand for payment accrues.
(4) The High Court rightfully observed “(t)hat cashflow is the lifeblood to sub-contractors in the construction industry is irrefragable”. Without such interim measures in place, sub-contractors run the risk of bleeding dry even before the merits of the dispute are heard at arbitration.
The Beneficiary has since filed an appeal against the decision of the High Court and the Sub-Contractor has since filed a cross-appeal.
Our Managing Partner, Edward Kuruvilla, successfully represented the Sub-Contractor as external Counsel in the above proceedings.
This article is authored by Andrea Boo, a Paralegal of Messrs. Kuruvilla, Yeoh & Benjamin.
For more information, please feel free to contact Edward Kuruvilla at email@example.com or visit his Profile at www.kyblegal.com/edward
To download the article, please click on the link below.