This judgment follows the December 2012 findings of the Court of Appeal that a payment guarantee issued by the Defendant in favour of the Claimant was a performance bond, not a guarantee. This present decision dealt with the arbitrator’s findings prior to the hearing in December 2012, which determined that the second instalment was not due under the shipbuilding contract; however the third instalment was due.

Background

The Claimant entered into a shipbuilding contract with the buyer. The price was to be paid in five instalments. The second instalment was due when the Defendant was notified that the first 300 metres of steel plate had been cut and approved by the buyer’s representative.

The Defendant had issued a payment guarantee for payment. The Claimant alleged that the cutting of the steel took place, however this was in the absence of the buyer’s representative. The Defendant failed to pay the second instalment and the Claimant issued a demand for payment under the payment guarantee, submitting that it was a performance bond due on demand.

The Defendant argued that the payment guarantee was a guarantee, not a bond and as a result, its liability was contingent on the obligation. As there was a dispute about whether the obligation had occurred, it was not liable under the payment guarantee.

Using guidance set out in Paget’s Law of Banking (11th edition), the Court of Appeal held in December 2012 that the payment guarantee was an on demand bond and not a payment guarantee. Paget’s states:

“Where an instrument (i) relates to an underlying transaction between the parties in different jurisdictions; (ii) is issued by a bank; (iii) contains an undertaking to pay “on demand” (with or without the words “first” and/or “written”); and does not contain clauses excluding or limiting the defences available to a guarantor, it will almost always be construed as a demand guarantee.”

The Defendant therefore made the payment due under the guarantee. However, the Court’s decision and the position in relation to this matter was complicated by the arbitrator’s findings that the second instalment was not due under the shipbuilding contract; however the third instalment had fallen due. This decision was final and could not be subject to further challenge.

The issue arose as to whether the monies paid were held by the Claimant on trust.  The Defendant contended that the Claimant held the payment on trust for the Defendant, or alternatively the buyer. The Claimant argued that it was liable to the Defendant, but only after offset of the unpaid third instalment pursuant to the arbitrator’s findings. The Court of Appeal was to decide whether the Claimant held the money for the Defendant or for the buyer, who would in turn hold the money on trust for the Defendant or for the buyer solely.

The Defendant drew analogy with cases where money was paid to a party in error, as a result the party held the money on constructive trust for the payee.  Once the decision of the arbitrator was made final, the Claimant was aware that the payment of the second instalment had not fallen due from the buyer and consequently the knowledge that the Claimant had receive money to which it was not entitle gave rise to a trust.

The Decision

The Court of Appeal held that the money was not held on trust.  The Claimant’s obligation was to account to the buyer, however the money was not held on trust for the buyer.

The Court of Appeal rejected that there was an analogy with cases of mistake, where no obligation to pay ever arose.  When the Claimant made the demand for payment to the Defendant, it acquired an enforceable cause of action against the Defendant and consequently a right to receipt of the payment of the second instalment from the Defendant.  The Court of Appeal stated that it was not relevant that the Claimant, as a result of the arbitrator’s decision, subsequently discovered that the demand for payment was incorrectly made.

The Court of Appeal confirmed that the bond is a guarantee of due performance.  The position crystallises upon presentation of demand for payment and it is only in the case of fraudulent demand that the Defendant could have resisted payment. It is only as a result of the Defendant’s breach of contract in failing to make payment when the Claimant made the demand for payment that circumstances have arisen in which it could be said that the money was not due.  This position would not have arisen had the payment been made by the Defendant when required.  Therefore, finding an existence of a trust would result in a finding that the Defendant can rely on its own wrongdoing. Whilst it was accepted that the Defendant was not in fact under an obligation to pay the second payment, the instalment did fall due and the Claimant in good faith issued demand for the payment.  The Court of Appeal found that once payment due under the guarantee became due, it remained due. As a result the money was not held on trust by the Claimant for the Defendant.

The Court of Appeal considered the terms of the contract and specifically the clause detailing the payment guarantee. Whilst there was no finding of trust, there is a requirement for accounting between the parties to reflect their rights and liabilities under the contract. Accordingly, the Claimant has a contractual duty to account to the buyer for the sum paid to it by the bank.

The Court of Appeal tentatively approached the issue as to whether the Claimant held the money on trust for the buyer, however concluded that the Defendant did not have authority to put forward this argument as it was a matter between the Claimant and the buyer. As the buyer was not present at the hearing, the Court declined to decide on this issue.

Commentary

This judgment is a useful reminder that once a payment guarantee due under a performance bond falls due and a demand for payment is issued in good faith (even where it is subsequently found that such demand was made in error) this does not lead to a presumption that monies paid pursuant to the demand is held on constructive trust.

For further information, please contact Georgina Squire or the Partner with whom you usually deal.