Tetronics: seeking to injunct fraudulent calls on on-demand bonds

In the case of Tetronics (International) Ltd v HSBC Bank Plc [2018] (Tetronics), the courts have demonstrated how difficult it will be for a party to resist a call for payment of an on demand guarantee.

Guarantees and bonds

Performance bonds and guarantees, which are often utilised in construction projects, can either be conditional or on demand. An on demand guarantee imposes a primary obligation on the surety or bondsman to pay in specified circumstances. For example, where a contractor fails to perform the building contract without the employer having to sue the contractor and prove breach of contract.

Previous case law has established that injunctions restraining performance by the bank of an on demand guarantee should not be granted save in the exceptional case of clear proof that the bank knew that any demand for payment was clearly fraudulent (Bolivinter Oil SA v Chase Manhattan Bank NA [1984]) or that the demand does not comply with the requirements of the bond. The reasons for the high bar, amongst other things, are that the courts are keen to avoid undermining the integrity of the banking system and the value of autonomous payment undertakings.

The case background

The Tetronics case related to a call for payment of an on demand guarantee which had been issued by HSBC in favour of BlueOak Arkansas LLC (Blue Oak) (the “Guarantee”).

As a pre-condition to issuing the Guarantee, Blue Oak were asked by HSBC whether they were aware of any current circumstances that would give rise to a breach of the underlying contract. A written assurance that there were no such circumstances was provided by Blue Oak on 13 November 2017, in consequence of which HSBC issued the Guarantee.

On 11 December 2017, Blue Oak issued a Notice of Default in respect of the underlying contract. This stated a range of matters it had become aware of which claimed that there were breaches to the contract. However, Tetronics alleged that Blue Oak had had knowledge of the majority of these breaches prior to the letter of assurance it had sent to HSBC.

On 17 January 2018, Blue Oak made a call on the Guarantee in compliance with its terms. Tetronics subsequently made an urgent application for an ex parte injunction preventing payment (i.e. an application for an injunction without the need to give notice to the other parties).

The court granted the preliminary injunction on the basis that either there had been no breaches of the underlying contract by Tetronics and the demand on the Guarantee was not valid, or there were breaches and the letter of assurance (provided by the beneficiary to obtain the Guarantee) was fraudulent.

If payment was allowed, Tetronics would suffer a fatal financial blow due to HSBC immediately seeking repayment under a counter indemnity. Therefore, the grounds for granting an initial injunction were met as it would preserve the status quo, the rights of the parties and avoid Tetronics becoming insolvent.

On 25 January 2018, Blue Oak applied for the injunction to be discharged though no factual evidence was provided in support of their application.

The judgement

The High Court (Fraser J) stated that in order to preserve the initial injunction, the court had to be satisfied that:

1. there was a seriously arguable case of fraud;
2. that HSBC was aware of the fraud; and
3. that the balance of convenience (i.e. preserving the status quo) must favour continuing the injunction.

The court found that there was a “cogent and compelling case of fraud” and the lack of evidence provided by Blue Oak indicated that the only realistic inference was that Blue Oak could not honestly have believed in the validity of its demand under the Guarantee. It was also found that HSBC were made aware of the fraud due to material served on it by Tetronics for the initial application on 18 January 2018.

However, during the second hearing, counsel for Tetronics informed the court that Tetronics had commenced an International Chamber of Commerce arbitration against Blue Oak under the supply contract. During these proceedings, it became apparent that Tetronics would not, in fact, become insolvent due to its shareholders being able to make additional contributions if HSBC were to make payment under the Guarantee. From these facts, the court reconsidered its initial decision and concluded that, despite the strong arguable case of fraud, the injunction should be discharged as the status quo would not be affected.