In many large commercial transactions a contracting party will often want some form of performance guarantee from its supplier. In many instances, this will take the form of a performance bond under which the supplier’s bank will agree irrevocably to make a payment to the customer against the presentation of certain documents. The commercial purpose of these bonds is to ensure that the beneficiary is entitled to make a call and receive payment in circumstances which are independent of the main contract. As such performance bonds and other forms of standby payments are vital for international and much national, commercial activity.

Whilst the supplier will not be a party to the bond, it will of course be vitally interested in any call because if its bank meets the call, then the supplier’s account will be immediately debited.

What then is the position when the parties are in a dispute over whether or not the supplier has performed its obligations and the customer makes a call on the bond before that dispute is resolved? Can the supplier stop the call from being made and, if so, in what circumstances? Equally, might such a dispute preclude the beneficiary from receiving payment?

The principles which will be applied by the court in such circumstances were considered in TTI Team Telecom International v Hutchison 3G UK Ltd [2003] All ER (D) 83 (Apr). Briefly the facts of this case were as follows. Hutchison contracted with TTI for the provision of computer hardware and software to manage the third generation (3G) mobile services network in the UK. Payment was to be made at certain specified milestones, with a substantial advance payment to be made. The payment structure meant that until the work was completed, Hutchison would always have paid for more than they had received from TTI. Therefore, TTI arranged a performance bond in favour of Hutchison in case they failed to perform and left Hutchison with a loss.

The work by TTI was delayed for a variety of reasons which were in dispute. Hutchison gave notices terminating the agreement and that it intended to call the bond. TTI applied for an injunction restraining the call and the court had to decide what test to apply when deciding whether to grant such relief: was it the normal test for interim injunctive relief (being the balance of convenience test set out in American Cyanamide Co v Ethicon Ltd [1975] AC 396, HL) or did TTI have to demonstrate something more onerous, for example that payment of the call would amount to fraud, dishonesty, or bad faith on the part of Hutchison?

The court rejected TTI’s application for an injunction. When reaching this decision it identified the following principles:

  1. TTI had to show that its application for an interim injunction was supported by an underlying claim based on a breach by Hutchison of the principal contract or on some other cause of action such as fraud, restitution or a breach of faith.
  2. In addition, a call will normally only be restrained where there has been fraud in setting up or calling the bond or where there is a breach of faith by the beneficiary in threatening a call.
  3. The basis for a contention of a breach of faith must be clearly established even for interim relief. A breach of faith can arise in circumstances such as: a failure to provide an essential element of the principal contract; misuse of the guarantee by failing to act according to the purpose for which it was given; a total failure of consideration in the principal contract; an unconscionable ulterior motive; or a lack of an honest or bona fide belief that the circumstances, such as poor performance, against which a performance bond has been provided, actually exist.
  4. In addition, where it appears that the call would be a nullity, a court will intervene to restrain that invalid call: for example, where a condition precedent to a call has not yet been fulfilled; where the bond is a “see to it” bond requiring prior proof of loss or poor performance which has not yet been established; or where the demand does not meet the requirements imposed by the bond for a valid demand.
  5. If none of the above factors exist then a threatened call will not be restrained. In particular, the calling of a bond will not be restrained merely because the factual basis of the call arising out of the principal contract is disputed. Disputes as to whether, for example, a breach of contract actually occurred, where this event is covered by the performance guarantee, will not be allowed to found an application to restrain a call unless these disputes reveal a breach of faith by the beneficiary. If payment under the bond over-compensates the beneficiary, the balance may be recouped in subsequent litigation by the supplier under the principal contract.

The TTI v Hutchison case is a strong indicator of the non-interventionist approach which the court takes towards performance bonds and other standby payments. The decision emphasises the need to consider very carefully when negotiating performance bonds the exact circumstances when the beneficiary is to be entitled to payment. This is because once the bond is in place it will be very difficult to restrain a call made in accordance with its terms whatever the nature of the dispute between the parties under the main contract.