Fraud and Performance Securities | White & Case LLP International Law Firm, Global Law Practice
Fraud and Performance Securities

Fraud and Performance Securities

Performance securities are an everyday feature of construction and engineering projects. It is increasingly common to see calls on performance securities challenged on the basis of "fraud". Two recent cases from the English courts confirm that "fraud" has a high threshold. If the party making the demand on the security honestly believed it was entitled to make the demand, fraud will not be made out, even if that party's belief was wrong.

 

PetroSaudi

PetroSaudi Oil Services (Venezuela) Ltd. v. Novo Banco S.A. [2017] EWCA Civ 9 involved a drilling services contract between a contractor and the Venezuelan state oil company. The drilling contractor was given a letter of credit arranged by the oil company as a payment guarantee, expressed in "on demand" language.

The contractor made a demand for payment under the security, due to non-payment of sums claimed to be due. The oil company disputed the contractor's entitlement to payment. In seeking to stop the contractor from obtaining payment under the security, the oil company claimed that the demand for payment was fraudulent, as the contractor's relevant personnel knew or must have known that there was no entitlement to payment.

The issue of the contractor's entitlement to payment was not wholly clear cut, but the court held that the contractor was indeed entitled to payment. This meant its demand on the performance security was lawful.

Despite this, the court went on to briefly consider what the position would be if the contractor was not entitled to payment. Would this mean that its demand under the security was fraudulent? The court considered that an honestly held incorrect opinion on legal entitlement should not necessarily make a demand fraudulent. It is only if the person making the demand actually knows and believes that it has no entitlement under the performance security that fraud will be found, or if the person is "recklessly indifferent" to whether it has an entitlement. No such knowledge or belief existed here.

 

NIDCO

In National Infrastructure Development Co. Ltd. v. Banco Santander S.A. [2017] EWCA Civ 27, an employer and a contractor entered into a contract for the construction of a highway in Trinidad. Performance guarantees were procured by the contractor from its bank in favour of the employer.

The project did not proceed well. Work ceased (for disputed reasons) and the employer terminated the contract. The employer then made demands under the performance guarantees, on the basis that certain sums were "due and owing" to it as damages following termination. The bank sought to resist the claim on the ground that sums would only be "due and owing" to the employer once its damages claim was crystallised by agreement or an arbitral award. Pending either of those outcomes, the contractor had no present entitlement to the money it claimed, and therefore (the bank's argument went) the demand was fraudulent.

The court rejected the suggestion of fraud. It said that the employer could make a demand under the performance guarantees, without first crystallising the amount due to it by way of an arbitral award or (if possible) an agreement with the contractor. The court went on to find that, notwithstanding this, the employer's demand could only be "fraudulent" (and therefore restrained) where "the only realistic inference is that [the employer] could not honestly have believed in the validity of its demands".

Comment

The judgments in both cases serve to confirm two important matters regarding performance securities.

First, that the threshold for "fraud" is a high one. It is not enough to show that a beneficiary was claiming more than it was actually entitled to, or that it had no entitlement to make a claim under a performance security. It needs to be demonstrated clearly that the beneficiary either knew it had no entitlement, or was recklessly indifferent as to whether it had an entitlement. Setting the threshold at this level gives comfort to banks, because it allows them to step back from the contracting parties' relationship and meet a demand in confidence of being obliged to do so, given the autonomous nature of performance securities. Only if there is a very clear case of fraud must the bank refuse payment.

Secondly, it confirms the value of "on demand" performance securities, and that demands on them usually cannot be prevented or stopped if there is a genuine dispute over whether the beneficiary is entitled to the sums it seeks to recoup through encashing the security. The question of "who owes what" is to be resolved in court or arbitration, between the employer and the contractor. But it does not usually hold up the conversion of a security in the meantime, where the security is treated as being "as good as cash".

 

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