Manx Electricity Authority v J P Morgan Chase Bank

This is an appeal by Manx Electricity Authority (“MEA”), part of whose claim against J P Morgan Chase Bank (the “Bank”) under a performance guaranty has been struck out by Tomlinson J under CPR Part 24 on the ground that in law there is no prospect of making it good. Thus MEA is claimant and appellant, and the Bank is defendant and respondent.

The Bank’s guarantee, called a “Form of Performance Security” (the “guarantee”) was entered into to support MEA’s contract with Nepco Europe Limited (“Nepco”) dated 10 July 2001 under which Nepco undertook to design and construct a generating station, called the Pulrose Station, at Pulrose, Douglas, Isle of Man (the “contract”).

Nepco was a subsidiary of the Enron Group of companies, and when in late 2001 Enron collapsed Nepco itself repudiated its contract with MEA: on 1 December 2001 it removed its equipment and “demobilised” from the Pulrose site.

As a result, MEA made a formal demand on the guarantee in a letter to the Bank dated 14 December 2001. The validity of that demand was not in issue before the judge below, nor is it in issue on this appeal. The Bank has pleaded that the demand was defective and invalid, and the questions generated by those contentions will be going to trial later in the year. That is why I said in opening that the judge had struck out part of MEA’s claim. I shall call the demand of December 2001 the “first demand”.

A few days after that demand, on 19 December 2001, MEA and the administrators of Nepco entered into a fresh agreement known as the Settlement and Transfer Agreement (or “STA”). In its preamble it referred to the first demand under the Bank’s guarantee. Clause 9, headed “Settlement and Release”, provided that “MEA hereby releases and discharges Nepco from any claims” (clause 9(2)) but also went on to state that the clause’s provisions were

On 2 and 11 October 2002, in consequence of the parties’ litigation arising out of the first demand, MEA served two further demands on the Bank. The purpose of them was to cure, if it was necessary to do so, the alleged defects of the first demand. For present purposes it is unnecessary to distinguish between the two demands of October 2002, which can collectively be referred to as the “second demand”. I will refer to its terms, and to the terms of the guarantee and the STA, in greater detail below, but it is sufficient at present to say that the demand stated, so as to reflect the language of the guarantee, that Nepco “is in breach of its obligations under the contract”.

The Bank’s response to the second demand was to say that, by reason of the STA, Nepco is no longer in breach of its obligations under the contract. That all lies in the past. There is, or rather as at October 2002 was, no present, current or existing, actionable breach.

The judge accepted the Bank’s submissions in this respect and struck out MEA’s amended particulars of claim to the extent that they relied on the second demand. MEA had obtained permission to amend its particulars to introduce reliance on the second demand, but that permission was recognised as being subject to the Bank’s right to apply to strike out the relevant amendments.

The judge’s principal reason for acceding to the Bank’s application was that Nepco’s breach in December 2001 had merely been of an anticipatory nature (“writ in water”), and that with the making of the STA that breach could no longer be said to exist since no further performance was required. It is important to stress that the judge did not decide that the STA had waived or discharged the December 2001 breach, if one existed and had accrued prior to the STA. That is an issue which the judge left open for trial. On this appeal Mr Mark Hapgood QC, who appears on behalf of the Bank, confirmed that at this stage and for present purposes it was accepted (although it would be in dispute at trial) that the STA did not waive or discharge an accrued breach.

On that basis Mr Michael Brindle QC, who appears for MEA, submits that the judge was wrong to find that the December breach was merely writ in water and therefore could not survive the making of the STA. He submits that the status of the December 2001 breach and whether it was an actual accrued breach or merely anticipatory was not in issue on the Bank’s application, had been no part of the Bank’s case to the court below, and that the judge’s conclusion in this respect was in any event wrong. If therefore Nepco was in breach at the time of the first demand, an issue among others for trial, it remained so at the time of the second demand.

Mr Hapgood, on the other hand, while exhibiting uncertainty as to whether he was supporting the judge’s reasoning, maintained that, irrespective of whether the STA had discharged any earlier breach, it made it impossible to say that any breach by Nepco was thereafter “actionable” in the sense that performance for it was required either in deed or by way of damages. If such performance could no longer be demanded as of October 2002, Nepco’s failure could not be the subject of a performance guarantee which contemplated that its beneficiary, MEA, would call upon Nepco to remedy its breach.

With that introduction, I will turn to the details of the facts, the arguments and the judge’s reasoning in greater detail.

The critical part of the guarantee provided as follows:

The guarantee had a validity expiring either 36 months after the takeover of the works as stated in the taking-over certificate, or 30 September 2006, whichever should first occur. Nothing turns on that. The guarantee also incorporated the Uniform Rules for Demand Guarantees published by the ICC as number 458. It is common ground that nothing in such Rules affects this appeal.

The letter to the Bank dated 14 December 2001 stated inter alia that:

Enclosed with the demand were three letters written by MEA to Nepco, dated 3, 4 and 13 December 2001 respectively. The letter of 3 December complained of Nepco’s ceasing work, required Nepco’s immediate proposals for remobilisation, and referred to clause 8.1 and also clause 15 (the contract’s “repudiation clause”) which permitted MEA to terminate the contract in the event of abandonment of the works or breach of clause 8. The letter concluded:

The letter of 4 December 2001 was to similar effect. It complained that Nepco had failed to remedy the situation; said that continued demobilisation “may” be a breach under clause 8.1 and “may” also trigger rights under clause 15 to terminate the contract; called on Nepco to return to site urgently; and ended with a final paragraph which was essentially in the same terms as that of the previous day’s letter.

The letter of 13 December 2001 stated as follows:

Mr Hapgood points out on behalf of the Bank that the breaches referred to in the letter of 13 December are only referred to in the two previous letters in terms of possibilities (“may”) or by way of anticipation.

The demand was sent under a covering letter of the same date (14 December), which stated as follows:

The Bank replied to the first demand by letter of 20 December 2001 (a day after the STA). It took a series of seven technical points on the form of the demand and the notice to Nepco dated 13 December. It did not complain that Nepco was not in breach.

The STA was designed to clear the decks for MEA to take over the project by means of a novation or assignment of Nepco’s sub-contracts into the hands of MEA’s subsidiary PGT Limited, itself a party to the STA. Nepco agreed to sell to PGT certain assets for £700,000. Nepco’s administrators wished of course to avoid any ongoing liability for the contract. No doubt they also desired to avoid any indirect liability to the Bank which may have been consequent upon any successful demand by MEA under the guarantee. It may be supposed that the Bank held certain security from Nepco to support the guarantee, but there is no evidence about that one way or the other. However, MEA was for its part certainly anxious not to prejudice its rights under the guarantee. The guarantee formed part of the background to the STA, as its preamble, headed “Background” made clear. Thus the preamble contained the following:

The conflicting interests of MEA and the administrators were compromised in clause 9, headed “Settlement and Release”, which provided as follows:

The demand of 11 October 2002 read inter alia as follows:

The documents enclosed with the second notice were identical to those enclosed with the first, namely the three letters to Nepco of 3, 4 and 13 December 2001. It will be observed therefore that the wording of the first and second demands, and the documents served with each, are for present purposes identical (save for the additional sentence to para 5 immediately above), and that the breaches by and notices to Nepco relied on relate back to December 2001 and not to any period after the STA.

By its defence signed on 22 July 2002, that is before the amendment of MEA’s particulars of claim to plead the second demand, the Bank made its technical objections to the first demand, which included the objection that the letters of 3 and 4 December 2001 did not allege “an actual present breach of contract, but rather merely alluded to the possibility that a breach may have been committed”, and then at para 8 went on to state “Further grounds of defence”. One of these was that by reason of clause 9 of the STA –

Another such defence was a denial that the Bank was liable to MEA where it had not suffered any loss (para 8.4). Neither of these defences is the subject matter of the Bank’s strike-out application. There has not yet been an amended defence in response to MEA’s December 2002 amendment to plead the second demand.

Under its strike-out application the Bank put forward two grounds for the relief requested. One was that the guarantee required that any demand include a statement that Nepco “is in breach” and that, as a result of the STA, MEA “has not been in a position to make that statement”. The other is that since the STA’s completion the Bank could have no liability under a guarantee “in respect of a contract which is no longer in existence”.

In Mr Hapgood’s skeleton argument below in support of the Bank’s application he stated expressly (at para 3) that “This application does not touch upon the issues raised by that [the first] demand.” He continued (at para 8):

The allegation that MEA “cannot assert” a present breach was developed in para 17(3) into a reflection on MEA’s honesty:

That language of “cannot assert” and “honestly believes” presumably takes its shape from the underlying law regarding such performance guarantees, which makes them effectively into obligations to pay on demand within the terms of the guarantee, irrespective of the rights and wrongs of any dispute between beneficiary and principal under the terms of their separate contract, subject only to fraud: see Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] 1 QB 159 and Bolivinter Oil SA v. Chase Manhattan Bank NA [1984] 1 WLR 392.

The reasoning of Tomlinson J does not depend on finding in the STA any waiver or discharge, an issue, as stated above, which has by common consent been left for trial. Nor is there any consideration of MEA’s honesty – something which could hardly be undertaken without trial. Rather, his conclusion in favour of the Bank appears to depend critically on his finding that any breach which may have occurred before the STA was “writ in water”, ie was a merely anticipatory breach. Thus the judge said (at para 28):

On this basis, which may not have been the Bank’s case before him and has not at any rate been Mr Hapgood’s case on appeal, the judge went on without too much difficulty to find that, if there had been nothing but an anticipatory breach in December 2001, it was impossible to find any accrued or existing breach still present in October 2002 after the contract had ceased to exist as a result of the STA. Thus he said (at paras 31/32):

On behalf of MEA, Mr Brindle adopts a straightforward position. He points out that the breaches complained of in October 2002 were the self-same breaches complained of in December 2001, the same breaches referred to in the same terms and by reference to the same documents. He disputes the judge’s characterisation of those breaches as merely writ in water: they were actual breaches, amounting to an actual and not merely anticipatory repudiation of the contract. As such, they were accrued breaches and, unless discharged by the STA, an issue left for another occasion, were unaffected by the disappearance of the contract. They were therefore present, current, breaches of which MEA could complain in October 2002. It did not matter that they may have been no longer actionable, in the sense that MEA had put it out of its power to sue Nepco on them, for breach was one thing and remedy another. Unless the breaches had themselves been discharged, they existed and could be made the subject-matter of demand under the guarantee. Moreover, it was impossible to seek summary disposal on the basis that MEA could not make an honest demand in October 2002. Similarly, any dispute as to the extent of MEA’s loss could only be dealt with at trial.

On behalf of the Bank, Mr Hapgood’s skeleton argument began by stating that the judge was “correct for the reasons he gave”. There is no respondent’s notice. Nevertheless, his skeleton went on to make additional points, and in his oral submissions he rather seemed to make it clear that he did not rely on the judge’s reasoning but sought instead to proceed by construing the guarantee as requiring an actionable breach and by construing the STA as depriving MEA of the opportunity to maintain any accrued breach as a currently actionable breach. The guarantee required the breach to be actionable because it was a performance guarantee and therefore did not bite unless the principal could perform, if not by remedying the breach by means of the contractual services, at any rate by paying damages. In this respect he referred to Lord Diplock’s analysis of primary and secondary obligations in Photo Production Ltd v. Securicor Transport Ltd [1980] AC 827 at 850. The continued ability to call for performance was also indicated by the fact that it was a term of the guarantee that a demand had to be accompanied by a notice to Nepco specifying the breach and MEA’s intention to make demand under the guarantee. That, Mr Hapgood submitted, was tantamount to calling on Nepco to perform or else be aware that it was liable to be called upon to repay the Bank. None of that made sense, however, once Nepco could not be sued by reason of the STA. As for that, clauses 9.2, 9.3 and 9.4 each made it clear, and possibly 9.4 most of all, that after completion “no claims…shall be made by either Nepco against MEA or by MEA against Nepco”. Moreover, whatever reservation in favour of the first demand and the breaches there complained of may have been created by clause 9.5 did not extend to a demand not yet in existence and not specifically referred to in that sub-clause.

In my judgment the point on which the judge decided the Bank’s application cannot be supported, and I do not think that Mr Hapgood sought to submit otherwise. If the judge was right that the December 2001 breach was only writ in water, then it may be that even MEA’s first demand could be attacked, subject, however, to the doctrine that a performance guarantee is autonomous from the underlying contract for which it is security and that only fraud is an exception to the rule that the merits of that underlying contract are irrelevant to the operation of the guarantee. It is still pertinent to observe that the judge’s analysis trespasses on the validity of the first demand, because that demonstrates that the parties did not intend such a point to be debated on this application. Be that as it may, I do not consider that the point is suitable for summary dismissal, even if the parties had come to court on the Bank’s application ready to debate it. Prima facie, moreover, on the limited material before this court, Nepco was in actual repudiatory breach of its contract; and it is plainly arguable, although it is unnecessary and undesirable to decide, that when on 13 December 2001 MEA wrote to Nepco to inform it that it was proceeding to make claim under the guarantee, it was thereby accepting that repudiatory breach as putting an end to the contract.

Moreover, once it has become plain, as it has, that the breaches complained about under the second demand are the same breaches as had been complained about under the first demand, the fact that the contract had ceased to exist between the two also seems to me to be irrelevant. A repudiatory breach will in the normal course of events lead to the termination of the repudiated contract (although of course it may not do so). It would be extraordinary if a performance guarantee was intended to cease to operate in exactly the situation in which its beneficiary most needs it – when the contract has failed because the principal has repudiated it.

In the end, therefore, the Bank’s application to strike out the second demand turns on a point which has not been successful before the judge, and which may not even have been fully argued before him – although I am uncertain about that, for Mr Hapgood’s skeleton in the court below did, however briefly, contend that the breach was not actionable at the time of the second notice. But why is it not actionable? That skeleton submits (at para 4) that the STA by clause 9.2 released and discharged all claims by MEA against Nepco. However, it is common ground that issues of waiver and discharge are left over for trial. It seems to me that Mr Hapgood’s present argument is an attempt to circumvent that concession. He submits that whether or not clause 9.5 saves the breaches complained about in the first demand from being discharged, a right to sue for damages is something different and that at least has been taken away by clause 9.4 above all. Therefore the December 2001 breaches are not actionable.

It is not clear to me whether that is common ground or whether MEA relies on clause 9.5 as carving out a total exception in favour of “Nepco’s breaches…referred to in the notifications sent by MEA to Nepco as referred to in Recital (D)”, ie in the letters of 3, 4 and 13 December, the subject matter of the first demand. In my judgment, that issue is so close to the question of waiver and discharge that, since the latter is to go to trial, it would be unsafe for the former not to go to trial along with it, if it remains in issue.

In any event, even if it were to be common ground that as a result of the STA the breaches complained of in the first demand were no longer actionable in the sense that, although they had not been discharged, they could no longer be made the subject matter of suit, the Bank still has to make good its ultimate submission that the guarantee does not bite on accrued, existing, but non-actionable breaches. The competing arguments on that issue are to my mind capable of being well balanced. But I am not so impressed by Mr Hapgood’s submission that the guarantee contemplates the continuing possibility of performance of Lord Diplock’s primary or secondary obligations. I would have thought that the parties to a performance guarantee contemplate that it will continue to provide security to its beneficiary in exactly those situations where the principal is in substance able to perform neither his primary nor his secondary obligations. The fact that in theory, but not in practice, he remains amenable to a claim to pay damages, seems to me to be of uncertain importance. Moreover, the guarantee contains its own terms to protect MEA’s rights under it despite, for instance, “any indulgence or concession…forebearance, forgiveness or any other thing done…” The ramifications of these provisions have not been considered at all.

In circumstances where the Bank’s application goes to only part of MEA’s claim and where there is thus in any event a trial in prospect, I do not consider that this court should strain to determine a point which has not been covered by the judge and which was still in the early stage of development of its analysis in the submissions before us. I consider that in these circumstances it would be unsafe to allow the parties’ disputes to proceed piecemeal and that the interests of justice require this appeal to be allowed. For the same reasons it would be undesirable to say more about the competing arguments which will have to go to trial.

I, too, would allow this appeal.

The obligation which the Bank assumed under the bond or guarantee into which it entered for the benefit of the contracting owner (“MEA”) was to pay the amount specified upon written demand by MEA stating (a) that Nepco, as the contractor and named principal, “is in breach of his (sic) obligation or obligations under the contract” and (b) “the respect in which the principal is in breach”. It was a condition of the obligation to pay that the demand be accompanied by a certified copy of a written notice given by MEA to Nepco under the contract specifying the breach and notifying the principal of MEA’s intention to make demand on the Bank under the bond.

As Lord Justice Rix has pointed out, the requisite statement as to the two matters referred to – that Nepco is in breach of its obligations under the contract and the respect in which it is in breach – is made in the first demand (made in December 2001) and in the second and third demands (made in October 2002) in terms which are identical. The notice of which certified copies accompanied the later demands was the same notice as that sent with the first demand. In the present context, the only feature which is said to distinguish the effect of the first demand from that of the later demands is that, in the intervening period, MEA and Nepco entered into the Settlement and Transfer Agreement of 19 December 2001 (the “STA”). That feature, it is said, leads to the conclusion that, whether or not the first demand was ineffective (a matter not in issue on this application and appeal), the later demands can have no effect in law.

It might, perhaps, have been expected that the contention that the post-STA demands – founded, as they are, on an alleged breach which precedes the STA - can have no effect would be advanced on the basis that the STA contained a term or terms which had the effect of waiving or discharging the antecedent breach (if any) upon which MEA seeks to rely. It appears that that was, indeed, the basis – or one basis – upon which the argument was put to the judge on behalf of the Bank. But it was not the basis upon which the judge reached the conclusion which he did; and it has not been the basis upon which the Bank has sought to uphold the judge’s conclusion in this Court. As Lord Justice Rix has observed, it was accepted on behalf of the Bank (for the purposes of this appeal only) that the STA did not have the effect of waiving or discharging an accrued antecedent breach.

The judge reached the conclusion which he did on the basis that the breach of contract upon which MEA relies – as the basis both for the first demand and for the later demands – was anticipatory in nature. As he put it at paragraph 28 of his judgment: “The breach consisted in the evincing of an intention not to perform the contract or perhaps by an actual inability to perform it.” The judge took the view that, by the date of the later demands, “. . . it is simply not possible to say that Nepco continues to evince an intention not to perform a contract which has been terminated [by the terms of the STA], requiring no further performance by Nepco.” So, he held, it was impossible for MEA to say, at the time of the later demands, that Nepco “is in breach” of an obligation to perform which was then current; and no demand, made in October 2002, which relied only on a breach, prior to 19 December 2001, of the obligation to perform to which Nepco had formerly been subject could be effective.

Counsel for the Bank recognised, I think, that there were difficulties in upholding the judge’s reasoning. I did not understand him to make more than a token attempt to do so in the course of his oral argument in this Court. The flaw in that reasoning, as it seems to me, is that the judge’s finding in relation to the later demands cannot be reconciled with the assumption which he was content to accept in relation to the first demand. The judge accepted, for the purposes of the application before him, that the Bank’s obligation to pay under the bond could be triggered by a demand made following a breach that was merely anticipatory – or, as the judge put it, a breach consisting of the evincing of an intention not to perform – without more. That was a necessary premise underlying what was common ground - that the efficacy of the first demand should go to trial. But the basis of the judge’s decision in relation to the later demands is that a demand, made following and in reliance on an anticipatory breach or notification of an intention not to perform (without more), must itself be made while the obligation to perform the contract continues to subsist. If the judge’s reasoning were correct, it would follow that a demand made under the bond after the beneficiary had accepted an anticipatory repudiation of the contract by the principal would be made too late. As Lord Justice Rix has pointed out, that would an extraordinary result. In order to reach that result the court would, in effect, have to construe the bond so as to attribute to the parties an intention that the bond would be of no effect in the situation in which the beneficiary was in most need of the security which it was to provide – that is to say where there was a total failure by the principal to perform its contractual obligations.

I should make it clear that I do not decide that the proposition that the Bank’s obligation to pay under the bond could be triggered by a demand made following a breach that was merely anticipatory (without more) is well founded. The point has not been argued before us. The basis upon which I decide this appeal is that if – as the judge accepted for the purposes of the application with which he was concerned – that proposition is to be taken as correct, then the conclusion which the judge reached in relation to the later demands cannot be supported. If that proposition is taken to be correct, the fact that the obligation to perform has come to an end following the anticipatory renunciation – whether by acceptance of the anticipatory renunciation as a repudiatory breach or otherwise – before the making of the demand under the bond cannot be material; unless, of course, the circumstances under which the obligation to perform has come to an end evidence an agreement to waive the breach or to treat it as discharged.

In the course of his oral argument in this Court, counsel for the Bank sought to uphold the judge’s order on grounds other than those which had attracted the judge. He sought to argue that, as a matter of construction, the bond required that, at the time when the demand was made, the breach relied upon by the beneficiary should be capable of remedy in a suit by the beneficiary against the principal. That does not seem to me so self-evident that this Court should determine the point against MEA in circumstances in which – the point not having been identified in a respondent’s notice – MEA were not required to come to this Court in order to meet it. Nor, as it seems to me, is it self-evident that the effect of the STA is that the breach complained of is not capable of remedy in a suit by MEA against Nepco. That turns on the effect of clause 9(4) of the STA when read and construed in the context of clause 9(5).

It is pertinent to have in mind that this is a case in which the parties accept that (absent agreement) there will have to be a trial to determine whether the first demand was effective. It may be that MEA will not need to rely on the later demands. If it does, the matters to which I have just referred can be argued at the trial without inconvenience or any significant additional expense.

I agree.