Enka Insaat Ve Sanayi AS v Banca Popolare Dell'alto Adige SPA

This is an application for summary judgment by the Claimant upon Advance Payment and Performance Guarantees issued by two banks, the Defendants. The Claimant says there is no defence to the claims on those guarantees. In essence the Defendants say that they have a defence with a real prospect of success, namely, that the demands on the guarantees were made fraudulently.

The Claimant, Enka Insaat Ve Sanayi AS (“ENKA”), is a Turkish company which carries out major construction projects in Turkey and Russia. On 12 October 2007 ENKA entered into a contract with the Russian company OAO “KMKI Dobryninsky” (the “Owner”) for the design and construction of a multifunctional retail and office building in Moscow. The façade works sub-contractor was OOO “Frener & Reifer Russia”(“F&R”), a Russian company. On 17 January 2008 ENKA signed a sub-contract with F&R pursuant to which F&R was to design and install the external façade of the building for the fixed price of US$36,304,345.15 plus VAT. The sub-contract obliged F&R to put in place certain guarantees by an international first class bank.

The banks who provided those guarantees were the Italian banks, Banca Popolare Dell’Alto Adige SPA (“BP”) who provided the Advance Payment Guarantees, dated 29 January 2008 and 4 June 2008, and Cassa Di Risparmio Di Bolzano SPA (“CRB”) who provided the Performance Guarantee dated 4 February 2008.

The sub-contract is governed by the laws of the Russian Federation and disputes are to be referred to arbitration in Moscow. The price payable by ENKA to F&R was payable by an advance payment of 30% of the price, a second advance payment of 10% of the price and thereafter a series of current or monthly progress payments against measured amounts of work. The advance payments were made. They were to be repaid by F&R to ENKA by way of deductions of a certain percentage from each current or monthly payment. In the event no current or monthly payment was made and so F&R retains the Advance Payments. ENKA was also entitled to retain from each current or monthly payment an amount equal to 5% of the amount due “in order to secure the due performance by [F&R] of its obligations hereunder.”

ENKA had power to terminate the sub-contract unilaterally in the event of non-performance and other failures by F&R.

F&R was obliged to put in place two unconditional and irrevocable guarantees by an international bank in respect of the two Advance Payments (totalling in excess of US$13.5m.) in a form exhibited to the sub-contract. F&R was also obliged to put in place a Performance Guarantee by an international first class bank in a form exhibited to the sub-contract in a sum equal to 5% of the purchase price, namely, US$1,815,218.

The Advance Payment Guarantees given by BP provided for English law and exclusive jurisdiction. They provided as follows:

“We, the undersigned [BP] ………………..hereby unconditionally and irrevocably guarantee to pay without delay to [ENKA] within 5 (five) business days upon presentation by [ENKA] to us of the first and any subsequent written demands duly signed by [ENKA’s] authorised signatory (the Demand(s)) any sums specified in such a Demand up to an amount not exceeding ……………..(the “Guaranteed Amount”).

The Demand shall state that:

1.

[F&R] has failed to fulfil its obligations to the Contractor under the Subcontract;

2.

accordingly [ENKA] is entitled to receive payment of the Advance Payment.

Payment to [ENKA] of the amount contained in the Demand shall be without the need for proof or conditions, and irrespective of the validity, and effects of the abovementioned Subcontract and waiving all rights of objection and defence arising therefrom. The Demand(s)s shall be conclusive evidence of our liability and of the amount of the sum or sums which we are liable to pay to the Contractor, notwithstanding any objection made by the Subcontractor or any other person.

More than one demand may be made hereunder prior to the Expiry Date ….Our maximum aggregate liability under or connection with this Guarantee shall not exceed the Guaranteed Amount which amount shall be decreased by the amount as being recouped by way of deduction from the Subcontractor’s monthly invoices upon presentation to us of the relevant invoices duly signed and stamped by [ENKA].”

The Performance Guarantee provided by CRB also provided for English law and jurisdiction. It was in very similar terms save that the demand was to state:

“1.

[F&R] has failed to fulfil its obligations to the Contractor under the Subcontract;

2.

accordingly the Contractor is entitled to receive payment under this Guarantee.”

The clause providing that more than one demand may be made was in the same terms but ended by saying:

“……..….Our maximum aggregate liability under or in connection with this Guarantee shall not exceed the Guaranteed Amount which amount shall be reduced by any partial amounts already paid by us under this Guarantee. ”

On 26 November 2008 the Owner gave ENKA 14 days notice of termination of the main contract and made demands on guarantees put in place under the main contract by ENKA.

On 2 December 2008 ENKA demanded payment from BP pursuant to the Advance Payment Guarantees in the following terms:

“We hereby state that,

1.

[F&R] has failed to fulfil its obligations to us under the subcontract; and

2.

Accordingly we as the Contractor are entitled to receive payment of the Advance Payment.

Therefore according to the terms and conditions of the guarantee we kindly request you to pay us, within five business days, the amount of USD 10,346,739 [or USD 3,448,913]……….”

On 2 December 2008 ENKA demanded payment from CRB in the following terms:

“We hereby state that,

1.

[F&R] has failed to fulfil its obligations to us under the subcontract; and

2.

Accordingly we as the Contractor are entitled to receive payment under this Guarantee.

Therefore according to the terms and conditions of the guarantee we kindly request you to pay us, within five business days, the amount of USD 1,815,218 ……….”

On 22 December 2008 ENKA gave notice to F&R terminating the sub-contract.

ENKA does not contend that as at 2 December 2008 F&R was liable to repay the Advance Payments or that, although it is said that F&R was in breach of the sub-contract in several respects, that such breaches had caused any measurable loss to ENKA. The demands were signed by Mr. Mehmet Gozen, the Deputy General Manager of ENKA. He has said in his witness statement as follows:

“On 2 December 2008 I decided that ENKA should make demands under the Banca Popolare guarantees. At that date I believed that the Banca Popolare guarantees were in effect, and that ENKA was entitled to make demand under those guarantees. ………….

I believed on 2 December 2008 that F&R had failed to fulfil its obligations under the subcontract, and that accordingly ENKA was entitled to receive payment under the guarantees…..That was my belief on 23 April 2009, and I continue to believe that that is the case. The guarantees were expressed to be payable on demand. The demand was required to state that F&R had failed to fulfil its obligations to ENKA under the subcontract, and that accordingly ENKA was entitled to receive payment of the amounts guaranteed. The demands made on 23 April 2009 (and 2 December 2008) made those statements. ……………I decided that those demands should be made by ENKA. When I made those decisions I believed that F&R was in breach of the subcontract, and that accordingly ENKA was entitled to receive payment of the performance guarantee and the amounts guaranteed under the advance payment guarantees.

I believed F&R was in breach of the subcontract for the reasons referred to by Mr. Bevan. Since it was in breach, ENKA was entitled to receive payment of the performance guarantee and of the amount of the advance payments net of any amounts already repaid by F&R by way of deduction from F&R’s monthly invoices (as stated in the advance payment guarantees). Since none of the advance payments had been repaid already, ENKA was entitled to receive the full amount of the advance payments. That was my belief at the time of the demands on 23 April 2009 (and 2 December 2008) and it remains my belief.

I do not understand the relevance of the assertions by Ms. Bachmann that the breaches by F&R were not “causative of any loss”. The guarantees did not require that the demand state that the breaches by F&R had caused any particular loss. …………………..”

On 7 January 2009, after the sub-contract had been terminated, ENKA claimed that F&R no longer had a right to retain the advance payments and informed F&R that they had commenced proceedings to recover those sums (and those due under the performance guarantees) from the guarantor banks.

It was later discovered that a formal requirement of the advance payment guarantees had not been complied with as at 2 December 2008 and so it is accepted by ENKA that the demand made on 2 December 2008 under those guarantees was not valid. The formal requirement was later satisfied and a further demand in the same terms as that made on 2 December 2008 was made on 23 April 2009.

Raymond Cox QC, counsel for ENKA, submitted that demands in the form required by both forms of guarantee have been made and that the banks are therefore liable to pay the sums demanded. He submitted that ENKA acted in good faith in making such demands.

Richard Salter QC, counsel for BP and CRB, submitted that in making the demand under the Performance Guarantee ENKA did not honestly believe that F&R was then liable to ENKA in the sum claimed of US$1,815,218, which demand was therefore fraudulent. CRB is not obliged to respond to a fraudulent demand. With regard to the Advanced Payment guarantees the argument is a little more complicated. It is not said that the demands made on 23 April 2009, after the sub-contract had been terminated, were made fraudulently. It is said that the demands made on 2 December 2008, before the sub-contract had been terminated, were made fraudulently in that when those demands were made ENKA had no honest belief that F&R was then liable to ENKA for the sums claimed of US$10,346,739 and US$3,448,913, which demands were therefore fraudulent. The making of such a demand is a breach of an implied condition (or a serious breach of an innominate term) in the Advance Payment Guarantees which, it was said in counsel’s Skeleton Argument, “had the effect of discharging BP from further liability under the Advance Payment Guarantees.” Accordingly, when the otherwise valid demands were made on 23 April 2009 BP was not obliged to respond to them because the Guarantees had by then been terminated.

This is an application pursuant to CPR Part 24 which provides that the court may give summary judgment against a defendant if the defendant has no real prospect of successfully defending the claim and there is no other compelling reason why the case should be disposed of at trial.

The manner in which this rule should be applied where summary judgment is sought against a bank under a letter of credit or performance bond has been discussed by the Court of Appeal in at least three cases; Safa Ltd. v Banque du Caire [2000] 2 Lloyd’s Rep.600, Solo Industries UK Ltd. v Canara Bank [2001] 1 WLR 1800 and Banque Saudi Fransi v Lear Siegler Services Inc. [2007] 2 Lloyd’s Rep.47. The discussion in those three cases suggests that the manner in which CPR Part 24 should be applied where summary judgment is sought against a bank under a letter of credit or performance guarantee is not entirely clear.

In Safa Ltd. v Banque du Caire [2000] 2 Lloyd’s Rep.600 Waller LJ said at p.608:

“If a bank can establish a claim with a real prospect of success ……that the demand was fraudulent even it if had no clear evidence of fraud at the time of demand……it may also be unjust to enter summary judgment against the bank …. because the bank has a reasonable prospect of succeeding in a defence of set-off …………..”

Hale LJ agreed. Schiemann LJ did also, adding that the facts of that case were most unusual. That was a reference to the circumstance that the bank in that case was involved in the transaction in connection with which the letter of credit had been issued.

In Solo Industries UK Ltd. v Canara Bank [2001] 1 WLR 1800 Mance LJ discussed this statement of principle by Waller LJ. He said that a “real prospect” was a low test to satisfy. He did not consider that such a low test was appropriate as between a bank and the beneficiary of a letter of credit or performance guarantee. He said:

“The courts in the Harbottle (Footnote: ¹) and Edward Owen (Footnote: ²) cases emphasised this, and, in my view, set a higher standard than “a real prospect of success” in relation to all these situations. Short of “established fraud”, a bank will not normally be allowed to raise any defence of set-off based on alleged impropriety affecting the demand.”

Mance LJ also had reservations about the test suggested in the United Trading case [1985] 2 Lloyd’s Rep. 554 (as reformulated to comply with CPR 24), namely, “whether there is a real prospect that, on the material available, the only realistic inference is that the beneficiary could not honestly have believed in the validity of its demands.” He observed that the courts in the Harbottle and Edward Owen cases made no reference to an “arguable case”. He agreed with the comment of Rix J in the Czarnikow-Rionda case [1999] 2 Lloyd’s Rep. 187, that “on any view ….the court should be careful not to allow too extensive a dilution of the presumption in favour of the fulfilment of independent banking commitments.” These comments of Mance LJ (with which Sir Martin Nourse and Potter LJ agreed) were obiter dicta because the actual decision in Solo concerned the test to be applied not when the defence raised by the bank was that the demand had been made fraudulently but when the defence raised by the bank was that the bank had been induced to issue the performance bond by a fraudulent conspiracy or representation.

In Banque Saudi Fransi v Lear Siegler Services Inc. [2007] 2 Lloyd’s Rep.47 Arden LJ reviewed Solo and said, at paragraph 16, that the test which found favour with the court in that case was a “heightened test” rather than that of a good arguable case. The actual decision in Banque Saudi Fransi concerned the test to be applied, not when the claim is against a bank under a performance bond, but when the claim is against a person who has given the bank a counter-indemnity, in which context Arden LJ said that the test was whether the defendant could show a real prospect that it will be able to prove the fraud exception at trial. Pill LJ agreed with Arden LJ and added some comments of his own. The third member of the court was Scott Baker LJ but his judgment does not appear to be reported.

In my judgment the test to be applied must be that of a “real prospect” because that is the test set out in CPR Part 24. I do not consider that this court is bound to apply a “heightened test” because the courts in Solo and Banque Saudi Fransi were not considering a claim against a bank under a guarantee where the defence was that the demand was said to be fraudulent. I therefore consider that the test in the present context is whether there is a real prospect that the Banks will establish at trial that the only realistic inference is that the fraud exception applies, that is, that ENKA could not honestly have believed in the validity of its demands.

However, there is considerable support for the view, which I accept, that in applying that test the Court must be mindful of the principle that banks, when sued on a letter of credit or performance bond or guarantee, need particularly cogent evidence to establish the fraud exception. Thus:

The demands made on BP and CRB were in the form required by the terms of the guarantees. BP and CRB can only resist those demands if they were made fraudulently. BP and CRB say that a demand which the maker of the demand does not honestly believe to be correct is a fraudulent demand. Their reasons for saying that Mr. Gozen did not honestly believe the demands he made on behalf of ENKA were correct may be summarised as follows:

Central to the Banks’ defence to this application is their contention that Mr. Gozen’s alleged belief is so remarkable and uncommercial that he could not honestly have held it. Counsel submitted that although the guarantees are autonomous instruments their economic function is to guarantee liability of F&R to ENKA. In that context the word “accordingly” implied a requirement that there must be a causal connection between the alleged breach and the amount claimed. The causal connection required that the sums claimed from the Banks were payable by F&R to ENKA, or at least that ENKA said or had reason to believe that they were so payable. This construction was said to be supported by the fact that both guarantees expressly contemplated demands of sums up to an amount not exceeding the Guaranteed Amount and expressly permitted more than one demand.

Counsel for ENKA submitted that “accordingly” simply required ENKA to state that it was entitled to receive payment from the Banks because F&R had breached its obligations. This was Mr. Gozen’s belief. There was no express requirement in either guarantee that ENKA must state that the breaches relied upon have caused loss to ENKA in the sums demanded or, in the Advance Payment guarantee, that ENKA is entitled to repayment of the advance payments by F&R.

In response Counsel for the Banks said that if “accordingly” simply required ENKA to state that it was entitled to receive payment from the banks because F&R had breached its obligations such an obligation added nothing to the statement of breach.

Neither party suggested that this short question of construction should not be determined on this Part 24 application. The Court is in as good a position to determine it now as it would be at trial.

In construing the performance and advance payment guarantees, that is, identifying the meaning which the words used reasonably convey, it is necessary to bear in mind the nature of performance guarantees or bonds (and hence of advance payment guarantees, for neither party suggested their nature was any different from performance guarantees or bonds) as revealed by the authorities. That is part of the background reasonably available to the parties, ENKA, CRB and BP.

In Edward Owen Engineering Ltd. v Barclays Bank International Ltd. [1978] 1 QB 159 Lord Denning concluded that a performance guarantee stood on a similar footing to a letter of credit.

“A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions.” (p.171 B)

Lord Denning had earlier observed that a performance guarantee can be called upon not only where there are substantial breaches of contract but also when the breaches are insubstantial or trivial (p.170 E). Lord Denning observed that this was in the nature of the penalty but nevertheless considered that this was the manner in which a performance guarantee operated.

In Cargill International v Bangladesh Sugar and Food Industries Corporation [1996] 2 Lloyd’s Rep. 524 Morison J. said at p.528:

“The Court will not grant an injunction …unless there has been a lack of good faith. The justification for this lies in the commercial purpose of the bond. Such a bond is, effectively, as valuable as a promissory note and is intended to affect the “tempo” of the parties’ obligations in the sense that when an allegation of breach of contract is made (in good faith), the beneficiary can call the bond and receive its value pending the resolution of the contractual disputes. He does not have to await the final determination of his rights before he receives some moneys.”

A little later, also on p. 528, he said:

“However, it seems to me to implicit in the nature of a bond, and in the approach of the Court to injunction applications, that, in the absence of some clear words to a different effect, when the bond is called, there will, at some stage in the future, be an “accounting” between the parties in the sense that their rights and obligations will be finally determined at some future date. The bond is not intended to represent an estimate of the amount of damages to which the beneficiary may be entitled for the breach alleged to give rise to the right to call.”

In that case particularly clear words were used; the bond was “liable to be forfeited…if the Seller fails to fulfil any of the terms and conditions of this contract…and also if any loss/damage occurs to the Buyer due to any fault of the Seller.”

Those authorities suggest that ENKA’s submission as to the meaning or effect of the word “accordingly” is at least consistent with the manner in which performance guarantees have been understood to operate.

In the light of those authorities it is appropriate to consider whether the words which oblige ENKA to state “accordingly ENKA is entitled to receive payment” impose on ENKA an obligation either to state (expressly or by implication) or to have reason to believe (in the case of the performance guarantee) that ENKA has suffered damage in the amount claimed or (in the case of the advance payment guarantees) is entitled to repayment by F&R of the price paid in advance. I do not consider that they do, for these reasons:

Some reliance was placed by counsel for the Banks upon an observation in Balfour Beatty Civil Enegineering v Technical and General Guarantee Co. Ltd. (1999) 68 Con LR 180 at p.191 that the question was whether, when the demand was made by a contractor upon the guarantor, the persons acting on behalf of the contractor knew that the sum claimed was not due from the sub-contractor. That observation was relied upon by David Steel J. in Uzinterimpex JSC v Standard Bank plc[2007] 2 Lloyd’s Rep. 187 at para. 107 in support of the proposition that a demand which the maker does not honestly believe to be correct as to its amount is a fraudulent demand. However, the terms of the guarantee in Balfour Beatty expressly required a statement that the sum demanded was due and payable; see p.182. The amount which a person is entitled to demand under a guarantee depends upon the true construction of the guarantee in question.

I therefore consider that the meaning which the word “accordingly” in both the Performance and Advance Payment Guarantees would convey to the reasonable commercial man familiar with the nature of performance guarantees and bonds is that the entitlement to the sum demanded from the Banks arises under the guarantees in circumstances where, and because, a demand has been made under the guarantees stating that F&R has failed to fulfil its obligations under the sub-contract. That is consistent with the manner in which such guarantees have been understood to operate and is, on that account, not unreasonable. If it had been intended that, when claiming upon the performance guarantee, ENKA could only demand such sum as it estimated represented the loss and damage caused by F&R’s breaches of contract the guarantee could easily have said so in clear terms. Similarly, if it had been intended that, when claiming upon the advance payment guarantees, ENKA could only demand such part of the advance payment as it claimed was at that time repayable the guarantees could easily have said so in clear terms. On the contrary “the demand shall be conclusive evidence of [BP’s] liability and of the amount of the sum or sums which [BP is] liable to pay to [ENKA], notwithstanding any objection made by [F&R] or any other person.” That ENKA does not need to assert an entitlement to repayment from F&R does not appear to me to be so unreasonable that it cannot be the meaning which the words of the guarantees reasonably convey. An ability to call upon the advance payment guarantees in the event of breach is consistent with ENKA being kept out of pocket in the amount of the advance payments (less any deductions from the monthly progress payments) only so long as F&R is not in breach.

Mr. Gozen’s alleged belief therefore reflects the true construction of the guarantees. It follows that I am unable to accept that his alleged belief is astounding and uncommercial or that it beggars belief. The basis for suggesting that his alleged belief was not honestly held therefore falls away, notwithstanding that the chronology certainly suggests that the demands of 2 December 2008 were a reaction to the termination of the main contract on 26 November 2008.

It was suggested that the terms of the letter dated 7 January 2008 assist BP because they show ENKA giving notice to F&R of a claim against the banks after F&R had become bound to repay the advance payments following the termination notice on 22 December 2008. But ENKA gave notice of proceedings which they had issued on 17 December 2008 prior to the termination notice dated 22 December 2008. I do not consider that the terms of the letter are so clear that they give rise to a real prospect that the Banks will establish at trial that the only realistic inference is that Mr. Gozen could not have honestly believed in the validity of the demands made on 2 December 2008.

I have concluded that CRB (who provided the performance guarantee) has not shown a real prospect that it will establish at trial that the only realistic inference is that ENKA could not honestly have believed in the validity of its demand of 2 December 2008. Since it is not suggested that there is any other compelling reason for trial I consider that ENKA is entitled to summary judgment against CRB. Whether ENKA can retain the amount of the guarantee will no doubt be decided in the arbitration in Moscow between ENKA and F&R.

I have also concluded that BP (who provided the advance payment guarantees) has not shown a real prospect that it will establish at trial that the only realistic inference is that ENKA could not honestly have believed in the validity of its demands of 2 December 2008. Since there is no other compelling reason for trial ENKA is entitled to summary judgment against BP. Whether ENKA can retain the amount of the guarantees will no doubt be decided in the arbitration in Moscow between ENKA and F&R.

If, contrary to my view, BP can show a real prospect that it will establish at trial that the only realistic inference is that ENKA could not honestly have believed in the validity of the demands of 2 December 2008 BP must then show a real prospect that the guarantees had been terminated before the demands of 23 April 2009, which were not said to be fraudulent, had been made. This requires BP to show a real prospect that the demands of 2 December 2008 were a breach of a condition which BP accepted as terminating the guarantee before 23 April 2009. It is arguable that a fraudulent demand is a breach of an implied condition (see Jack, Documentary Credits paragraph 9.14) but I do not consider that the guarantees can be terminated in this way. They were unconditional and irrevocable guarantees. I do not consider that an irrevocable guarantee can be terminated by the guarantor in the manner suggested. The guarantor’s only defence to a claim on the guarantee arises when the demand is made fraudulently.

For the reasons which I have endeavoured to express I shall give judgment to ENKA on its claims against BP and CRB.