In the first half of 2019, Malaysia’s Court of Appeal considered no less than four appeals relating to applications to restrain the calling of performance bonds in the construction sector. These applications were made in support of arbitration under Section 11(1)(f) and (h) of the Malaysian Arbitration Act 2005 (“Act”) (prior to its amendments in 2018), which reads:

“11 Arbitration agreement and interim measures by High Court
(1) A party may, before or during arbitral proceedings, apply to a High Court for any interim measure and the High Court may make the following orders for:

(f) the preservation, interim custody or sale of any property which is the subject-matter of the dispute;

(h) an interim injunction or any other interim measures”

We briefly consider the four decisions of the Court of Appeal where the injunction sought to restrain the call on a performance bond was based on unconscionability,[1] and the practical considerations arising from the Malaysian courts’ treatment of such applications.

In East Coast Economic Region Development Council v Inai Kiara Sdn Bhd & Another[2], the employers commenced litigation in the Malaysian High Court in breach of an arbitration agreement between the parties. The Court of Appeal reversed the injunction granted by the High Court to restrain the employer from calling on the performance bond, and granted a stay of litigation proceedings in favour of arbitration.

The Court of Appeal found that the contractor “failed to establish a strong prima facie case” that the employer had acted in an unconscionable manner in calling upon the performance bond. Referring to various decisions of the English, Singaporean and Malaysian courts, the Court of Appeal remarked that the traditional considerations of ‘serious issues to be tried’ and ‘balance of convenience’ were not relevant in determining whether to grant an injunction against a beneficiary to stop payment by a bank under a performance bond. Yet, the Court of Appeal went on to consider whether there were serious issues to be tried, and whether the balance of convenience was in favour of granting the injunction.

Importantly, the Court of Appeal held that an ongoing arbitration between the parties is not of itself a valid reason to stop the call on a performance bond.

In Target Resources Sdn Bhd v THP Bina Sdn Bhd[3], the dispute related to the termination of a construction contract which was pending determination in arbitration. The contractor applied to the High Court for an interim injunction to restrain the employer from receiving the proceeds under a bank guarantee, and from making any further demand on the bank guarantee pending the resolution of the arbitration. The contractor argued that it would be unconscionable for the employer to receive the proceeds under the bank guarantee. The Court of Appeal considered that the “allegation of unconscionability is fact sensitive and having considered the material facts of this appeal … there is sufficient manifest or strong evidence of some degree in respect of the alleged unconscionable conduct complained of, and not a mere bare assertion.” The Court of Appeal also considered that there were serious issues to be tried, and that the balance of convenience lay in favour of granting the injunction.

In Maxwell Accent JV Sdn Bhd v Kuala Lumpur Aviation Fuelling System Sdn Bhd[4], an application was filed in the High Court for an injunction to restrain the employer from calling on or receiving the proceeds under a bank guarantee pending the commencement and disposal of their dispute by arbitration. The Court of Appeal granted the injunction, noting that there was sufficient evidence to demonstrate a strong prima facie case that “the events leading to the call and conduct of the [employer] are of such degree as to prick the conscience of a reasonable and sensible man“.

In Dunggon Jaya Sdn Bhd v Aeropod Sdn Bhd and Another[5], the contractor alleged that under the express terms of the bank guarantee, monies can only be released by the guarantor bank once the contractor is adjudicated to be in breach of the contract. Although the Court of Appeal noted that the bank guarantee was an unconditional and on-demand performance bond, the employer was restrained from calling on the bank guarantee on the basis that it was unconscionable to do so.

The Court of Appeal found that the employer had engineered a situation to unfairly avoid making payment of sums which were due and owing to the contractor for works completed under the contract. The court accepted that these were “unproven allegations” by the contractor, but stressed that “the test is not whether they are proven or otherwise, but whether sufficient evidence had been placed before the court so as to enable the court to be satisfied, not necessarily beyond reasonable doubt, that a case of unconscionability had been established to an extent that is sufficient for the court to be minded to order the injunction sought…

The Court of Appeal considered that once it was established that (i) there are bona fide serious issues to be tried, (ii) there is a strong prima facie case of unconscionability, (iii) damages would not be an adequate remedy, and (iv) the balance of convenience favours the grant of an injunction, an injunction would be granted. Interestingly, the Court of Appeal noted that there is no need to demonstrate how the injunction supports, assists, aids or facilitates arbitral proceedings.

As a result, the Court of Appeal restrained the employer from calling on or receiving any monies from the guarantee “before any adjudication or decision is made in the [a]rbitration proceedings on the question whether the termination of the contract was wrongful or otherwise.

Comment

Although these cases relate to the Malaysian construction sector and domestic arbitration, it illustrates the importance of being conscious to the choice of law and arbitral seat of a performance bond in the international construction industry.

While courts in common law jurisdictions – including England, Singapore and Malaysia – tend to accept the notion that a performance bond is treated as cash in hand and the beneficiary of the bond should be allowed to avail itself of the bond, there are instances where a different approach is adopted, i.e. Singapore and Malaysia. Parties should be alive to the differences between these jurisdictions, as well as the finer distinctions in how courts of different jurisdictions approach the unconscionability exception in practice.

Where suitable, a party should also be aware of the various options available for contracting out of the possibility of injunctions restraining calls on performance bonds at the negotiation and drafting stage.

  • Trigger events can be defined in advance. To this end, conditional bonds or bonds that require certificates from a third party may help mitigate the risk of wrongful calls.
  • Unconscionability as a ground to restrain a call on a bond may be contractually excluded. While such exclusions are possible under Singapore law (see CKR Contract Services Pte Ltd v Asplenium Land Pte Ltd[6] (here)), it should not be assumed that every other jurisdiction would allow such exclusions.
  • Parties can agree to a law governing a performance bond which does not adopt unconscionability as an exception, such as English law.

Apart from choice of substantive law, the identity of the arbitral seat has significant legal implications. The extent of judicial supervision and intervention in arbitration is governed by the law of the arbitral seat and the practice of its courts, often regardless of the parties’ choice of applicable substantive law. It is equally important to select an arbitral seat whose courts are able to perform such functions well. These are some of the issues:

  • National courts in the arbitral seat will potentially have the authority to grant interim measures in aid of arbitration. Prior to the 2018 amendments, tribunals seated in Malaysia did not have any default powers to grant interim relief under the Act. This made it necessary for parties in arbitrations seated in Malaysia to apply to Malaysian courts for interim relief. It remains to be seen whether the parties to arbitrations seated in Malaysia would resort to a tribunal’s express default powers to grant interim relief in aid of arbitration.
  • Unlike arbitration legislations in Hong Kong and Singapore, the exercise and duration of interim relief granted by a Malaysian court under the Act is not affected by any ability of the tribunal to determine such application in the arbitration itself. For example, under Singapore law, interim measures granted by a court cease to have effect once an arbitral tribunal makes an order which expressly relates to the whole or part of the court’s order on interim measures.[7] In Hong Kong, courts may decline to grant interim measures where the measures sought are currently the subject of arbitral proceedings, and the court considers it more appropriate for the interim measure sought to be dealt with by the arbitral tribunal.[8]
  • Consider the degree of predictability of a national court’s approach to applications for interim relief owing to the specific nature of arbitrations. From the cases considered above, there does not appear to be a uniform approach to applications for injunctions to restrain a call on performance bonds in the specific context of aiding arbitration.

For further information, please contact Peter Godwin, Regional Head of Practice – Dispute Resolution, Asia and Managing Partner, Kuala Lumpur, Nicholas Hoh, Senior Associate, Daniel Chua, Associate, or your usual Herbert Smith Freehills contact.

[1] Since 2012, the Malaysian Federal Court confirmed that Malaysian law joins the ranks of Singapore in allowing unconscionability as an exception to allowing calls on performance bonds: see Sumatec Engineering and Construction Sdn Bhd v Malaysian Refining Company Sdn Bhd [2012] 4 MLJ 1

[2] Civil Appeal No. W-02(IM)(NCVC)-1048-05/2018

[3] Civil Appeal No. B-02(C)(A)-664-03/2018

[4] Civil Appeal No. W-02(C)(A)-827-04/2017

[5] Civil Appeal Nos. S-02(NCVC)(A)-1146-06/2017 and S-02(NCVC)(A)-1147-06/2017

[6] [2015] 3 SLR 1041

[7] Section 31(2) of the Arbitration Act and Section 12A(7) of the International Arbitration Act

[8] Section 45(4) of the Arbitration Ordinance

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.

Peter Godwin
Peter Godwin
Partner
+60 3 2777 5104
Nicholas Hoh
Nicholas Hoh
Senior Associate
+60 3 2777 5106
Daniel Chua
Daniel Chua
Associate
+60 3 2777 5101

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a foreign law practice in Singapore. Where advice on Singapore law is required, we will refer the matter to and work with licensed Singapore law practices where necessary.