Change of Circumstances: Frustration and Force Majeure
The COVID-19 pandemic has led to increased awareness of the issues that might arise if 8.46 obligations that are guaranteed by performance bonds are affected by frustration or force majeure.
This section discusses whether the courts in the UK and Singapore might grant an injunction to restrain call on a performance bond by a beneficiary in a situation where the applicant is unable to perform its obligations in the underlying contract due to a change in circumstances; and also the potential effect of government action on the grant of such injunctions.A. General Principles
Whether the applicant has breached the underlying contract, or at least, whether the bene- 8.47 ficiary believes that the applicant has done so, is crucial to the availability of an injunctive remedy. Non-performance would normally constitute a breach of contract, unless the nonperforming party has a lawful excuse. Under the common law, a change in circumstances will excuse the applicant from its duty to perform if the underlying contract is frustrated (this is difficult to show),[828] or if the new situation falls within a force majeure clause which has the effect of releasing a party from its contractual obligations, either temporarily or permanently (this depends on the drafting and construction of the clause).[829]
8.48 Applying the doctrine of autonomy, the performance bond is separate from the underlying contract, and the bank has a duty to honour the call on the bond if a complying demand is made, regardless of what happens in the underlying contract. But would this still be the case if the underlying contract is frustrated, or the applicant is released from its obligations by a force majeure clause? Frustration discharges both parties from the contract, whereas the consequences of force majeure will depend on the provisions of the force majeure clause.
If the contract has clearly been frustrated or performance has clearly been excused by a force majeure event, one could argue that it would be at least unconscionable, and possibly also fraudulent, for the beneficiary to call on the performance bond, and an injunction is likely to be ordered in these circumstances. However, the situation is rarely so clear cut. At the time of the call on the bond, the contracting parties would usually not have had the benefit of a judicial or arbitral ruling. They may not be sure whether the underlying contract has been frustrated or whether a force majeure clause has been activated.B. Frustration
8.49 The law of frustration operates within narrow limits. In order for a contract to be frustrated, the performance of the obligation must be radically different from the performance that had been undertaken by the parties.[830] The courts in both the UK and Singapore have made it clear that the fact that performance of the contract has become more onerous or less profitable will not cause a contract to be frustrated.[831] In normal circumstances, if a performance bond guarantees proper performance of the seller's obligations under a sale contract, and the seller anticipates that the goods will be shipped from a certain port, but that port is closed, even if the seller claims that the contract has been frustrated, the buyer is likely to argue that the goods could still have been shipped through a different port. However, an event of the scale of the COVID-19 pandemic that has devastated countries across the globe, where transport, labour, and business activities are severely disrupted, is likely to make performance of the contract truly impossible and therefore be found to be a frustrating event. A contract would also be frustrated if performance becomes illegal,[832] which would be the case, for instance, if performance would contravene government regulations introduced to manage the pandemic.
It may be that in the most obvious cases where it is clear that the contract cannot be performed, the court might find that the beneficiary did not honestly believe that the applicant was in breach of contract, and a call on the bond will be restrained as being fraudulent, or at least unconscionable; but this will usually not be the case. Whether a contract is frustrated is a matter of law, and it is difficult for the parties to be sure whether frustration has taken place until the courts have decided on the matter. A beneficiary should, therefore, be able to justifiably call on the bond regardless of the applicant’s assertions that the contract has been frustrated.[833]C. Force Majeure
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The uncertainty of the doctrine of frustration can be avoided by inserting a force majeure clause into a contract, providing for the obligations of the parties if an unexpected event happens that is outside their control. The relevant force majeure events and their consequences depend on how the clause is drafted. For example, the contract may provide that the obligations of the parties are to be suspended for a certain period, or that they are to enter into negotiations for an amicable settlement, or simply that the obligations will come to an end. Force majeure clauses are subject to interpretation, and it may not be clear whether a certain event falls within its scope. For instance, if the clause applies to acts of God, followed by a list of specific examples like floods, earthquakes, and typhoons, and does not include mention of virus outbreaks, it is not clear if a virus pandemic would be covered by the clause. It would be difficult for the applicant to show a strong prima facie case that the beneficiary had no honest belief that it was entitled to call on the bond, unless the relevant event is one that obviously fell within the force majeure clause and was the cause of the applicant’s inability to perform.
Obtaining an injunction based on the unconscionability exception is not necessarily easier, because calling on a bond when there is a genuine dispute whether the applicant’s failure to perform is excused under the force majeure clause does not indicate sharp practice or a lack of bona fides. It would seem difficult to obtain an injunction based on either exception.8.51
Min Thai Holdings Pte Ltd v Sunlabel Pte Ltd (Min Thai’),[834] a case that came before the High Court in Singapore, involved a force majeure situation. The seller of rice from China procured a performance guarantee that was payable to the buyer if the seller defaulted on delivering the rice within an agreed schedule. The seller gave notice that it was unable to deliver the rice on time because of severe flooding in China, to an extent that the country had not experienced in the last 100 years, and that this inability fell within the force majeure clause in the sale contract. The clause provided that a party was not liable for a failure to perform any of his obligations if he could prove that the failure was due to an impediment beyond his control.[835] Events such as ‘floods’ were explicitly identified as being included within the meaning of ‘impediment’. The buyer nevertheless called on the performance guarantee. It asserted that due performance of the contract was not excused by the floods and typhoons, as the areas from which the rice was to be supplied were not affected and the seller was still able to source the rice. The High Court ordered the continuance of an interim injunction that had earlier been granted to restrain the buyer from receiving any money under the guarantee. The Court found that it was unconscionable for the beneficiary to receive payment under the performance bond as there were serious issues to be tried between the parties, such as whether the contract was affected by force majeure and also whether the force majeure clause applied.[836]
8.52 The Min Thai decision requires further analysis.
If indeed there were serious issues to be tried between the parties, this would seem to be precisely the situation in which a performance bond is needed, so that the beneficiary could be paid while waiting for the dispute to be settled. The question arises whether there are different expectations between the parties when the reason for non-performance is allegedly a force majeure event (rather than some other reason), which would require the beneficiary to wait until the dispute was settled before claiming on the bond. There was nothing in the reported judgment which pointed specifically to such different expectations in the Min Thai case.8.53New Roman"'> Some guidance may be obtained from another Singapore case, China Resources (S) Pte Ltd v Magenta Resources (S) Pte Ltd (‘China Resources’),[837] although this was not a decision involving the grant of an injunction as the beneficiary had already been paid under the performance bond. The contract here was for the sale of ‘prilled urea of USSR origin’. The buyer was unable to meet the first shipment date provided in the contract and notified the seller that it was invoking the force majeure clause in the sale contract, on the basis of the political turmoil in Russia. The Singapore Court of Appeal was satisfied that the breakup of the former USSR fell within the force majeure clause, which explicitly extended to situations such as ‘war, military action... etc’. The Court was of the view that the collapse of the Soviet Union ‘had caused so much uncertainty, tension and chaos in the territories of the former Soviet Union that it was a situation akin to war and was capable of being a force majeure situation’ within the contemplation of the force majeure clause.[838] The Court found that the seller had shown that their inability to ship the urea was due to the force majeure situation, that they informed the buyer immediately of the force majeure, and that they produced certification of the event that complied with the requirements of the clause.[839] The Court’s decision that the buyer should not have called on the bond was reinforced by the fact any dispute could have been settled in accordance with the arbitration clause.
The contract also provided that, in the event that the force majeure continued for more than 120 consecutive days, the parties were to ‘discuss through friendly negotiation as soon as possible their obligation to continue to perform under the terms and conditions of the contract’.[840] The Court found that there was ‘no justification for the buyers peremptorily to call on the performance bond in the way they did’.[841] The Court concluded that the wrongful call was a clear a repudiation of the sale contract by the buyers, and the sellers were entitled to accept the repudiation and claim for damages and a refund of the amount that had been paid to the buyers under the performance bond.An important question in situations involving a force majeure clause is whether the parties intended that the beneficiary should be able to make a demand on the performance bond even though the applicant who is unable to perform seeks relief under the force majeure clause.[842] This will be a deciding factor in the court's decision whether an injunction should be granted to restrain the beneficiary from calling on the bond in these circumstances. Given that the main purpose of a force majeure clause is to allocate risks if one of the parties is unable to perform as a result of a disruptive external event, the parties in a contract may well have intended that the provisions of the force majeure clause should first be applied to decide the obligations of the parties, before the performance bond was called on. This interpretation of the parties' intentions will be strengthened if the force majeure clause prescribes dispute settlement mechanisms, such as for arbitration or negotiation, as was the case in China Resources. One potential danger of this interpretation from the beneficiary's point of view is that its protection under the performance bond may be thwarted if the applicant frivolously claims relief under the force majeure clause in order to excuse a delay in performance. However, this situation can be dealt with by the court, even at an interlocutory stage. In deciding whether to grant an injunction to restrain payment, the court can consider the genuineness of the applicant's assertion of force majeure when it is assessing whether the beneficiary was acting dishonestly or unconscionably in calling on the bond.
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For the sake of greater clarity, it might be a good idea for contracting parties to make their intentions clear, and state whether the beneficiary is entitled to call on the performance bond in circumstances where the applicant has invoked relief under a force majeure clause, or whether the right to call on the bond is to be suspended until the procedures set out in the force majeure clause have been exhausted. If there is a clause in the underlying contract that expressly suspends the beneficiary's right to call on the bond when the applicant has claimed relief under a force majeure clause, there may be an additional ground to apply for an injunction if the beneficiary makes a call in contravention of the clause. In these circumstances, restraint may be obtained on the basis of a breach of the underlying contract.[843]
D. Government Action
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While the operation of performance bonds has been relatively undisturbed by government actions in the past, this cannot be taken for granted, as the examples from the UK and Singapore arising from the COVID-19 pandemic illustrate.
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In May 2020, the UK government published Guidelines to strongly encourage ‘all individuals, businesses (including funders) and public authorities to act responsibly and fairly in the national interest in performing and enforcing their contracts, to support the response to Covid-19 and to protect jobs and the economy'.[844] The Guidelines requested responsible behaviour in relation to various matters including requesting, and giving, relief for impaired performance in respect of time for delivery of goods and completion of works and services and the making of payments; requesting, and allowing, extensions of time; making, and responding to, force majeure or frustration claims; and ‘exercising remedies in respect of impaired performance, including... calling of bonds or guarantees... (emphasis added)’.[845]
8.58 A relevant question is whether an applicant could succeed in obtaining an injunction if a beneficiary called on the bond without regard to the Guidelines. It would be unlikely to succeed under the fraud exception. It would be difficult to show that the beneficiary did not honestly believe that it was entitled to make a demand under the bond, merely by virtue of the fact that it did not behave according to the Guidelines, as these are non-statutory guidance with no mandatory effect. They are expressly stated not to be intended to override contractual provisions or the law.[846] The applicant may stand a better chance of obtaining an injunction based on the unconscionability exception (if this exception applied in the UK). But even if the beneficiary is not willing to make concessions or renegotiate the contract to accommodate the other party as requested by the Guidelines, this may not mean that it is acting in a manner that is lacking in bona fides so as to justify the grant of an injunction.[847]
8.59 An example of a different response to the CO VID-19 pandemic was seen in Singapore, where there was legislation to impose a moratorium (initially for a period of six months) on certain acts in relation to specific types of contracts if parties were unable to perform their obligations due to COVID-19.[848] This legislation did not excuse a breach of contract by the non-performing party, but merely prevented the aggrieved party from taking certain actions in relation to the scheduled contracts, such as bringing or continuing a court action or arbitration proceedings against the non-performing party, or terminating the contract, during the period of relief.[849] There were specific provisions that applied to performance bonds given in the context of international trade. These provisions prohibited the call on any performance bond given in relation to construction or supply contracts at any time earlier than seven days before the date of expiry of the bond; or where the term of the performance bond had been extended, earlier than seven days before the expiry following such extension.[850] Such legislative intervention clearly affected the rights of beneficiaries, but like interim injunctions, they were temporary, designed to preserve the applicant’s liquidity and allow it some lead time before the beneficiary could call on the bond. The beneficiary’s right to call on the bond was postponed but not otherwise affected. A beneficiary who called on a performance bond in contravention of the statute would be liable for an offence, and
government/uploads/system/uploads/attachment_data/file/883737/_Covid-19_and_Responsible_Contractual_ Behaviour web_final_________________ 7_May_.pdf> [1]. This was updated on 30 June 2020: accessed 21 August 2020.
the call would be void.[851] Interestingly, there was no similar moratorium or prohibition in Singapore applying to documentary presentations under commercial LCs. Presumably, the thinking was that if a seller had shipped goods, he was entitled to be paid. This is consistent with the policy distinction between performance bonds and commercial LCs in the development of the unconscionability exception in Singapore.
VI.