A long-held legal position on performance bonds in Kenya is that the terms of an underlying construction contract are irrelevant to a Court when deciding interdict proceedings arising from payments under an on-demand guarantee. The position is anchored upon the principle that liability under an on-demand guarantee is primary and payment by the guarantor is to be made in response to a demand, irrespective of any default under the principal contract.

Performance Bonds Defined

A performance bond is defined as a financial guarantee to one party in a contract against the failure of another party to meet its obligations. It is ordinarily issued by a bank or other financier, to ensure that a contractor fulfills its contractual obligations under a contract.

Important to performance bonds are the parties involved. The principal is the party who requests the surety to issue the bond and whose obligations are guaranteed. The obligee is the party who requires the principal to obtain the bond and who receives the benefit of the guarantee. The surety is the party who issues the bond that guarantees the obligations of the principal, such as a banking institution.

A performance bond is ordinarily triggered by the principal’s default in the performance of the bonded contract. At times, the contract specifies certain events which would constitute a “default”. More often than not however, a default is determined simply by the principal’s failure to meet a contractual obligation.

In this article, we consider a recent decision by the High Court of Kenya (Mongare J) in HCCCOMM No. E359 of 2022: Civicon Limited v Fuji Electric Co. Limited & 2 Others (the Suit) in which the Court dismissed two (2) applications seeking to restrain Equity Bank (Kenya) Limited (the Bank) from paying Fuji Electric Co. Limited (Fuji) the proceeds of a USD 2.3 million performance bond issued in Fuji’s favour (the Performance Bond).

Background to the Case

Sometime in 2018, Kenya Electricity Generating Company PLC (KenGen) and Marubeni Corporation (Marubeni) entered into a contract for the construction of a Geothermal Power Plant Project. Marubeni subcontracted its scope of works to Civicon Limited (Civicon) and Fuji who formed a consortium and entered into various agreements detailing their respective scope of works. It was also agreed by the parties that Civicon would provide and maintain with Fuji, the Performance Bond to secure its due performance under the contracts. Accordingly, Equity Bank issued the Performance Bond to Fuji in the sum of USD 2.3 million on behalf of Civicon.

In 2022, a dispute between the parties arose from Fuji’s decision to call up the said Performance Bond which Civicon alleged, inter alia, to have been done in breach of the relevant agreements signed by the parties. Civicon therefore filed a suit accompanied by an application in which it sought and obtained an interim order restraining the Bank from effecting any payment to Fuji arising out of the Performance Bond (the Status Quo Order).

The Stay Application

By a Notice of Motion application dated 30th September 2022 (the Stay Application), Fuji applied to stay the Suit and the proceedings filed by Civicon. The Stay Application was based on grounds that, they concerned a dispute regarding Fuji’s right to call up the Performance Bond, which was subject to an arbitration clause under the various agreements entered into between the parties. Fuji submitted that the parties expressly ousted the jurisdiction of the High Court in electing to resolve any dispute arising between them by way of arbitration.

Civicon opposed the Stay Application on grounds that the issue of calling up or not of the Performance Bond is not an arbitrable matter within the framework of the arbitration clause contained under the various agreements. Further, Civicon argued that the dispute in the matter involves the Bank which is not privy to the agreements whose arbitral clause Fuji purported to invoke.

The High Court Decision

By way of a Ruling delivered on 12th June 2023 (the Ruling) Hon. Lady Justice Mongare (the Judge) allowed Fuji’s Stay Application on grounds, amongst others, that it was expressly intended that all disputes between the parties, including a dispute concerning the Performance Bond, be resolved by way of arbitration. The Judge considered the fact that Civicon’s Suit and its application was hinged upon whether or not Fuji had a right to call up the Performance Bond on account of the various claims it had against Civicon and found that the Performance Bond was a creation of the agreements from which the arbitral clause emanated.

For the said reasons, the Judge stayed the proceedings in the Suit pending reference of the matters raised therein to arbitration and also set aside the Status Quo Order restraining the Bank from effecting any payment to Fuji arising out of the Performance Bond.

The Section 7 Application

Notwithstanding the stay order and the Ruling, Civicon proceeded to file another application before the High Court under section 7 of the Arbitration Act, 1995 (the Arbitration Act) in which it sought and was granted, an interim measure of protection restraining the Bank from effecting any payments arising out of the Performance Bond to Fuji, pending conclusion of the arbitration proceedings (the Section 7 Application).

Civicon anchored the Section 7 Application on grounds amongst others, that if the Bank were to honour the Performance Bond, the substratum of the arbitral proceedings would be eroded.

In response thereto, Fuji raised a preliminary jurisdictional issue that the Court, having stayed the proceedings and directed the parties to submit their dispute to arbitration, was now functus officio and could not make any further orders in the matter.

The Judge delivered a Ruling on the Section 7 Application on 15^th August 2023 (the Section 7 Ruling), the upshot of which was that the Court agreed with the arguments proffered by Fuji, specifically that the Court, having already rendered its decision in the matter, is now bereft of jurisdiction and could not make any further orders therein. Accordingly, the Judge dismissed the Section 7 Application and once again, vacated the interim Orders restraining the Bank from effecting any payment to Fuji arising out of the Performance Bond.

Upshot

The High Court’s decision sets an important precedent in two (2) respects. Firstly, where parties have expressly ousted the jurisdiction of the Court in deciding that any dispute arising between them be settled through arbitration, the Court is duty bound to uphold the arbitration agreement between them. This is notwithstanding the fact that the dispute arose from a decision to call up a performance bond in which the principal is not privy to. The fact that the Performance Bond was a creation of the agreement between the parties in which the arbitral clause emanated from is sufficient for the Court to hold parties to the terms of their agreement.

Secondly, a Court will be reluctant to grant interim measures of protection where it has already stayed the matter and referred the proceedings to arbitration. This principle is anchored upon the basis that the Court is functus officio i.e. it has already rendered its decision in the matter and therefore lacks the power or jurisdiction to make any further orders until the arbitration process is finalized.

The Sanctity of Performance Bonds

In rendering its decisions, the High Court has affirmed the sanctity and commercial importance of on-demand guarantees. The very nature of an on-demand-guarantee means that it is payable unconditionally upon demand. By agreeing to provide a bond which is payable on demand, a principal agrees that the bond may be called pending resolution of any dispute with the counterparty beneficiary. It therefore requires strict compliance and its enforcement is neither dependent nor affected by any underlying dispute between the parties.

As was aptly put by the High Court in Eli Holdings Ltd v Kenya Commercial Bank (2020) eKLR:

“A bank guarantee is an autonomous contract which requires strict compliance to its terms. The Bank has no obligation to question the performance or otherwise of the obligations of the parties in the underlying contract…As a general proposition, a demand guarantee is independent of the primary contract and will not be affected by a dispute between the parties to the underlying transaction.”

As Civicon has lodged an Appeal against the initial Ruling, it will be interesting to see what the Court of Appeal makes of the matter. For now, we align ourselves with Lord Denning in the case Edward Owen Engineering Ltd. v Barclays Bank International Ltd. and Another (1978) 1 All ER 976 where the learned Judge opined that:

“The performance bond given by the bank is a binding international obligation payable on demand. If an interim injunction were granted in a case of this sort it would affect the pattern of international trading. There is no reason why the bank should be involved in disputes between buyer and seller.”