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The Unconscionability Exception

to which the beneficiary is entitled under the underlying contract, the court should allow the beneficiary to receive full payment under the performance bond, since that is the very purpose of the bond. Any overpayment will be recouped in the final accounting exercise between the parties, as explained in Chapter 11 below.

7.13 The lack of good faith exception identified in the T T I case appears to be limited to injunc­ tions to restrain a beneficiary from demanding payment20 where the bank is not a party and where the injunction would stop a demand before it is made. The court appeared to accept that where the application is for an injunction to restrain a bank from making payment the lack of good faith exception does not apply.21

7.14 Although the exception cannot be relied on to restrain a bank from making payment to the beneficiary, the question arises whether the bank can rely on it to refuse payment to the beneficiary. In many cases the bank will not be in a position to support an allegation of unconscionable conduct without evidence provided by the account party. But where the bank has knowledge of unconscionable conduct on the part of the beneficiary, should the bank be entitled to refuse payment and to raise unconscionable conduct as a defence in an action by the beneficiary against the bank for summary judgment? In the case of fraud by the beneficiary, if the bank has knowledge it is obliged and entitled to refuse payment and to raise fraud as a defence in an action by the beneficiary against the bank. It may be said that fraud is different because the bank is sometimes the target of the fraud22 whereas in the case of unconscionable conduct the victim will normally be the account party rather than the bank. It is not entirely clear whether the same applies in the case of unconscionable conduct.

7.15 Considering the standard of proof, in T TI v. Hutchison 3G ,23 in an application for an interim injunction, Judge Thornton QC said that the lack of faith needed to found a restraining order ‘must be established by clear evidence even for the purposes of interim relief’.24 This seems to suggest that the standard required is that of an ‘established’ lack of good faith, which is the standard required at a full trial, rather than the lower standard of a ‘good arguable case’ that on the material available the only realistic inference is that of lack of good faith, which by analogy with the fraud exception, should be the standard required at the interim injunc­ tion stage.25 The Singapore courts have now adopted the lower standard of ‘strong prima facie’ case for the interlocutory stage both for the fraud and the unconscionable conduct exceptions.26

2. Secure in Authority?

7.16 The policy considerations in favour of and against recognition of an unconscionable conduct or lack of good faith exception are discussed at paragraphs 7.29 to 7.35 below. This section examines the question whether the proposition advanced in the T T I case that English law already recognizes a separate unconscionable conduct exception is well founded in

20[2003] EWHC 762 (TCC); [2003] 1 All ER (Comm) 914 at [46(1)].

21Ibid., at [31].

22That is why a bank that pays pursuant to a fraudulent demand has a claim in damages in an action for

deceit against the fraudulent beneficiary. See discussion in Chapter 11.

23[2003] 1 AUER (Comm) 914.

24Ibid., at [46(3)] and also [37].

25See discussion at paras 5.71 to 5.74.

26See discussion at para 7.55.

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by the Court of Appeal in cases involving demand guarantees or performance bonds. In

Howe Richardson Scale Co Ltd v. Polimpex-Cekop,30 where the court refused to intervene,

27[1966] 2 Lloyd’s Rep. 495.

28Ibid., at 497.

29Ibid., at 498.

30[1978] 1 Lloyd’s Rep. 161.

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Roskill L.J. said that the Elian case should be regarded as a very special case.3132The decision in Howe Richardson was approved by the Court of Appeal in Edward Owen Engineering Ltd v. Barclays Bank International, K where the court also refused to grant an injunction restrain­ ing payment under a performance bond. In Edward Owen, the Elian and Rabbath case was cited to the court in support of the account party’s claim for an injunction to restrain pay­ ment. However, Lord Denning M.R., who was a member of the court in the Elian and Rabbath case, refused to apply the case, holding that the Edward Owen case ‘is a new case on a performance bond or guarantee which must be decided on the principle applicable to it’.33345 Lord Denning appeared to be suggesting that the instrument in the Elian and Rabbath case was not considered to be a performance bond (it might have been regarded as a suretyship guarantee). Indeed in GroupJosi v. WalbrookInsurance3*Staughton L.J. explicitly stated that the Elian and Rabbath case ‘was not about a letter of credit or a performance bond, but merely an ordinary guarantee’. Against this background, can the Elian and Rabbath case really be regarded as a solid foundation for an unconscionable conduct exception to the general principle of autonomy of performance bonds?

7.20In the T T I case the court also relied on a passage in the judgment of Morison J. in Cargill International SA v. Bangladesh Sugar and Food Industries Corp35 where the learned Judge said that the court will not grant an injunction restraining a call or payment ‘unless there had been a lack of good faith’. However, closer inspection reveals that Morison J. used the phrase ‘lack of good faith’ to mean the fraud exception. The passage in which the phrase is found contains a general statement of the law in this area and there is no separate mention of the fraud exception as another ground for intervention. Morison J. could not have intended to add a bad faith exception to the well-established fraud exception without saying so expressly.

7.21Moreover, in the Cargill case, one issue for decision was whether the beneficiary was entitled to demand payment of the full amount of the bond if the breach of the underlying contract had caused no loss to the beneficiary or had caused loss which was less than the amount of the performance bond. Morison J. actually answered that question in the affirmative,36 whereas a bad faith or unconscionable conduct exception may be used to prevent calls in precisely such a case where the beneficiary demands payment of the full amount of the bond even though he has suffered no loss or has suffered loss which is less than the full amount of the bond.37 If Morison J. was recognizing a new lack of good faith exception, surely he would have relied on it to hold that a beneficiary is not entitled to demand full payment at least where he has suffered no loss. Thus, the decision in Cargill, far from being in line with the position in Singapore where an unconscionable conduct exception has been recognized as a deliberate departure from the position of English law, may be regarded as an example of the divergence between the English position (which does not recognize an unconscionable

31Indeed in Group Josi Re v. Walbrook Insurance [1996] 1 Lloyds Rep. 345, 357, Clarke J. refused to accept that the Elian case is authority for the proposition that there is an additional exception to the autonomy principle apart from fraud.

32[1978] 1 QB 159.

33Ibid., at 172.

34[1996] 1 Lloyd’s Rep. 345 at 359.

35 [1996] 4 All ER 563 at 5 6 8 . [ 1998] 1 WLR461.

36If, as a result, the beneficiary is overpaid, that overpayment can be recovered in accordance with the principles discussed in Chapter 12 below.

37e.g. Eltraco InternationalPte Ltd v. CGH Developments Pte Ltd [2000] 4 SLR 290.

1 6 6

exception apart from fraud, he did not identify lack of faith or unconscionable conduct as the other possible exception. Instead he identified a couple of specific instances when, he suggested, a court could intervene to restrain the beneficiary from demanding payment. One of these is where there has been a failure of consideration in the underlying contract. Yet the authorities indicate that even this specific instance is not a recognized basis for restraining a demand for payment. In Potton Homes Eveleigh L.J. gave the example of an employer under a large construction project who agreed to provide finance (perhaps by way of advance payment) and a contractor who agreed to provide a performance bond. He said that if the contractor was unable to perform because the employer failed to provide the finance the court should be able to have regard to the terms of the underlying contract and restrain the employer from demanding payment under the bond. Eveleigh L.J.’s statement was fol­ lowed by the High Court of Singapore in one case41 where buyers who had failed to open a letter of credit under the underlying contract of sale were restrained from demanding pay­ ment under a performance bond. That is perhaps not surprising in a jurisdiction where an unconscionable conduct exception is recognized. But in England, in Edward Owen Engineering Ltd v. Barclays Bank International,42 on similar facts, the Court ofAppeal refused to grant an injunction to restrain payment under a performance bond to the beneficiary buyers, who had also failed to open a letter of credit in accordance with the underlying con­ tract. If, as the court in TTTsuggested, English law recognized a lack of good faith exception applicable in cases of this type then the Court of Appeal would have applied the exception in the Edward Owen case.

38See, e.g. Q. Loh and Fang Hang Wu, ‘Injunctions Restraining Calls on Performance Bonds —Is Fraud the Only Ground in Singapore?’ [2000] LMCLQ 348, 362.

39(1984) 28 BLR 19.

40Ibid., at 28.

41Kvaemer SingaporePte Ltd v. UDL Shipbuilding (Singapore) Pte Ltd [1993] 3 SLR 350.

42[1978] 1 QB 159.

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The Unconscionability Exception

7.25Thirdly, there is no other English authority adopting the suggested additional exception, whether in the specific instances identified43 or as the basis of a wider lack of faith exception.44 On the contrary, in GroupJosi Fie v. Walbrook Insurance,4546Staughton L.J., who expressed the view that English law on this topic ‘is not wholly satisfactory’, recognized that the traditional approach that fraud is the only exception is ‘too well established for change to take place in this court’. He therefore envisaged that if the position of English law is to be shifted from the current non-interventionist leanings to a more interventionist approach that can only be achieved at the higher level.

7.26Another authority which may be taken to support the view that there is, in addition to the fraud exception, a separate exception based on the unfairness of a demand is Bristol Meci Australasia Pty Ltd v. Ericsson Business Networks A B Aealthough this was not referred to in the judgment in the 7 7 7 case. In the BristolMeci case it was argued47 that apart from the fraud exception, there was a wider exception to the effect that the court will grant an exception to prevent payment being made to the beneficiary unjustly. In that case Saville L.J., who deliv­ ered the judgment of the Court of Appeal, was prepared to accept, without hearing counsel for the beneficiary, ‘that there might be some argument that performance bonds might be subject to what one can describe as a further exception over and above the fraud exception, which is of course well established’. However, Saville L.J. was only accepting that there might be some argument in favour of a separate exception in addition to the well-established fraud exception. He was not saying that the separate exception was already established like the fraud exception. Moreover, Saville L.J. did not hear argument on the point and he rejected

the claim on the facts.

B. Authorities that cast doubt on the existence of the exception

7.27The proposition that English law already recognizes an unconscionable conduct exception runs directly contrary to numerous dicta in the Court of Appeal and the House of Lords to the effect that fraud is the only exception.48 In the United City Merchants case Lord Diplock, who delivered the judgment of the House of Lords, said that the fraud exception was the ‘one established exception’.49 These authorities were not mentioned in the judgment in the

T T I case.

7.28Even after the decision in T T I there is still doubt as to whether the unconscionability exception is recognized in English law. HLCEngenharia E Gesto deProjectosSA v. AM NAmro

43 In Moussaka Inc v. Golden SeagullMaritime Inc [2002] 1 Lloyd’s Rep. 797, for example, the court refused to accept an argument that failure or absence of consideration between the parties to the underlying contract affects the issuers undertaking under the autonomous instrument.

44Although the statement inspired the Singapore courts in adopting a separate unconscionability exception. See, e.g. Kvarner Singapore Pte Ltd v. UDL Shipbuilding (Singapore) Pte l.td{ 1993) SLR 350, approv’d\a GHL Pte Ltd v. Unitrack Building Constructions Pte Ltd [19991 4 SLR 604.

45[1996] 1 WLR 1152, 1162.

46[1996] EWCA Civ 807.

47 Relying on Potton Homes v. Coleman Contractors Ltd (1984) 28 BLR 19 and Ihemehelp v. West [1996] 1 QB 84.

48e.g. UnitedCityMerchants (Investments)Ltd v. RoyalBank of Canada [1983] 1AC 168, 182\Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] QB 159, 171; [1978] 1 Lloyd’s Rep. 166, 172; The Bhoja Trader [1981] 2 Lloyd’s Rep. 256, 257; Bolivinter OilSA v. ChaseManhattan Bank[ 1984] 1 Lloyd’s Rep. 251,257; United Trading CorpSAv. AlliedArab Bank Ltd [1985] 2 Lloyd’s Rep. 554.

49[1983] 1 AC 168, 182.

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II. Status o f the Exception Under English Law

Bank N V 50 concerned an ex parte application for an interim injunction against the benefi­ ciary and the bank. It was argued for the applicant that, apart from the fraud exception, there was a wider exception in equity that an injunction will be granted to prevent money being paid out unjustly, although counsel for the applicant freely accepted that the authorities on the point were not entirely clear. The judge found that there was enough evidence for him to conclude that the only realistic inference to be drawn from the facts was that the demand was made fraudulently. Consequently, it was not necessary to decide the question whether or not there is a principle in equity that would justify the granting of an injunction in these circumstances absent the existence of fraud’. However, the judge came to the conclusion that ‘the authorities are far from clear-cut’ on the point.5' So, in terms of authority it is an open question whether English law recognizes a general lack of good faith or unconscionable conduct exception separate from the fraud exception. That question is unlikely to be settled, so far as English law is concerned, unless there is a clear decision on it in a case where the point is fully argued between the parties. In such a debate, policy considerations are likely to play an important role.

3. Policy Considerations

ous purpose, as where it is used during negotiations for a separate contract between the par­ ties as a means of putting pressure on the account party to agree to contractual terms more

50[2005] EWHC 2074 (QB).

51Ibid., at [38].

52GHL Pte Ltd v. Unitrack Building Construction Pte Ltd [1999] 4 SLR 604.

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The Unconscionability Exception

favourable to the beneficiary.53 A further situation where the reach of the unconscionable conduct exception goes beyond that of the fraud exception is where the breach relied upon to call on the guarantee was induced by the beneficiary’s own breach of the underlying contract. Thus, whereas in Edward Owen Engineering Ltd v. Barclays Bank International the court could not intervene on the ground of fraud, in a similar situation the Singapore court was able to intervene on the ground of the unconscionable conduct exception.54 In short, there are a wide variety of situations where protection against abusive calls will be available under the unconscionable conduct exception in circumstances where recourse to the fraud exception is not possible.55

B. Reasons against an unconscionable conduct exception

7.32 Three main reasons may be advanced against recognition of an unconscionable conduct exception.

7.33 The first reason against an unconscionable conduct exception is that the doctrine of uncon­ scionability is an imprecise and vague ground for relief.56 If it is recognized, it is likely to inject considerable uncertainty in this area ol the law where clarity and certainty are highly valued. Such uncertainty is likely to increase litigation on the enforceability of the benefi­ ciary’s apparent right to demand payment under the letter of credit or demand guarantee.57 If that were to happen the unique attraction of these instruments as the equivalent of cash would be undermined. The danger of uncertainty may be one of the reasons why the excep­ tion has not been adopted in certain overseas jurisdictions although it has been recognized in others.

7 .3 4 The second reason against the unconscionable conduct exception is that since conduct which falls short of fraud could be unconscionable or lacking in good faith, recognition of the exception will result in more frequent judicial interference in the operation of letters of credit or performance bonds. Easy availability of injunctions would destroy confidence in letters of credit and demand guarantees as the equivalent of cash and undermine their utility as the lifeblood of international commerce. It is perhaps worth noting that in Singapore, where the exception has been recognized, and where initially injunctions were granted in a

53e.g. Samwoh Asphalt Premix PTE Ltd v. Sum Cheong Piling PTE Ltd [2002] BLR 459.

54Royal Design Studio Pte Ltd v. Chang Development [1991] 2 MLJ 229; Kvaemer Singapore Pte Ltd v. UDL Shipbuilding (Singapore) Pte Ltd (1993) SLR 350. However, the mere fact that the beneficiary has committed a breach of contract does not render his call unconscionable if the beneficiary’s breach did not induce or cause the breach relied upon as the basis of the call or if the breach had been affirmed by the account party; Dauphin Offshore Engineering dr Trading Pte Ltd v. The Private Office o f HRH Sheikh Sultan bin Khalifa nin ZayedAl Nahyan [2000] 1 SLR 657.

55Such as where the beneficiary has suffered no loss or where the loss suffered is less than the amount demanded under the bond. See, e.g. Eltraco International Pte Ltd v, CGH Development Pte Ltd [2000] 4 SLR 290, where the court intervened to restrain the call but only as to the part of the amount that was over and above the loss suffered as a result of the breach, cf. the Australian case of OlexFocas PtyLtd v. Skodaexport Co Ltd [1998] 3 VR 380, in respect of the mobilization guarantees.

56For the difficulties encountered in Australia and Singapore in defining what amounts to unconscionable conduct for this purpose, see the discussions in paras 7.43 to 7.49 and 7.52 to 7.53 below.

57In Singapore an initial burst of litigation appears to have slowed down: Anwar v. Teo Нее Lai Building

Construction Pte Ltd [2003] 1 SLR 394; Samwoh Asphalt Premix Pte Ltd v. Sum Cheong Piling Pte Ltd [2002]

Khalifa nin Zayed Al Nahyan [2000] 1 SLR 657; Eltraco International Pte Ltd v. CGH Development Pte Ltd

[2000] 4 SLR 290.

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III. Some Overseas Authorities

number of cases, the courts now appear to be attempting to roll back the ground covered by the exception. Thus, in a series of recent cases58 the courts have refused to intervene on the ground of unconscionable conduct stating, in one case, that it ‘is important that the courts guard against unnecessarily interfering with contractual arrangements freely entered into by the parties. The parties must abide by the deal they have struck’.59

Thirdly, recognition of the unconscionable conduct exception is likely to get the courts 7.35 involved, at the interlocutory stage, in what are essentially disputes relating to the perfor­ mance or breach of the underlying contract when such disputes should be resolved in separate proceedings and in accordance with any arbitration or jurisdiction clause of the underlying contract. This may arise, for example, where it is alleged that a call is unconscionable because

the breach on which the beneficiary relies was due to the beneficiary’s own breach of con­ tract, the beneficiary has suffered no loss as a result of the breach, the loss suffered is less than the amount claimed under the bond, or the beneficiary already holds a substantial amount of money due and owing to the account party.60 Allegations of this kind will require the court to look into the consequences of the breach to ascertain what loss if any the beneficiary has suffered or, where the beneficiary already holds some security, whether the cost of rectifying the breach exceeds the amount held by the beneficiary.61 Yet the purpose of the letter ofcredit or demand guarantee is to provide the beneficiary with payment pending resolution of dis­ putes of this kind. The letter of credit or demand guarantee is simply a mechanism of risk allocation the purpose of which is to ensure that the beneficiary is paid before the resolution of any dispute between the parties arising from the underlying contract. To the extent that an unconscionable conduct exception prevents the beneficiary from receiving payment before resolution of disputes arising from the underlying contract it defeats the purpose of the instrument. It is suggested that the correct approach is that adopted by Morison J. in Cargill International v. Bangladesh Sugar62 to the effect that the beneficiary is entitled to payment even if he has suffered no loss or his loss is less than the amount demanded under the performance bond and that any overpayment will be recovered in the final accounting between the parties in accordance with the terms of the underlying contract.

III. SOME OVERSEAS AUTHORITIES

The picture in other jurisdictions is mixed. In the Commonwealth some countries, such as 7.36

Australia and Singapore, have recognized the exception, albeit by different routes, and some, notably Malaysia, have rejected it, after some early flirtations with the concept. In the civilian

58Eltraco International Pte Ltd v. CGH Development Pte Ltd [2000] 4 S LR 290; Anwar v. Tea Нее Lai Building Construction Pte Ltd [2003] 1 SLR 394; McConnell Dowell Constructors (Aust) Pty Ltd v. Sembcorp Engineers and Constructors Pte Ltd [2002\ 1 SLR 199.

59Eltraco International Pte Ltd v. CGH Development Pte Ltd [2000] 4 SLR 290 at [30]. That passage was adopted by the Singapore Court o f Appeal in Anwar v. Teo Нее Lai Buikling Construction Pte Ltd [2003] 1 SLR

394 at [16].

60As in RoyalDesign Studio Pte Ltd v. ChangDevelopment [1991] 2 M L J 229.

61Anwar Siraj andAnother v. Teo Нее Lai Building Construction Pte Ltd [2003] 1 SLR 394, where although

the beneficiary held about US$ 290,000 o f the account party’s money in the form o f uncertified progress pay­ ments and retention sums, the estimated cost of rectifying the breach was in excess of US$500,000.

“ [1998] 1 W LR 46 1 .

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The Unconscionability Exception

jurisdiction of France a similar exception, based on the civilian doctrine of abuse of right, has been recognized. And the UN Convention on Independent Guarantees and Standby Letters of Credit contains provisions which, in substance if not in name, serve the same function as a lack of good faith or unconscionability exception.

1. Australia

7.37 In Australia the courts have drawn a distinction between judicial intervention on the ground of unconscionable conduct under the common law and unconscionable conduct under statute.

A. Under common law

7.38 So far as the general law is concerned, the courts in Australia have not recognized a separate exception to the autonomy principle of demand guarantees based on unconscionable conduct. There was a cautious inclination in that direction by YoungJ. in Hortico (Australia) Pty Ltd v. Energy Equipment Co (Australia) Ply Ltda when he said obiter that ‘it does not seem to me that anything short of actual fraud would warrant this Court in intervening, though it may be that in some cases (not this case), the unconscionable conduct may be so gross as to lead to the exercise of the discretionary power’.634 And, in Tenore v. Roleystone Pty Ltd,65 Giles ]. also considered that in certain cases unconscionable conduct may be so gross as to constitute a separate ground ol intervention. However, this view did not prosper6667and it was expressly rejected in Olex Focas Pty Ltd v. Skodaexport Co Ltd67 where Batt J. refused to treat gross ‘unconscionability falling short of actual fraud’ as a ground for an injunction. So, although in Australia the equitable doctrine of unconscionability in relation to precontractual conduct has developed a much wider scope than its English counterpart,68 it is not regarded to be wide enough to support an exception to the principle of autonomy of demand guarantees or letters of credit based on conduct in the performance of the contract or in the exercise of a contractual right.

B. Under statute

7.39 However, although under the general law in Australia even gross unconscionable conduct may not be a ground for interference by the court, it is now recognized that under statute unconscionable conduct is a ground for intervention.

63(1985) 1 NSWLR 545.

64See also Inflatable Toy Co Pty Ltd v. State Bank opNSW (1994) 34 NSWLR 243,251, where YoungJ. again expressed the view that ‘it is still wise to keep open the possibility that unconscionable conduct may be an exception.

6514 September 1990, NSW Supreme Court, Giles J.

66In Penda Pty Ltd (trading as Zone Communications) v. Sitep Society per Azioni, 8 January 1997, Supreme Court ofNew South Wiles, SantowJ. refused to accept unconscionability as aseparate exception and noted that the observations ofYoungJ. were obiter.

67(1998) 3V R 380.

68See, Enonchong, N.. Duress, Undue Influence and Unconscionable Dealing (Sweet & Maxwell, 2006) paras

20- 016- 20- 020.

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III. Some Overseas Authorities

(i) Statutoryfoundations o fthe exception

credit or demand guarantee issued in respect of an international trade transaction. Thus, in Olex Focas Pty Ltd v. Skodaexport Co Ltd,1* although Batt J. rejected unconscionability as a ground for an injunction under the general common law, he accepted that under the Act unconscionability is a ground for intervention. He said that the effect of the statute, applying as it does to international trade and commerce, ‘is to work a substantial inroad into the wellestablished common law autonomy of letters ol credit and performance bonds’. He therefore

69Similar provisions are contained in Pt 2C of the Australian Securities and Investment Commission Act 2001 (ss 12CA, 12CB and 12CC).

70This provision does not apply to conduct that is prohibited by s 5 IAB or 51AC.

71 Under s 51AAB(1), s 51AA does not apply to conduct in relation to financial services, as defined by s 12BAB of the Australian Securities and Investment Commission Act 2001.

72 Under s 51AAB(2), s 5 IAB does not apply to conduct in relation to financial services, as defined by s 12BAB of the Australian Securities and Investment Commission Act 2001.

73In the sense of trade or commerce between Australia and places outside Australia. See s 6(2) of the Act.

74(1998) 3 VR 380 (CA, 17 September 1996). The lower court decision was delivered on 27-28 August 1996, although it was not reported until 1998.

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