Court: Supreme Court of the Democratic Socialist Republic of Sri Lanka. Case No: SC/CHC/Appeal No: 52/2007. Date of Judgment: 25th February 2025
Presiding Judges:
Murdu N. B. Fernando, PC, CJ, E.A.G.R. Amarasekera, J and Arjuna Obeyesekere, J
Parties Involved:
- Plaintiff – Respondent: Lagan International Limited
- Defendant – Appellant: Janashakthi Insurance Company Limited (subsequently Alliansz Insurance Lanka Limited)
Background of the Case: The case arises from a contract dispute related to the Gan Airport Development Project in the Maldives. Lagan International Limited, a civil engineering company based in Northern Ireland, entered into a contract with the Ministry of Finance and Treasury of the Republic of Maldives to carry out the Gan Airport Development Project, which included the construction of a fuel farm.
To subcontract the fuel farm work, Lagan International Limited selected V Com Heavy Engineers (Pvt) Limited (V Com HE), a Sri Lankan company, through a tender process. A performance bond was issued by Janashakthi Insurance Company Limited on 31st December 2003 for the value of USD 247,000 to secure the obligations of V Com HE. However, the subcontract agreement was formally executed with V Com International UK Limited (V Com UK), a sister company of V Com HE, due to the requirement of having a bank account in the United Kingdom.
Nature of Dispute: Lagan International Limited claimed that V Com UK and V Com HE failed to meet the contractual obligations, including delays and failure to procure materials of the required specifications. Consequently, the plaintiff terminated the contract and made a demand for USD 247,000 under the performance bond issued by the defendant.
The defendant refused to honour the claim, alleging that the demand was not made in accordance with the performance bond and that the guarantee was issued to secure the obligations of V Com HE, not V Com UK.
Legal Issues Raised:
- Whether the plaintiff made a valid written demand in accordance with the performance bond.
- Whether the defendant was liable under the performance bond despite the subcontract being executed with V Com UK instead of V Com HE.
- Whether the performance bond was independent of the underlying contract and the dispute between the parties.
- Whether the defendant could refuse payment on grounds of fraud or technical deficiencies.
Judicial Review and Related Judgments: The Supreme Court examined several landmark judgments to interpret the nature of performance bonds and their enforceability:
- Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] QB 159: This case established that performance bonds are autonomous contracts, separate from the underlying contract, and must be honoured without regard to disputes in the underlying contract.
- R.D. Harbottle (Mercantile) Ltd v National Westminster Bank Ltd [1978] QB 146: The judgment reinforced the principle that banks must honour performance bonds except in cases of established fraud.
- Standard Bank London Ltd v Canara Bank [2002] EWHC 1032 (Comm): This case affirmed that demand guarantees are autonomous and must be paid if the demand is made in accordance with the guarantee’s terms.
- Indica Traders (Pvt) Limited v Seoul Lanka Construction (Pvt) Limited [(1994) 3 Sri LR 387]: The Sri Lankan Supreme Court upheld the principle that banks must honour demand guarantees regardless of disputes between the contracting parties.
- Hemas Marketing (Pvt) Limited v Chandrasiri and others [(1994) 2 Sri LR 181]: This case emphasized that performance bonds are separate from the main contract and should be paid upon demand unless fraud is proven.
The Supreme Court in this case reaffirmed these principles, stating that the performance bond was independent of the subcontract between Lagan International Limited and V Com HE or V Com UK. It concluded that the defendant was bound to honour the demand made by the plaintiff as the demand was made in conformity with the bond’s terms.
Conclusion: The Supreme Court dismissed the appeal, affirming the decision of the Commercial High Court. It held that the defendant was liable to honour the performance bond as per its terms and awarded the plaintiff the sum of USD 247,000 with interest. The defendant was also ordered to pay costs before both the High Court and the Supreme Court.
Legal Significance: This case reinforces the principle that performance bonds are autonomous instruments separate from the underlying contracts. It highlights the limited grounds on which issuers of performance bonds can refuse payment, restricting refusals to cases of fraud or non-compliance with express terms. The judgment underscores the importance of upholding the commercial integrity of demand guarantees in international transactions.
Recommendations:
- Companies issuing performance bonds must carefully review the terms and conditions of the underlying transactions before issuing guarantees.
- Beneficiaries should ensure that demands under performance bonds strictly comply with the bond’s terms to avoid disputes.
- Contracting parties should include explicit clauses regarding modifications to the underlying contract and their effect on performance bonds.
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