Banking law

Performance bonds - cash principle and validitySolo Industries UK Ltd v Canara Bank [2001] 1 WLR 1800 CAS entered into a contract with H for the purchase of aluminium.

It was an express term of the purchase agreement that H would indemnify S in the event of H failing to deliver the agreed monthly quantities of aluminium.By performance bond Canara Bank undertook unconditionally and irrevocably as a separate and continuing obligation to indemnify S in the event of H failing to meet its indemnity obligation under the purchase agreement.

Therefore, S was the beneficiary of the performance bond.

H failed to deliver the agreed quantities of aluminium and failed to indemnify S.

Canara Bank sought to avoid the performance bond on the basis that the purported purchase contract between S and H was a sham transaction and that the performance bond had been obtained by fraud and misrepresentation.

S demanded the sums due under the performance bond and applied for summary judgment.

After the dismissal of that application, S appealed.Aside from fraud, banks are not entitled to avoid payment obligations under performance bonds, letters of credit or bills of exchange.

In relation to the enforcement of obligations these banking instruments are to be treated as the equivalent of cash ('the cash principle').

In the Court of Appeal, S sought to argue that the cash principle ought to be extended to cover additional questions of validity, and that in the circumstances S ought to be entitled to summary judgment on the performance bond.The court refused to extend the cash principle to cover questions of validity and dismissed the appeal.

In doing so, the court held that there was no contractual basis for extending the principle and no commercial need for doing so.

Furthermore, the argument sought to impose on banks the risk of being misled into entering into the instrument, when the only risks that banks may fairly be taken to have accepted are the risks undertaken in the instrument assuming it to be valid.

Prior to the judgment in this case there was no clearly binding Court of Appeal authority dealing with whether the cash principle could be extended to cover questions of validity.

Lord Justice Mance thought it a matter of common sense that the reason why this issue had not previously been determined was probably because of the fact that banks rarely seek to avoid performance bonds or for that matter letters of credit.

Whether or not the judge's assumption is correct, this decision provides unequivocal guidance and consequently a degree of certainty in commercial practice.

A bank that has a suspicion of foul play faces a dilemma when faced with a demand under a performance bond or letter of credit.

To fail to honour the demand will be a breach of contract but the circumstances will be rare indeed for a bank to be comfortable in exposing itself to a potential damages claim in the hope that suspicion will be confirmed by hard evidence.

This may in itself provide one explanation for why banks rarely seek to avoid bonds or letters of credit.

It follows that a bank may be best protected by taking sufficient details and references prior to issuing bonds or letters of credit so as to minimise the risk of issuing instruments as a consequence of fraud or misrepresentation.Orders for sale - balance now likely to be tipped in favour of familiesMortgage Corpn v Shaire and Others [2001] 3 WLR 630 (Mr Justice Neuberger) S and F lived together as husband and wife.

They jointly owned their home subject to a mortgage with Chase Manhattan Bank.

F died.

S subsequently discovered F had forged her signature on a mortgage with the claimant bank and discharged the Chase Manhattan mortgage.

It was accepted that the claimant's mortgage was valid as against F's 25% beneficial interest in the house.

Repayments were not maintained under the mortgage and the claimant applied for an order for possession and sale of the family home under section 14(1) of the Trusts of Land and Appointment of Trustees Act 1996.Under the old law the normal rule that applied in applications under section 30 of the Law of Property Act 1925 was that save in exceptional circumstances the wish of the person wanting the sale, be it a trustee in bankruptcy or a chargee, would prevail, and that the interests of children and families in occupation was unlikely to prevail: see In re Citro [1991] Ch 142 and Lloyds Bank v Byrne & Byrne [1993] 1 FLR 369.

Sections 14 and 15 of the 1996 Act have now replaced section 30.

The court was required to determine whether the law, relating to the way in which the court will exercise its power to order a sale at the suit of a chargee of the interest of one of the owners of the beneficial interest in property, has changed? This was the first time that the High Court had been required to answer this question.

Mr Justice Neuberger held that as a consequence of section 15 of the 1996 Act the law had changed.He went on to state that it did not seem unlikely that the balance had now been tipped somewhat more in favour of families and against banks and other chargees.

Consequently, the judge advised that authorities dealing with section 30 should now be treated with caution and would be unlikely to be of any decisive assistance for applications made under section 14 of the 1996 Act.It is likely that as a consequence of the 1996 Act and this decision, banks will find their commercial interest in obtaining an order for sale subjugated to the wider interests of family and of children in particular.

Depending on your point of view, or indeed your client, this may or may not be good news.

By Simon Sugar, barrister, 36 Bedford Row, London