Consequences of Staying Unconditional Performance Bond Litigation in Singapore Construction Arbitration

What happens when the underlying contract provides for disputes to be referred to arbitration but separate documents that form part of the contract provide for court litigation? This was the situation considered by the Singapore courts in the case of Star Engineering Pte Ltd v Pollisum Engineering Pte Ltd where the underlying construction contract contained an arbitration agreement and an unconditional performance bond contained a non-exclusive Singapore court dispute resolution clause.

The dispute related to payment under an unconditional performance bond given by Star to Pollisum. 

The agreed standard contractual terms referred disputes to arbitration. Further, the parties also agreed to refer to arbitration "[a]ny dispute which the Contractor has in relation to such call, demand, receipt, payment …". However, this agreement was contradicted by the terms of the performance bond, which provided for the resolution of disputes in court.

Pollisum later made a demand for payment under the performance bond, following which Star filed for an injunction before the court to restrain both Pollisum from receiving payment under the performance bond and Great Eastern, an insurer, from making any payment pursuant to it. Star thereafter obtained a temporary restraining order, following which Pollisum filed its own application seeking a stay of the original injunction proceeding in favour of arbitration. Pollisum's application was subsequently dismissed by the courts. 

Pollisum appealed to the High Court and was successful in obtaining an order to stay the injunction proceedings in favour of arbitration. In summary, the High Court concluded that it "was satisfied that the dispute over the Payment Demand fell within the scope of the arbitration agreement" and that "it was clear from the Contract that the parties intended any disputes between the parties, including those arising out of the PB [i.e. the performance bond], to be referred to arbitration notwithstanding the non-exclusive jurisdiction clause in the PB, which was in favour of the Singapore courts."

The case was then further appealed to the Court of Appeal, before which:

1. Star argued that the entitlement of Pollisum to call on the bond was an overlapping issue as between the dispute between Star and Pollisum and the dispute between Great Eastern and Star. Star argued that this was itself sufficient reason to refuse a stay in favour of arbitration and further argued that the overlap gave rise to "a real prospect of inconsistent findings being arrived at by the two fora" and that, as Great Eastern would not be bound by any arbitral finding, there would be "a risk of undermining confidence in the administration of justice." 
2. However, significantly, Pollisum had never applied to set aside the temporary restraining order (which it could have sought to do by showing there was not any fraud on the payment demand on the bond), arguing instead that the issue of whether it was entitled to call on the unconditional performance bond was an issue that would need to be determined in the arbitration. This proved significant: the Court of Appeal stated that Pollisum, by raising this argument, had effectively converted its unconditional performance bond into a conditional one. In this regard, the Court of Appeal found that the issue of entitlement was a substantive issue of the underlying construction contract, and therefore had to be determined in arbitration.
3. In making its determination, the Court of Appeal also referred to the parties' additional agreement, which "specifically refers[s] all disputes between the parties to the Contract relating to any demand on the PB to arbitration."

The Court of Appeal's judgment summarizes some key principles the Court will consider when dealing with any party’s attempt to interfere with a payment demand under an unconditional on-demand performance bond:-

1. The Court will only grant an injunction interfering with the obligation of a financial institution to honour a demand under an unconditional on-demand performance bond where the demand is made fraudulently or unconscionably.
2. The Court, when considering potentially interfering with payment under a bond, is not concerned "at all" with the underlying dispute; rather, it is interested only in whether there are sufficient grounds to interfere with payment.
3. Entitlement is clearly in the scope of the arbitration agreement in the REDAS Conditions (being the standard conditions on which the parties contracted in this case).

Pollisum was successful in staying the injunction proceedings in favour of arbitration at the expense of – somewhat oddly – converting its unconditional performance bond payment to a conditional one. Whilst this may not have been the intended consequence, it obtained its stay. Consequently, parties should be aware that the issue of entitlement to payment under a performance bond will ordinarily be decided by reference to the contract’s dispute resolution provision (e.g. arbitration), whilst the performance bond itself may nevertheless remain subject to its own dispute resolution mechanism (e.g. court litigation). In practice, the latter is likely to focus solely on issues such as to whether a demand has been made fraudulently or unconscionably, such that it should be declared invalid.

In light of the Court of Appeal’s decision, parties should think twice before insisting on such stays where the better option may simply be to reject the existence of any fraud or unconscionability and demand payment within the court proceedings.