Bank guarantees are an essential feature, and key form of security, in construction contracts. At different stages of the project lifecycle, a bank guarantee may be required to ensure timely performance. Although the contractor’s obligation to provide a bank guarantee is contractual, the bank guarantee itself is an independent commercial instrument containing the issuing bank’s undertaking to the beneficiary, who is typically the employer (or the main contractor under a subcontract).
The bank guarantee determines the conditions and mechanism for demanding payment and normally reflects a prescribed form in the underlying contract. Encashing a bank guarantee is a major decision that often triggers formal dispute resolution processes, including urgent applications to enjoin the beneficiary from liquidating the bank guarantee.
In this blog we focus on the two main avenues for interim relief when a bank guarantee is called in a Saudi-based project, namely the Saudi courts and arbitral tribunals.
Engaging the Saudi courts
The Law of Civil Procedure provides that interim measures may be sought in an independent action or as part of substantive proceedings. An application for interim measures is submitted to the court with original jurisdiction over the dispute. The interim measures application is decided without prejudice to the merits of the main dispute. This applies equally where there is an arbitration clause in the underlying construction contract or pending arbitration between the employer and the contractor.
Saudi courts have broad discretion to grant interim measures, including injunctions to attach bank guarantees. As a matter of practice, Saudi courts grant attachment orders in fairly limited circumstances. The test for granting an attachment order under Saudi law is not dissimilar to that in neighbouring jurisdictions—the applicant must demonstrate: (i) urgency; (ii) a risk of serious or inevitable harm; and (iii) a good prima facie case on the merits.
The most critical aspect of this test is the element of ‘urgency’. The applicant must prove that intervention by the court is required urgently — to use the words of the Saudi Commercial Court, the urgency requirement is satisfied when there is a real fear of being “too late” if no immediate action is taken. In the context of bank guarantees, this threshold can be met when the beneficiary has already submitted a formal demand for encashment to the issuing bank or communicated its intention to do so. Without such evidence, an application for interim measures might be rejected as premature.
In addition, the applicant has to demonstrate the risk of serious or inevitable harm if the relief is not granted. When assessing this risk, Saudi courts weigh the potential harm to the applicant and beneficiary. The contractor must show why the harm it will suffer after a successful call outweighs any damage to the employer if the bank guarantee is attached pending resolution of the main dispute. Saudi courts often cite the Shari’a maxim that “greater harm can be removed by lesser harm” to attach bank guarantees when they are satisfied that the applicant will likely suffer more harm than the beneficiary if the call is not prevented. For example, Saudi courts have attached bank guarantees where there was a considerable risk that the applicant would not be able to recover damages from the beneficiary if the call was later found to be wrongful.
Finally, a Saudi court is unlikely to attach a bank guarantee unless the applicant has a reasonably good case on the merits. The court makes this assessment on a prima facie basis—that is, on first impression and without delving into the substance of the dispute (which is the remit of the competent trial court or arbitral tribunal). Typically, the applicant must adduce clear evidence that it is entitled to the return of the bank guarantee such as a project completion certificate or equally compelling evidence. For this reason, an application to attach a bank guarantee may be denied if the applicant fails to demonstrate a prima facie entitlement to the interim payments secured by the bank guarantee and an attachment order could be lifted if the employer can show that the contractor has been overpaid.
Interim measures by arbitral tribunals
Tribunals (and emergency arbitrators) normally look at three aspects when deciding whether to grant interim relief: (i) the arbitration agreement, including any institutional rules referred to therein along with their related commentary; (ii) the national laws of the seat; and (iii) any applicable international arbitration instrument.
Arbitral tribunals in Saudi-seated proceedings have the power to grant interim measures, including to attach bank guarantees. Under Article 23 of the Saudi Arbitration Law, should a party fail to comply, the other party can apply to the tribunal for permission to “take the necessary measures to execute” the order without prejudice to their right to apply to any “competent authority” for an order compelling compliance. Moreover, Article 22 of the same law empowers arbitral tribunals to request the Saudi courts to grant interim measures in support of ongoing arbitration proceedings.
Tribunals can also rely on any applicable arbitration rules as a source of their power to grant interim relief. For example, the 2018 Arbitration Rules of the Saudi Center for Commercial Arbitration (SCCA Rules) enable tribunals to grant interim relief to maintain or restore the status quo throughout the proceedings, to prevent imminent harm or prejudice to the process, or provide means of preserving assets which may be used to satisfy the award. To that end, the requesting party must demonstrate to the tribunal that: (i) if the interim measure is not granted, it will suffer harm which is not adequately reparable by an award of damages, and such harm substantially outweighs the harm to the party against whom the measures are directed; and (ii) there is a reasonable possibility of the requesting party succeeding on the merits.
In line with many major rules, the SCCA Rules also provide for emergency relief, prior to the constitution of the tribunal but concurrent with or following the filing of the notice of arbitration, through an emergency arbitrator. However, the emergency arbitrator procedure will not apply where the parties have opted out or agreed to another pre-arbitral procedure for interim relief. While emergency arbitrator orders are not strictly seen as arbitral ‘awards’, there are methods of compelling compliance with emergency arbitrator orders.
Once an attachment order is issued by an emergency arbitrator or tribunal, and where Saudi Arabia is the arbitral seat, parties can generally seek enforcement of the emergency arbitrator order through the Saudi courts under the Saudi Arbitration Law. In MENA jurisdictions where there is no clear basis for enforcing emergency arbitrator orders, a party who obtains a favourable emergency arbitrator order will typically seek an ‘ordinary’ court-ordered attachment order and submit the emergency arbitrator order as a supporting document to persuade the judge that court-ordered attachment is warranted. This is not, strictly speaking, an application for enforcement of the order, but a traditional application for an attachment order from the courts, with the emergency arbitrator’s order being relegated to the status of a mere supporting fact rather than the legal basis for the application.
Parties should articulate their positions in writing as clearly and early as possible, particularly when there are warning signs of an impending call. If the employer calls a bank guarantee, the contractor must act swiftly to secure interim relief. Where a call is wrongful, the immediate impact on the contractor’s cash position is significant because the bank will typically seize or demand payment of the full value of the bank guarantee that has been liquidated and the contractor’s ability to obtain further guarantees on favourable terms will be impaired. The contractor may also suffer reputational damage and be disqualified from future tenders. If the call is ultimately found to be wrongful, the contractor may not be able to recover its resulting financial loss in full because of the restrictions under Saudi law on claiming interest, loss of profit, or indirect/consequential loss. In similar cases, Saudi courts have compensated the contractor by awarding only the principal sum of the bank guarantee.
Employers should ensure they have satisfied any preconditions under the bank guarantee (as well as the contract) before demanding its liquidation. However, many guarantees used in connection with construction projects in the MENA region are payable on first demand and therefore, matters can escalate quickly. Parties should proactively manage the risk of a call being made and prepare to take protective measures as soon as it appears that a bond is under threat.
This is part of a series of blog posts on managing risk in commercial and construction disputes under Saudi law. Click here to see other posts in the series.