Contractors’ interim remedies concerning on-demand guarantees in the UAE
Real Estate & Construction and Hotels & Leisure
Demand guarantees are a common feature in construction contracts in the United Arab Emirates (UAE) and, indeed, the wider region.
Law Update: Issue 369 - Real Estate & Construction and Hotels & Leisure
Naief YahiaPartner, Head of Litigation - Dubai
Justin Jie ZhangSenior Counsel,Dispute Resolution
Rashid KhanSenior Associate,Dispute Resolution
On-demand guarantees are a common feature in the construction industry in the United Arab Emirates (UAE) and, indeed, the wider MENA region. These guarantees normally take the form of performance bonds and advance payment guarantees, which a contractor is required to obtain in favour of the project owner (also referred to as the “employer”). Such guarantees (or bonds) are typically unconditional and on-demand, meaning the employer can encash them at any time without needing to substantiate the cause for doing so. This often occurs in circumstances where the project encounters delays or faces other difficulties, which can significantly impact the contractor’s cashflow.
Issuing banks in the UAE are obliged to make payment under an on-demand guarantee upon receiving a demand regardless of any issues or disputes arising from the underlying
construction contract, or the relationship between the contractor and the bank.
Article 417(1) of Federal Decree by Law No. 50/2022 Concerning the Commercial Transactions Law (the “Commercial Code”) states the following:
"A bank may not refuse payment to the beneficiary for a reason attributed to the bank’s relationship with the person making the application or the relationship of the latter with the beneficiary.”
In the context of a construction project, the “person making the application” is generally the contractor. When a contractor is faced with the potential encashment of one of its on-demand bonds, there are certain steps it can take to prevent the liquidation. However, the contractor must act quickly in light of the strict obligations on the issuing banks under the Commercial Code.
This article explores some of interim relief available to a contractor in arbitration and litigation proceedings in the UAE to prevent encashment. The term “interim relief” is distinct from the “final relief” typically granted through a final court judgment or arbitral award. In doing so, we consider a scenario where both the construction contract and the bond are governed by UAE law.
Obtaining a final arbitral award or court judgment can take months or years and so, the most efficient route to prevent the encashment of a bond upon a demand having been made is to seek an urgent interim order from an arbitral tribunal or the appropriate court. This is particularly relevant in circumstances where the contractor requires immediate relief to protect its financial position and, quite often, its reputation in the market.As far as arbitration is concerned, as with many other jurisdictions, it is an established principle in the UAE that the designated seat of arbitration determines both the law governing the conduct of the proceedings and the court of the seat (or “curial court”), which will have supervisory jurisdiction over the arbitration. The UAE comprises onshore jurisdictions (such as Dubai and Abu Dhabi) and offshore jurisdictions (including the Dubai International Financial Centre (the DIFC) and the Abu Dhabi Global Market (the ADGM)). Depending on the parties' agreement regarding the seat, a party's route to preventing the liquidation of a bond may be via the Courts of either the onshore or offshore jurisdictions in the UAE. These different fora are explored below. Onshore UAE CourtsWhere the parties to an arbitration have agreed to a seat in an onshore UAE jurisdiction, the contractor may apply for interim relief from the onshore UAE Courts pursuant to Federal Law No. 6 of 2018 (the “UAE Arbitration Law”). In this regard, Article 18(2) of the UAE Arbitration Law provides the following:“The court's president may, at the request of one of the parties or the Arbitral Tribunal, order provisional or precautionary measures, as it deems appropriate, for the existing or potential arbitral proceedings whether prior to or during arbitral proceedings.”
This entitles the competent court to grant interim measures in support of the proceedings at any stage of arbitration. The president of the competent court, as established by the case law, refers to the Chief Justice of the Court of Appeal (as opposed to the judges at the Court of First Instance).
DIFC CourtsOn the other hand, the parties may have agreed to a seat located in an offshore jurisdiction such as the DIFC. Where the seat is the DIFC, the DIFC Courts would have supervisory jurisdiction over the arbitration proceedings and may award interim relief prior to or during the arbitration in accordance with the DIFC Law No. 1 of 2008, as amended in 2013 (the “DIFC Arbitration Law”).
The DIFC Arbitration Law sets out a non-exhaustive list of the interim measures available such as, freezing orders, search orders and injunctions which the Court may order irrespective of the venue (the physical place rather than the legal place of the arbitration) of the arbitration and the availability of an arbitral tribunal.
An injunction is a court order which prohibits the taking of a particular action (a prohibitory injunction) or requires the taking of a particular action (a mandatory injunction), the former being the relevant order required to prevent the liquidation of an on-demand bond.
Arbitral TribunalAlmost all of the leading arbitration institutions in the UAE have rules empowering an arbitral tribunal to award interim measures.For example, under the DIAC Arbitration Rules 2022 (the “DIAC Rules”) a tribunal may order interim measures including injunctions to restrain a party from taking certain actions that would cause harm to the other. This is also available in circumstance where the arbitral tribunal has not yet been constituted, whereby an emergency arbitrator would be appointed to determine an application.Regardless of whether the seat of arbitration is onshore or offshore in the UAE, the tribunal’s power to grant the interim measures are invariably endorsed by the respective local laws.
Onshore UAE CourtsIn the UAE Courts, interim measures. known as precautionary attachment orders, are available. These operate in a similar way to interim injunctions insofar as they would prevent the beneficiary of an on-demand bond from encashing it. Under Article 417(2) of UAE Commercial Code, the Court must be satisfied that there are “serious and confirmed grounds” for prevent the encashment of a bond. That Article of the Commercial Code states the following:“Notwithstanding the provisions of Clause (1) above, the bank may refrain from payment to the beneficiary where an enforceable order or court judgment is rendered to impose seizure on the guarantee amount with the bank. In such case, in order for such order or judgment to be rendered, the person making the order shall rely for his claim on serious and confirmed grounds.”The UAE Commercial Code offers little guidance as to what constitutes “serious and confirmed grounds”. In any event, this will be a matter for the Court’s discretion. However, in practice, the Courts have been satisfied with the following grounds:
The project is substantially completed, as evidenced by the issuance of a taking-over certificate or the employer's occupation and use of the project.
There is clear evidence that the employer owes significant sums to the contractor; and/or
The employer is clearly not entitled to call on the bond based on the underlying construction contract.
These are only indicative of the Court’s approach, and it is important to note that there is no doctrine of binding precedent applicable to the UAE onshore judiciary which means, the outcome of any application is a matter of the Court’s discretion on a case-by-case basis.
Also of great importance is the requirement for a protective attachment to be sustained by an underlying substantive action as set out in UAE Cabinet Resolution No 57 of 2018 (which amended provisions of the UAE Civil Procedures Law). Where an interim measure is ordered before a party has initiated substantive proceedings (either litigation or arbitration where the parties have agreed to arbitrate), such proceedings must be commenced no later than eight days from the date of the order. Failure to do so would result in the interim measure being lifted.
DIFC CourtsThe DIFC Courts may issue interim measures in support of arbitration proceedings in the same way they would in relation to DIFC Court proceedings. In doing so, the Court must be satisfied that:
there is a serious question to be tried;
if the Court were to decline to order an injunction, damages would not be an adequate remedy; and
the 'balance of convenience' favours granting an injunction.
Is there a serious question to be tried?The burden is on the applicant to satisfy the court that there is and to discharge that burden, the applicant must demonstrate that:
the application is not 'frivolous or vexatious'; and
at the time of the application, there is an actual or threatened breach of the applicant’s rights.
The DIFC Courts will not grant an injunction in circumstances where the applicant is unable to point to an action that needs to be stopped. Are damages an adequate remedy?
The Court will consider whether damages would be an adequate remedy (in place of an injunction). If damages would be adequate and the respondent is in a financial position to pay them, an injunction would not normally be granted.
The balance of convenience
The Court will also consider where the ‘balance of convenience’ lies which is a question that typically only arises once the Court is satisfied that the above requirements have been satisfied. The Court assessing all factors, will take the course of action which presents the lowest risk of injustice, i.e., would wrongly refusing the injunction do greater damage to the applicant than it would do to the respondent if the injunction was wrongly granted.
Other factors to consider are as follows:
the applicant has a duty of full and frank disclosure whereby the applying party must disclose all material facts to the Court, whether they help or harm the case for an injunction;
the Court may require the applicant to provide an undertaking as to damages, which is intended to compensate the responding party in the event that the granting of an injunction is later found to be wrong and has caused harm; and
breaching an injunction is a serious matter, which could amount to contempt of court and lead penalties such as a fine or imprisonment.
When considering on-demand bonds, the English Courts have previously taken a narrow approach to granting prohibitory injunctions and would only do so where there is clear evidence of “fraud”. In recent years, a slightly broader approach has been adopted and injunctions have been granted absent fraud. This is clear from Simon Carves Ltd v Ensus UK Ltd [2011] EWHC 657 (TCC) where the Court decided that fraud was not the only ground upon which a call on the bond can be restrained by injunction. In Doosan Babcock Ltd v Comercializadora de Equipos y Materiales Mabe Limitada [2013] EWHC 3010 (TCC ), [2013] EWHC 3201 (TCC), the Court granted an order preventing a beneficiary from calling an on-demand bond on the grounds that the underlying contract expressly disentitled the beneficiary from doing so.
The DIFC Courts have shown a willingness to prevent the liquidation of on-demand bonds where the demand to liquidate has been made in breach of contract, for example, a failure to give contractual notice as was the case in Bin Belaila Baytur General Contracting LLC v (1) Nakheel PJSC and (2) Standard Chartered Bank [2010] DWT/APP25/003/2010. This was a decision of the Dubai World Tribunal which was acknowledged by the DIFC Courts.
Arbitral TribunalAs a general rule, the arbitral tribunal is expected to follow the same tests as those applicable in onshore UAE Courts or DIFC Courts, depending on the seat of arbitration and the governing law of the contract. Under the DIFC Arbitration Law, the tribunal must be satisfied that “there is a reasonable possibility that the requesting party will succeed on the merits of the claim.” This essentially requires the tribunal to extend its investigation to the underlying disputes and merits of the case (such requirement is not mentioned when the same application is brought before the onshore UAE Courts or the DIFC Courts).
Nonetheless, this requirement is understandable since the tribunal is tasked with ruling on the substantive claims and is arguably in a better position than the supervisory courts to make a preliminary assessment of the claimant's claims. However, this additional criterion makes for a more challenging forum for obtaining a prohibitory injunction.
When faced with the imminent encashment of an on-demand bond, a contractor must act quickly. The routes available in onshore or offshore in the UAE can mean securing suitable interim relief (a prohibitory injunction or protective attachment order respectively) much earlier than waiting for litigation or arbitration proceedings to conclude.
Contractors must be vigilant and proactive when faced with the threat of their bonds being called upon. It is advisable to engage legal counsel early in the process to navigate the complexities of securing interim relief, whether through the onshore UAE Courts, the DIFC Courts, or arbitral tribunals. Early involvement of legal counsel ensures sufficient time for preparing the relevant application although, UAE banks typically take only 3 to 5 working days to liquidate the bond after receiving a demand so time is of the essence. There are also preliminary requirements to be factored in such as, the need for a contractor to grant a power of attorney to their legal representatives. This is document is required by the onshore UAE courts before an application can be filed.
Employers should also be aware that they are not free of risks when liquidating a bond, as a wrongful demand may result in substantial claims from the contractor, including claims for finance charges.
There are also reputational risks to consider on both sides.
In order to obtain interim relief in any of the fora considered above, the applying party must demonstrate that it has an underlying substantive claim. This can present a challenge and, even where this requirement has been satisfied, there are other tests to overcome. The threshold in the DIFC Courts is high whereas, arguably, the position onshore in the UAE is slightly more flexible and the courts are perceived as more likely to grant suitable relief. An arbitral tribunal is expected to follow tests applicable in the curial court, although the governing law of the contract may have some relevance when considering which test to apply. In DIFC seated arbitrations, the tribunal would be required to delve into the merits of the case meaning this also present a challenge for the applying party.
In any case, substantive proceedings will need to be filed shortly after any interim relief is granted (within 8 days in respect of the onshore UAE Courts). This can present a separate challenge as, a contractor must consider any conditions precedent to arbitration and this could create uncertainty as to whether an interim measure can be maintained. Advice from experienced legal counsel is crucial to overcoming these potential obstacles.
For further information,please contact Naief Yahia, Justin Jie Zhang and Rashid Khan.
Published in June - July 2024
