Chris Kidd Head of Shipbuilding and Offshore Construction, Joint Head of Energy & Infrastructure, Partner
Court of Appeal emphasises importance of language used in construing nature of guarantee
Shanghai Shipyard Co. Ltd. v. Reignwood International Investment (Group) Company Limited  EWCA Civ 1147
The Court of Appeal has allowed an appeal on two preliminary issues related to questions of construction of a guarantee provided in the context of a shipbuilding contract. In doing so, the Court of Appeal emphasised that the language used by the parties in a guarantee, in its commercial context, will be paramount in construing the nature and scope of the obligations it imposes on the guarantor.
The background facts
Shanghai Shipyard (the “Builder”) agreed to build an offshore drillship for Reignwood (the “Guarantor”). The Guarantor, acting as an initial buyer and financial investor, provided an Irrevocable Payment Guarantee (the “Guarantee”) securing the Buyer’s obligation to pay the final instalment due on delivery (the “Final Instalment”). The contract was novated to a special purpose vehicle company, Opus Tiger 1 (the “Buyer”), which was an indirect subsidiary of the Guarantor.
When the Buyer rejected delivery of the drillship, the Builder issued a claim for the Final Instalment, and made a demand under the Guarantee. This was refused by the Guarantor, which commenced London arbitration in the name of the Buyer under the contract, as a derivative action against the Builder. The Builder in turn issued court proceedings under the Guarantee against the Guarantor.
The Commercial Court was asked to consider two preliminary issues, namely:
- Whether the Guarantee was a demand guarantee where the Guarantor’s obligation to pay would arise primarily by reason of the demand; or a traditional “see to it” or a surety guarantee, in which the obligation to pay would only arise if and to the extent that the Buyer was liable to pay the Final Instalment; and
- Whether the Guarantor was entitled to withhold payment, pursuant to Clause 4 of the Guarantee, pending the outcome of an arbitration between the Buyer and the Builder, concerning the Buyer’s liability to pay and the Builder’s entitlement to claim the Final Instalment.
The Paget Presumption
In Wuhan Guoyo Logistics Group Co Ltd v. Emporiki Bank of Greece SA  1 All ER (Comm) 1191, the Court of Appeal referred to Paget’s Presumption, derived from Paget’s Law of Banking (15th edition). This lists four elements to be considered when identifying the nature of a guarantee. The Court of Appeal in that case stated that an instrument will almost always be construed as a demand guarantee if it: (i) relates to an underlying transaction between the parties in different jurisdictions; (ii) is issued by a bank; (iii) contains an undertaking to pay ‘on demand” and; (iv) does not contain clauses excluding or limiting the defences available to a guarantor.
The Commercial Court decision
In summary, the Court held that:
- The Guarantor was not a bank, so Paget’s Presumption was not applicable;
- Based on the language of the Guarantee, it was a “see to it” instrument; and
- The Guarantor could withhold payment pending the arbitration award, even though the arbitration was commenced after the demand was made.
The Builder appealed.
The Court of Appeal decision
The first issue
Firstly, the Court stated that no assumption could be made as to the nature of the guarantee based on the identity of the guarantor. What mattered was the wording used by the parties in the guarantee instrument. Furthermore, the fact that the Guarantor was a parent company not a bank was not significant in this context because the Guarantor clearly exercised a financing function that went beyond that which normally arose between parent and subsidiary. The fact that the Guarantor was a non-bank entity was no hindrance to it issuing a demand guarantee and, on construction, the words of the Guarantee favoured it being so.
As to the language of the Guarantee, the Guarantor’s obligation under Clause 1 was described as being to “absolutely and unconditionally guarantee”. This wording supported the conclusion that it was a demand instrument; a condition to present a valid demand (in good faith) did not change the nature of an instrument, since this could be said of any obligation in any guarantee.
The Guarantee also expressly stated that the Guarantor was a primary obligor and “not merely as the surety” which went to the heart of the Guarantor’s obligation under Clause 1. It was also relevant that Clause 7(a) excluded the effect of any contractual dispute between the Builder and the Buyer on the Guarantor’s obligation to pay, which was the very thing that a surety guarantee would make a guarantor’s obligation dependent on.
The Guarantor argued that Clause 4, which entitled the Guarantor to withhold and defer payment pending publication of an arbitration award, was only consistent with a surety guarantee. However, the Court of Appeal stated that, if triggered, Clause 4 would merely render the obligation to pay conditional on the issuance of the award rather than on any underlying liability, irrespective of how the award was reached or of any subsequent challenges to it.
The Court of Appeal, therefore, allowed the appeal on this issue and held that the instrument was a demand guarantee.
The second issue
The Guarantor argued that Clause 4 would allow it to defer payment if there was a dispute prior to the demand even if arbitration was not commenced until after the demand had been made. It further described the 15-day time frame to commence arbitration as artificial and uncommercially short.
The Court of Appeal found nothing uncommercial about using a short timeframe to commence arbitration as it could be aimed at protecting cash flow. The clause was also clear in providing that it would be triggered only if arbitration was commenced prior to the Builder’s demand. Denying the Builder of its accrued right for payment would require clear language, which Clause 4 lacked.
Therefore, the Court of Appeal allowed the appeal on this point also.
The Court of Appeal’s decision is welcome for clarifying that, when construing the nature of a guarantee instrument, the language used by the parties is paramount and that there is an inherent risk in over-reliance on presumptions or preconceptions in this area. Those drafting and issuing guarantees should take note that they should choose their words carefully to ensure that the guarantee instrument correctly and clearly reflects the obligations that are being undertaken.
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