Chris Kidd Head of Shipbuilding and Offshore Construction, Joint Head of Energy & Infrastructure, Partner
We demand that you see to this guarantee right away
Shanghai Shipyard Co Ltd v. Reignwood International Investment (Group) Company Limited  EWHC 803 (Comm)
The Commercial Court has recently given an important decision that highlights how the different types of guarantee provided under shipbuilding contracts can have important consequences as to how quickly a demand has to be paid.
The background facts
Shanghai Shipyard Co Ltd and Reignwood International Investment (Group) Company Limited were parties to a shipbuilding contract of a drillship (the “Contract”). An Irrevocable Payment Guarantee ("the Guarantee”) was provided to secure a final payment of US $170 million (the “Final Instalment”) by the Buyer. The contract was novated to bring in a new buyer, Opus Tiger 1 PTE Ltd, who was an indirect subsidiary of the Guarantor.
When Opus did not accept 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 pending resolution of the parties’ LMAA arbitration.
The Commercial Court decision
The Commercial Court was asked to consider the following two preliminary issues:
1) Whether a guarantee provided on behalf of the Buyer was a demand guarantee or a traditional “see to it” guarantee.
a) A demand guarantee is an autonomous, irrevocable and absolute undertaking to pay a sum of money to a named beneficiary upon the guarantor's receipt of the beneficiary's demand, without concerning itself with the rights and wrongs of the underlying dispute (except where there are allegations of fraud). If properly drafted, a demand guarantee is more akin to a letter of credit than a contract of suretyship, and a guarantor's liability is a primary liability.
b) A “see to it” guarantee is more like an ancillary contract. It is a promise that when a debtor is in default of its contractual obligations, the guarantor will step in on its behalf. This type of guarantee is a secondary obligation which gives rise to a claim for damages rather than a claim in debt. Consequently, the guarantor is only liable to the extent that the original debtor was and the rules regarding mitigation of damages apply. There is, therefore, a need for the guaranteed party to establish liability in respect of the guaranteed obligation for payment to be made.
2) Whether the Guarantor was entitled to refuse payment pending the outcome of an arbitration between the Builder and Buyer in respect of the Builder’s entitlement to claim the final instalment and the Buyer’s liability to pay.
The first issue
The Court acknowledged that determining whether a guarantee is a demand guarantee is very difficult given the significant commonality in the language between the two different types of guarantees, and that one must consider the instrument as a whole without any preconceptions. The practical question to consider was whether the instrument was effectively payable on demand, with or without some supporting documentation, rather than the underlying liability being determined before a demand could be made.
The Court approached the interpretation of the guarantee in line with recent decisions in Wood v. Capita Insurance Services Ltd  UKSC 24;  AC 1173, Lukoil Asia Pacific Pte Ltd v. Ocean Tankers (Pte) Ltd  EWHC 163 (Comm), and considered the presumption from Marubeni Hong Kong and South China Ltd v. Government of Mongolia  1 WLR 2497 that, where a guarantee is given outside of a banking context, there is a strong presumption against it being interpreted as a demand bond.
The Court also considered Wuhan Guoyo Logistics Group v. Emporiki Bank of Greece  1 Lloyd’s Rep 266 at  – , where the Court of Appeal indicated that the only assistance the courts can in practice give is to say that “while everything must in the end depend on the words actually used by the parties, there is nevertheless a presumption that, if certain elements are present in the document, the document will be construed in one way or the other.” Such elements include those derived from Paget’s Law of Banking, which states:
"Where an instrument (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' (with or without the words 'first' and/or 'written') and (iv) does not contain clauses excluding or limiting the defences available to a guarantor, it will almost always be construed as a demand guarantee.
In construing guarantees it must be remembered that a demand guarantee can hardly avoid making reference to the obligation for whose performance the guarantee is security. …"
While considering Paget’s presumptions, the Court focused on the fact that the Guarantee was not issued by a bank, despite the fact that the Guarantor had previously described itself in separate legal proceedings as a company that offered investment services. It, therefore, concluded that where the instrument was not given by a bank or other financial institution, there needed to be cogent indications that the instrument was intended to operate as a demand guarantee and the absence of indications of that strength, or quality, was material and adverse to the Builder’s position. Accordingly, based on the language of the Guarantee, and with consideration to the background circumstances, the Court held that in this instance the Guarantee was a “see to it” guarantee such that a demand could not be validly made until the underlying liability had been determined in the arbitration.
The second issue
The Builder also argued that even if the guarantee were held to be a “see to it” guarantee, based on its true construction Clause 4 only operated as a defence to a claim under the Guarantee if the arbitration was commenced before the demand was made, which in this instance it had not been, and that any alternative construction of this clause would lead to an uncommercial result as the Guarantor would be given two opportunities to litigate its liability under the contract which could result in undue delay to any payment.
Clause 4 of the Guarantee stated:
“In the event that [the Buyer] fails to punctually pay the Final Instalment guaranteed hereunder in accordance with the Contract or [the Buyer] fails to pay any interest thereon, and any such default continues for a period of fifteen (15) days, then, upon receipt by [the Guarantor] of [the Builder's] first written demand, [the Guarantor] shall immediately pay to [the Builder] or [the Builder's] assignee all unpaid Final [I]nstalment, together with the interest as specified in paragraph (3) hereof, without requesting [the Builder] to take any further action, procedure or step against [the Buyer] or with respect to any other security which you may hold.
In the event that there exists dispute between [the Buyer] and the Builder as to whether:
(i) [The Buyer] is liable to pay to the Builder the Final Instalment; and
(ii)The Builder is entitled to claim the Final Instalment from [the Buyer],
and such dispute is submitted either by [the Buyer] or by [the Builder] for arbitration in accordance with Clause 17 of the Contract, [the Guarantor] shall be entitled to withhold and defer payment until the arbitration award is published. [The Guarantor] shall not be obligated to make any payment to [the Builder] unless the arbitration award orders [the Buyer] to pay the Final Instalment. If [the Buyer] fails to honour the award, then [the Guarantor] shall pay you to the extent the arbitration award orders."
While the Court appreciated the thrust of the argument put before it, it found that the two opportunities to litigate under the Guarantee came from two different perspectives. The first perspective was that the Guarantor could claim that no sums were payable by the Buyer and, therefore, no demand could be made under the Guarantee. The second could arise in the form of a dispute under the contract and would relieve the Guarantor’s obligation to make a payment under the Guarantee until an award determining this point was published.
The Court was not persuaded that the benefits of Clause 4 would only arise when the dispute had been submitted to arbitration before the demand under the Guarantee was made. It also found no basis to suggest that the parties had expressed any preference over whether the right to arbitrate or issue a demand should prevail first. Accordingly, the Court held that the true construction of Clause 4 of the Guarantee entitled the Guarantor to refuse to make payment pending the outcome of an arbitration between the Builder and Buyer irrespective of when the arbitration may be commenced.
This decision provides further guidance on the different types of guarantee that might be given under the same contract and which could have an impact on when payment has to be made. This is important as it can take some time for an arbitral tribunal to reach a decision and issue an award.
Furthermore, it highlights the potential difference where a Builder provides a refund guarantee from its bank without a provision similar to Clause 4 where payment may need to be made immediately in response to a demand even when the liability of the Builder to pay is disputed and referred to arbitration.
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