When is a guarantee an on demand bond?
Ultrabulk A/S v. Jagatramka  EWHC 2792 (Comm)
The Commercial Court has indicated when a guarantee might give rise to a primary liability arising independently and upon demand, as opposed to a secondary liability where the guarantor’s liability mirrors the liability of the debtor.
The background facts
In June 2007, the Claimant, a Danish shipping company, entered into two cooperation agreements with an Indian coke producer (the “Company”). The Defendant was the chairman and managing director of the Company.
In early 2013, the Company was indebted to the Claimant for US$ 4,259,395 (the “Liabilities”). By a deed of agreement dated 2 July 2013, the Company agreed to repay the Claimant the Liabilities in instalments by 30 December 2013.
By a personal guarantee (the “Guarantee”), the Defendant agreed that he was aware of the Liabilities and guaranteed that if the Company did not pay the Liabilities to the Claimant by 31 December 2013, he would, on the Claimant’s “first written demand”, personally pay a sum equivalent to the Liabilities plus interest.
The salient terms of the Guarantee provided as follows:
“...I am also aware of the liability due on date, i.e. USD 4,259,395/- to the Beneficiary by [the Company] under the Agreement (the '[Company] Liabilities').
NOW, therefore, I, the Guarantor, hereby unconditionally and irrevocably guarantee that, if for any reason [the Company does] not repay the [Company] Liabilities latest by 31 December 2013 then I will on the Beneficiary's first written demand from the Beneficiary, pay a sum equivalent to the [Company] Liabilities plus the interest based on annual Libor plus 2% to the Beneficiary...”
The Company failed to settle the Liabilities by 31 December 2013. On 16 June 2015, the Claimant demanded the amount due under the Guarantee from the Defendant. The Defendant failed to make any payment to the Claimant and the Claimant commenced proceedings.
The Commercial Court decision
The Claimant’s lawyers submitted that the Guarantee gave rise to a primary liability akin to that under a performance bond, and that the Defendant was obliged to pay a sum equivalent to US$ 4,259,395 plus interest, in the event that the Company failed to discharge its liabilities.
The Defendant’s main defence was that the Company had paid US$ 1.95 million towards the Liabilities and that, if the Guarantee was enforceable, the Defendant should only be liable for the US$ 2.31 million that remained outstanding, plus interest.
In a succinct judgment, the Court addressed whether the Guarantee:
(i) provided for a primary liability arising upon demand, as contended by the Claimant, or
(ii) whether the Guarantee was a true guarantee that provided for a secondary liability in the sense that the guarantor’s liability mirrored the liability of the Company, as contended by the Defendant.
Ultimately, the issue of whether the instrument in question was a true guarantee, or an on demand bond, depended on construction of the actual document. The Court considered the following features of the Guarantee.
First, the Court concluded that by the use of the phrase “a sum equivalent to” US$ 4,259,395 plus interest, the Defendant did not agree to pay the actual outstanding liability of the Company at the relevant time, but specifically agreed to pay a stated amount.
Secondly, the Defendant agreed to pay the sum “unconditionally and irrevocably” and “on demand” if the Company did not pay the Liabilities by 31 December 2013. The Court found that such language was indicative of a primary liability and there was no dispute about the fact that the Company did not pay US$ 4,259,395 by 31 December 2013.
Thirdly, the words “I irrevocably confirm that I will not contest and/or defend any application and/or proceedings to enforce this Personal Guarantee” were indicative of a primary liability.
Although the Court acknowledged that there is English law authority for the general presumption that an instrument is not an “on demand bond” unless given by a bank or other financial institution, it nevertheless held that the wording of the Guarantee counteracted any such presumption in this case and that the Guarantee was in fact an on demand bond. The Defendant was accordingly liable for the whole sum of US$ 4,259,395 plus interest, regardless of the fact that a significant proportion of that amount had since been repaid by the Company.
This case shows how strictly the courts are prepared to interpret guarantees. It provides a useful illustration of the differences between a guarantee that creates primary and secondary liabilities. A true guarantee creates a secondary liability that mirrors the liability of the principal debtor, whereas an on demand bond creates a primary liability independent of the underlying contract. This decision indicates that the fact that an instrument is issued by an individual, and labelled as a guarantee, does not prevent it from being construed by the courts as an on demand bond.
For potential guarantors looking to enter into similar guarantees, great care should be taken to ensure that the guarantee refers to the outstanding amounts due as at the date upon which the guarantee crystallises, and that the wording is not akin to that of a performance bond, in order for the guarantor to avoid becoming liable for sums in excess of those that are actually owed.
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