China - English Commercial Court Interprets Buyer’s Final Instalment Guarantee.
Legal News & Analysis - Asia Pacific - China - Shipping Maritime & Aviation
11 June 2020
In Shanghai Shipyard Co. Ltd v Reignwood International Investment (Group) Company Ltd  EWHC 803 (Comm), Justice Knowles interpreted a guarantee providing for a refund of the buyer's final instalment due under a shipbuilding contract. The guarantee provided that, if a dispute arose between the buyer and the builder about whether or not the final instalment was due, and such dispute was submitted to arbitration, the guarantor would be entitled to withhold and defer payment until the publication of the arbitral award. The key issue before the Court was whether, on the wording of the clause, the arbitration had to be commenced before the demand for payment was made.
The Court also decided whether the guarantee was a demand guarantee (sometimes called a demand bond) or a “see to it” guarantee (also referred to as conditional payment obligation), and much has been written about the Court's decision in this regard. Whilst many shipyards may rely on the decision to seek to ensure that guarantees provided by buyers may be interpreted as "demand" guarantees, this will be of little assistance where there is a dispute about whether or not payment is due, and the guarantee provides - as most do - that payment is conditional upon an arbitration award which decides the dispute. It will be more important to ensure that there is clarity about whether or not arbitration must be commenced prior to the demand for payment being made.
Shanghai Shipyard Co. Ltd (the "Builder") and Reignwood International Investment (Group) Company Ltd (the "Defendant") entered into a shipbuilding contract (the “Contract”) to build a drillship for a total price of US$200 million, of which US$170 million was to be paid upon delivery (the “Final Instalment”). The parties entered into a further agreement entitled “Irrevocable Payment Guarantee” (the “Guarantee”) to secure this final payment. A Novation Agreement was also agreed whereby the Defendant was substituted by its indirect subsidiary, Opus Tiger 1 PTE Ltd (the “Buyer”).
Following the Buyer’s refusal to take delivery of the drillship on the basis that the vessel was not deliverable, the Builder requested the Final Instalment from the Buyer and subsequently demanded payment from the Guarantor under the Guarantee.
None of these requests were satisfied and as a result arbitration proceedings were commenced. The Commercial Court was asked to review preliminary issues in respect of the nature of the Guarantee and circumstances in which payment was required.
The preliminary issues put before the Commercial Court (Knowles J) were as follows:
- whether the Guarantee was a demand bond making the guarantor liable for payment regardless of whether the Buyer was liable to pay the Final Instalment, or whether the Guarantee was a “see to it” guarantee which would make the Guarantor liable only if the Buyer was liable to pay the Final Instalment; and
- whether the Guarantor was entitled to refuse payment pursuant to Clause 4 of the Guarantee regardless of when the arbitration proceedings were commenced or whether this right of refusal applied only if the arbitration had been commenced by the time the guarantee demand was made.
The court recognised that distinguishing a demand guarantee from a "see to it" guarantee could be challenging as the language used in both instances showed a large degree of commonality. The context was an important factor to bear in mind. The Guarantee, in this instance, was not issued by an independent entity such as a bank but by a parent company, although that fact on its own did not constitute a sufficient basis to negate the possibility of a demand guarantee.
The court took the view that the language used in the Guarantee ("… upon receipt by us of your first written demand, we shall immediately pay to you or your assignee all unpaid Final Instalment …"), which the Builder attempted to rely on to make the case in favour of a demand guarantee, did not stand alone, was not deemed to be determinative and was not inconsistent with the instrument being a "see to it" guarantee.
In its analysis, the Commercial Court underlined the importance of approaching the language of the Guarantee in line with the guidance offered by the Court of Appeal in Wuhan Guoyo Logistics Group v Emporiki Bank of Greece  1 Lloyd’s Rep 266 (“Wuhan”) which relied on a presumption set out in the textbook Paget's Law of Banking. “Paget’s presumption”, which lists four elements to be considered when identifying the nature of a guarantee, states that a guarantee will almost always be construed as a demand guarantee where an instrument:
- relates to an underlying transaction between the parties in different jurisdictions,
- is issued by a bank [“or other financial institution” – this wording was added in the current fifteenth edition of the textbook],
- contains an undertaking to pay “on demand” (with or without the words ‘first’ and/or ‘written’) and
- does not contain clauses excluding or limiting the defence available to a guarantor.
In Wuhan, the Court of Appeal held 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”. The fact that, in Wuhan, the Guarantor was a bank, and other presumptions were satisfied, led the court to conclude that the instrument was a demand guarantee.
In the present case, the Guarantor was neither a bank nor a financial institution, and the court suggested that the other three elements were “not necessarily a powerful combination” to establish a demand bond.
Further, Paget suggests that in the event that the instrument is not issued by a bank or other financial institution “cogent indications that the instrument was intended to operate as a demand guarantee will be required…” With this in mind and the Court of Appeal’s guidance on the importance of consistency, Knowles J concluded that such indications were absent from the relevant provisions in the Guarantee and, as a result, it was a ‘see to it’ guarantee.
Clause 4 of the Guarantee stated that:
In the event that there exists dispute between [the Buyer] and the Builder as to whether:
- [The Buyer] is liable to pay to the Builder the Final Instalment; and
- The Builder is entitled to claim the Final Instalment from [the Buyer],
and such dispute is submitted either by the [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 obliged to make any payment to [the Builder] unless the arbitration award order [the Buyer] to pay Final Instalment. If [the Buyer] fails to honour the award, then [the Guarantor] shall pay you to the extent the arbitration award orders.
The Claimant argued that under Clause 4 the Guarantor was only released from its obligation to pay in the event that arbitration proceedings were commenced before the demand for payment under the Guarantee was made.
Knowles J disagreed with this and held that there was no basis in the language of the Guarantee to draw such conclusion. The Guarantor was therefore entitled to refuse payment pursuant to Clause 4 until the arbitration award was issued, and this regardless of when such arbitration was commenced.
The judgment highlights the importance of carefully drafting the terms of a guarantee to ensure that parties know exactly what obligations they are agreeing to. The decision appears to indicate that, for a guarantee to operate as a demand bond, specific wording should be included to indicate the guarantor’s obligation to pay on demand without further investigation. It also suggests that, unless expressly stated in the terms of the agreement, the professional function of the guarantor (for example, whether it is a bank or a financial institution) will heavily impact on the characterisation of the guarantee. The Commercial Court confirmed the approach adopted in previous cases and shed some light on this particular point of law. However, as stated in our introduction, if the guarantee provides that payment is conditional upon an arbitration award determining liability to pay, it will make little difference whether or not the guarantee is construed as "on demand" or not. The case has now been appealed, with the permission of Knowles J, and it remains to be seen how the English Court of Appeal approach this case
For further information, please contact:
Sapna Jhangiani, Partner, Clyde & Co