Keywords: bank guarantees, shipbuilding contracts, China

For a shipowner the process of buying a new vessel from a shipyard can be a hazardous venture, much riskier than buying an existing, second-hand vessel. This is because the shipowner has to part with millions of dollars "up front" to a shipyard/builder, by way of payment instalments to fund the construction. The shipowner as buyer generally has no mortgage or other security in the ship under construction; all the shipowner has is the refund guarantee issued by the shipyard's bank, which therefore forms the cornerstone of the entire project. If the shipyard defaults and is obliged to return the shipowner's instalments, the bank refund guarantee provides the shipowner with the necessary security.

Shipowners buying from mainland Chinese shipyards will often receive refund guarantees issued by PRC banks, and may therefore stipulate that the bank guarantee should be subject to Hong Kong law and court jurisdiction. If the mainland bank maintains a Hong Kong branch, any judgment obtained through the Hong Kong court will be enforceable in Hong Kong.

The refund guarantee can be one of two types. A "traditional" guarantee creates a co-extensive or secondary liability on the part of the bank, meaning in practice that the shipowner must succeed in the underlying shipbuilding contract arbitration. Such traditional guarantees can only be called once the shipowner has obtained an arbitration award upholding his right to cancel the shipbuilding contract and obtain the return of the instalments.

The second type of guarantee is the "on-demand" guarantee or bond which, as the name suggests, can be triggered by simply a written demand from the shipowner. A shipowner with an on-demand guarantee thus has the strongest form of security, giving the right to payment of the funds irrespective of any ongoing arbitration under the shipbuilding contract.

In Otto Offshore Ltd v. Bank of Communications [2014] HKEC 1073 the shipowner brought an action in Hong Kong under the bank's refund guarantee. Separately, the shipyard obtained from the Tianjin Court a restraining order/injunction to prevent the bank from making payment under the refund guarantee. The bank applied to the Hong Kong court to stay the Hong Kong court action, pending the outcome of the Tianjin Court proceedings and the underlying shipbuilding contract arbitration. The bank contended that it should not be exposed to the risk that it would either be in breach of (a) the Tianjin restraining order or (b) a Hong Kong court order for payment under the guarantee. Significantly, the Hong Kong court rejected this argument and refused to stay the Hong Kong proceedings. The shipowner had not agreed, or submitted, to the jurisdiction of the Tianjin Court. In addition, the Tianjin Court restraining order, not being a money judgment, was not recognisable either under the relevant Hong Kong statute or at common law. The Tianjin Court therefore did not have jurisdiction over the shipowner to give a judgment capable of being recognised in Hong Kong.

The Hong Kong court's decision upheld both the vital role of the refund guarantee in the shipbuilding process, as well as the parties' agreement in the guarantee to the jurisdiction of the Hong Kong court.

For inquiries related to this Legal Update, please contact Bill Amos, who appeared for the shipowner, or your usual contacts with our firm.

Originally published 10 July 2014

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