UK: Shipping Update - Refund Guarantees: 'all sums due'?

Background

Refund guarantees are an increasingly important element of any shipbuilding contract. The trading environment for all parties remains difficult and there are clear advantages to obtaining security for key aspects of performance under a shipbuilding contract wherever possible.

In difficult market conditions, banks who may previously have regarded the provision of such guarantees as relatively low-risk business have found themselves exposed to significant liabilities. This has resulted in guarantee wordings coming under detailed legal scrutiny in the face of a large number of very significant claims.

This update considers the implications of the recent Court of Appeal decision in Kookmin Bank v Rainy Sky & others [2010] EWCA Civ 582 in which a bank refused repayment under "advance payment bonds" in respect of purchase price instalments, the shipyard having become insolvent.

The Facts

Kookmin bank issued six on demand advance payments bonds to secure certain obligations assumed by its shipyard customer under six shipbuilding contracts made with the claimants as buyers, each on materially identical terms.

Each shipbuilding contract required the buyer to pay the contract price in pre-delivery instalments, and entitled him, in the event of the shipbuilder's insolvency, to a refund of any instalments paid.

Paragraph 2 of the bond entitled the buyer, on certain specified grounds including rejection of the vessel, to repayment of any pre-delivery instalments. By para.3 of the bond, the bank guaranteed "all such sums due to you under the contract".

After the buyers had paid the first instalments the shipyard became insolvent and the buyers sought repayment of US$46,652,000 plus interest under the bonds. The bank argued that it was entitled to review "evidence" in relation to the underlying dispute and therefore form a view about the underlying merits. The buyers argued that this was a form of on demand guarantee which was payable immediately once notice was given in accordance with its terms, in the absence of fraud.

A further issue between the parties was whether the words "all such sums due to you under the contract" in para.3 of the bond referred to the instalments becoming repayable in any circumstances under the shipbuilding contracts (including the insolvency of the shipyard) or whether, as the bank contended, the guarantee was restricted to covering only the circumstances described in para.2 of the bond, namely;

"...upon your rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract or upon a Total Loss of the Vessel."

Significantly, the circumstances listed in para. 2 did not include the insolvency of the shipyard.

The High Court


In the High Court, the judge agreed with the buyer in summary judgment proceedings. Mr. Justice Simon said that where an instrument issued by a bank relating to an underlying transaction contains an undertaking to pay "on demand" and does not contain clauses excluding or limiting the defences of the bank, it will almost always be construed as a demand guarantee.

All that was required in such circumstances was a statement by the Claimant specifying in what respect the Builder had failed to fulfil the terms and conditions of the Contract.

Crucially the judge held that the words 'such sums' as used in para. 3 of the bond were intended to apply to the pre-delivery instalments rather than the repayment obligations recited in para. 2. A key aspect of the judge's analysis was his finding that the bank's construction had the 'surprising and uncommercial' result that the buyers would not be able to call on the bond upon the insolvency of the shipyard; an event which he considered would be most likely to require the provision of first class security. The bank obtained leave to appeal to the Court of Appeal.

The Court of Appeal

By a majority decision (Sir Simon Tuckey dissenting) the bank's appeal was upheld and the decision of the High Court was overturned in relation to the interpretation of "all such sums due ... under the contract".

It was agreed by all the judges that there was a case to be made for either of the differing interpretations of the bond contended for by the parties. The key area for debate was the extent to which Simon J was correct in rejecting the bank's interpretation on the basis that it produced an outcome that was surprising or uncommercial.

In his dissenting judgment, Sir Simon Tuckey felt that the views of an experienced commercial judge on such a matter should be given considerable weight by the Court of Appeal. He agreed with the judge that it "defies commercial common sense" to think that the insolvency of the shipyard, of all such other obligations, was the only one which the parties intended should not be secured.

By contrast Lord Justice Patten (supported by Lord Justice Thorpe) felt that the wording of the contract should be given its true meaning so far as possible. As he put it:

"In a commercial contract (like any other contract) the parties have chosen to define the limits of the obligations which they have undertaken by the language they have used. The purpose of the contract is to provide an objective record of what has been agreed so as to regulate the legal relationship between them. The Court's function is to give effect to those obligations by respecting the terms in which they are cast."

With this in mind he went on to note:

"Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended, the Court has no alternative but to give effect it its terms. To do otherwise would be to risk imposing obligations on one or other party which they were never willing to assume and in circumstances which amount to no more than guesswork on the part on the Court."

On this basis Patten LJ had little difficulty in adopting an interpretation in favour of the bank that excluded repayments in the event of insolvency under the bond. The fact that cover for this eventuality may have been desirable from the perspective of the buyer was insufficient in his view to depart from what would otherwise be the natural and obvious construction of the bond

Comment

The fact that four judges (one in the High Court and three in the Court of Appeal) are evenly divided as to the correct interpretation of the guarantee in this case indicates the difficulty and uncertainty that can surround litigation concerning bank guarantees in a shipbuilding context. In the circumstances an appeal to the Supreme Court may well be likely in this case.

Given the rarity in the past of situations where such guarantees were called upon, the parties to this litigation may perhaps be forgiven for adopting contract wordings that have proved so difficult to interpret. However, in light of recent experience and market conditions there can no longer be any doubt that guarantee wordings of this type require the most careful attention.

As this case illustrates, if an 'on demand' guarantee is required then the clearest possible language should be adopted if the intended effect is to be achieved. By the same token, there is no reason why such a guarantee should not contain a provision requiring that the underlying dispute should be determined before payment is made if that is the intention of the parties.

The approach to be adopted will doubtless depend on market conditions and negotiating strength in any given case. However, whichever the approach chosen, it is clear that the price for adopting language that is less than precise is likely to be long and expensive litigation

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions