UK: Shipbuilding Guarantees: Latest Decisions

Last Updated: 6 March 2013
Article by Thomas Kelly

The Court of Appeal recently considered the wording of a payment guarantee issued on behalf of the buyers, under a shipbuilding contract, in the case of Wuhan Guoyo Logistics Group Co Ltd & Others v Emporiki Bank of Greece SA [2012].

The dispute centred on whether the document was a standard guarantee, dependent on the buyers' liability to pay, or whether it was an "on-demand" bond, and could be called on regardless of the underlying shipbuilding contract.

The document was called a "payment guarantee", and contained the words: "In the event that the BUYER fails to punctually pay the second instalment guaranteed hereunder... we shall immediately pay to you or your assignee the unpaid 2nd instalment..." The document also stated in Clause 1 that the bank guaranteed "the due and punctual payment by the BUYER". However, payment was to be made "upon receipt by us of your first written demand" and was also expressed to be immediate. Clause 7 further provided that the bank's obligations were not affected by any dispute between buyer and seller.

The Court of Appeal, overruling the decision at first instance, found that the document was an on-demand bond, and that the bank was required to pay on the seller's written demand, without reference to the obligation of the buyer under the shipbuilding contract. The Court referred to Paget's Law of Banking, which stated:

"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."

The decision of the Court of Appeal should be no great surprise in that it brings the construction of payment guarantees broadly into line with that of refund guarantees in shipbuilding contracts, as established by Meritz v Jan de Nul [2011]. Following Meritz, it is well established in the industry that wording of this sort, with reference to payment "on written demand" is likely to establish the document as an on-demand bond, under which a guarantor must, absent bad faith, pay the guaranteed sum without reference to the underlying contract. Buyers, as well as sellers, should therefore take care not to be caught out by a claim over disputed sums being presented under the guarantee, unless arbitration is commenced within any time limit set out in the guarantee.

Refund guarantees were themselves considered in Wuhan Ocean Economic & Technical Cooperation Co Ltd & Others v Schiffahrts-Gesellschaft "HANSA MURCIA" mbH & Co KG [2012]. Under an addendum agreeing an extension of the delivery date under the shipbuilding contract, the buyers undertook to extend the validity of the refund guarantee applicable to the contract from 30 June 2010 to 31 May 2012. The guarantee also provided that where arbitration was commenced prior to delivery of the vessel, the guarantee validity would be extended to 60 days following any award.

By 28 June 2010, the sellers had not yet secured the extension to the refund guarantee in accordance with the addendum, so the buyers purported to hold them in repudiatory breach of the contract, and terminated the shipbuilding agreement. The buyers alleged that the sellers were under an implied obligation to secure the extension within a reasonable time, and their failure was sufficiently serious a breach as to justify termination of the contract.

On appeal from arbitrators, Cooke J considered that there was an implied term requiring the extension within a reasonable time, in order to provide the buyers with certainty as to the security of their advance instalments. If the sellers were allowed to delay obtaining an extension up to the date of expiry of the refund guarantee, that would be too late for the buyers to protect themselves (other than by commencing arbitration).

The Court then turned to the nature of the implied term, and whether its breach entitled buyers to terminate. After brief consideration, Cooke J held that it was an innominate term, a breach of which had the potential to deprive the buyers of substantially the whole benefit of the contract. The question, therefore, was: had that happened in this case?

Overall, Cooke J thought not. It was clear, under the terms of the guarantee, that its validity could be extended, even after it had otherwise expired, provided arbitration was commenced prior to delivery of the vessel. That being so, the buyers' security was not seriously imperilled because they could commence arbitration, and would then have 60 days, following any award, to claim under the guarantee.

As with many other situations, it is clear that buyers need to take great care before "jumping" and terminating a shipbuilding contract for repudiatory breach. Unless there is specific wording making the renewal of a refund guarantee a condition, or providing for sanctions where the extension is not procured, then, where buyers have some form of protection on expiry (as in this case), the Court may well find that any termination by buyers was wrongful.

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.

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Thomas Kelly
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