UK: The true colours of English law governing refund guarantees

In the recent case of Spliethoff's Bevrachtingskantoor BV v Bank of China Ltd [2015] EWHC 999 (Comm), the Commercial Court considered the nature of refund guarantees and whether a foreign court order affects the bank's liability to pay on demand. The decision is timely, clarifying repeatedly occurring issues arising out of refund guarantees. It sends a clear message that English law governing refund guarantees is of the nature of a performance bond and the obligation to pay on demand should not be affected by extraneous matters, even, in some cases, fraud.

Background

Spliethoff's Bevrachtingskantoor BV (SBV), a Netherlands ship operator, brought two actions against Bank of China (BOC) in respect of refund guarantees issued by BOC in support of two shipbuilding contracts between SBV as buyer and Chinese sellers. Between October 2006 and July 2011, SBV paid instalments of US$28.68 million towards the purchase price, on terms that the instalments would be refunded with interest if the contracts were cancelled. The BOC guarantees secured the sellers' obligation to refund.

The ships were not delivered on time and SBV claimed repayment of the instalments from the sellers. This was disputed, so SBV obtained arbitration awards against the sellers.

Meanwhile, the sellers brought two sets of proceedings against SBV and the engine suppliers in China, alleging that SBV and the engine suppliers conspired fraudulently to provide defective refurbished engines to the sellers for installation aboard the ships. BOC was not a party to those proceedings. The sellers obtained ex parte orders from the Chinese court in 2011 prohibiting BOC from making any payment, anywhere in the world, under the BOC guarantees to SBV.

SBV unsuccessfully challenged the jurisdiction of the Chinese courts, citing the arbitration clauses in the shipbuilding contracts. Thereafter, it fully defended the claims in the Chinese proceedings, but again failed. In April 2013, the Chinese court awarded the sellers substantial damages for fraud. In April 2014 those judgments were upheld on appeal, becoming effective and enforceable.

SBV brought claims in England against BOC for payment under the guarantees. BOC defended the claim, on the basis that the Chinese judgments afforded BOC a defence to SBV's claims under the guarantees, or alternatively argued that a stay of enforcement was justified.

The wording of BOC refund guarantees

The BOC refund guarantees contain the following material terms:

We, Bank of China, as the primary obligor, not as security, do hereby irrevocably, unconditionally and absolutely guarantee repayment to you by the Seller of an amount up to ... as you may have paid to the Seller under the [shipbuilding contract] prior to the delivery of the Vessel...
Should the Seller fail to make such payment, we shall pay you the amount the Seller ought to pay with interest on that amount...within 30 days after our receipt of the relevant written demand from you for repayment.
Our obligations under this guarantee shall not be affected or prejudiced by any dispute between you as the Buyer and the Seller under the Shipbuilding Contract...

The nature of the refund guarantees

BOC's primary case was that the refund guarantees are contracts of surety. If so, any material variation of the terms of the principal contract (i.e. the shipbuilding contract) discharges the surety. BOC contended that there had been a breach of an implied term of the shipbuilding contracts (to the effect that SBV would not prevent or hinder the sellers from performing its obligation to deliver vessels with new engines) and so BOC should be discharged from liability.

As a matter of construction, Carr J concluded that the guarantees were in the nature of performance bonds. The guarantees only secured the obligation of the sellers under the shipbuilding contracts to refund advance instalment payments (with interest) in the event of cancellation of the shipbuilding contracts. Their target was cashflow, a hallmark of a performance bond.

In this regard, Carr J relied on the authority Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA [2012] EWCA Civ 1629 ("Wuhan"), where the Court of Appeal cited, with approval, Paget's Law of Banking, which sets out the following factors:

"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."

Carr J held that three of the four Paget factors justifying a presumption in favour of a performance bond were present: the guarantees were issued by a bank, in the context of international trade between international parties, with an undertaking to pay "on demand". In her view, the guarantees made it clear that any disputes between SBV and the sellers were irrelevant to BOC's obligation to pay. The phrase "should the Seller fail to make...repayment" did not impose a secondary liability, but rather pointed to the circumstances in which BOC's obligation was triggered.

Effect of findings of fraud in China

BOC also argued that their obligation was discharged by the Chinese courts' findings of fraud against SBV. If the BOC guarantees were performance bonds rather than contracts of surety, then this defence fell away. However, for completeness, Carr J concluded that even if the guarantees were true guarantees and not performance bonds, their express terms excluded discharge, even for fraud as determined by the Chinese courts.

As to whether the English courts should recognise the Chinese judgments and orders, this turned on whether SBV had submitted to Chinese jurisdiction. In choosing to defend the claims against it in the Chinese proceedings, SBV was held to have done so. Accordingly, Carr J held that there was no residual judicial discretion for the court to evaluate the overseas court judgment on the ground of public policy by reference to breach of an arbitration agreement.

That said, Carr J held that the clear intention of the guarantees, objectively construed, was that any dispute between buyer and seller, resolved or unresolved, should not affect BOC's obligations to pay.

The stay of enforcement

The English court has a discretionary power to stay enforcement. So in the alternative, BOC sought a general stay of execution, on the basis that the English court should have due regard to the Chinese court orders as a matter of international comity. Carr J rejected international comity as a factor in this case. This was not to disrespect the Chinese courts but when considering an English law contract, English law regards illegality by the law of the place of the performing party's domicile, or place of business, as irrelevant.

The Chinese law experts agreed that BOC would not be at any real risk of criminal prosecution, given the lack of the necessary intention by BOC to flout the Chinese court orders, so risk of sanction was not a factor to take into account. Nor was the alleged risk of double jeopardy without a stay, as there was, in Carr J's view, a real prospect of onward subrogated recovery by BOC.

In any event, BOC, as an international commercial organisation in the business of providing external guarantees, is aware of these risks when entering into the guarantees on the terms that it did. For these reasons, the application for a stay was dismissed.

Conclusion

The decision is a helpful judicial clarification of the nature of refund guarantees. Although it is a matter of construction in each case, the usual guarantee wording was construed as a performance bond rather than a contract of surety, imposing an irrevocable, unconditional and absolute obligation on the issuer to pay on demand, independent of the underlying contract. As such, foreign judgments and orders against the buyer in respect of the underlying shipbuilding contract are unlikely to provide a defence to the issuer of the guarantee, even though those judgments and orders are to be recognised by the English court. The decision emphasises the desire of the English court to give effect to the contractual bargains between parties, and to recognise the commercial purpose behind refund guarantee arrangements.

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