UK: “Sea Emerald SA V Prominvestbank – Joint Stockpoint Commercial Industrial And Investment Bank” [2008] EWHC 1979 (Comm): Dispute Relating To Refund Guarantee In Shipbuilding Contracts

Last Updated: 27 August 2008

In the shipbuilding industry, the refund guarantee is often an essential document because it allows the buyer and its financiers to hold security from the shipyard which will respond in the event that the ship is not delivered. The exact wording of the refund guarantee is normally a matter of negotiation between the buyer and the shipyard.

In this case, the buyer was a Panamanian company that was part of a group of companies (the "Group") with extensive shipping interests and a fleet of about 80 vessels, including refrigerated cargo vessels and smaller tankers. The shipyard was in the Ukraine. In the 1990s, the Group placed several contracts with the yard, ordering a total of 19 ships for over US$200 million. Each ship was the subject of a separate contract, entered into by a different company in the Group that was intended to own and operate the ship. All the contracts provided for the yard to provide a refund guarantee to the purchasing company.

The contract that resulted in this dispute was for the construction and purchase of a refrigerated cargo vessel. The contract stated it was governed by English law and provided for English arbitration. Inter alia, the contract provided for the yard to furnish a refund guarantee to be issued by the yard's bank, "the State Commercial Industrial Bank, - Nikolaev Branch" within 30 days from the signing of the contract, failing which the buyer had the option to declare the contract null and void. It was also stated that "the furnishing of this Guarantee is to form an integral part of this Contract".

The guarantee in question was signed by S, head of the Nikolaev regional branch of the bank, and the Director General of the yard. It provided that in consideration of the payment of the instalments under the shipbuilding contract, the Nikolaev branch of the bank would "at the request of the Builder, hereby irrevocably and unconditionally guarantee the payment to you [the buyer] by the Builder" the total maximum sum of US$9.9 million or any amount to be paid to the yard as the instalments under the contract. The bank's liability under the guarantee was "limited to the total sum of the instalments or any lesser amount mutually agreed" between the buyer and the yard and actually paid by the buyer. The guarantee was stated to be governed by English law.

The bank subsequently extended substantial amounts of credit to the yard, including credit for the purpose of constructing the vessels for the Group. S subsequently left the bank but the bank continued to make loans to the yard for construction of the vessels. Nonetheless, the yard found itself in financial difficulties and eventually it went into receivership. The ship relating to this particular contract was not completed or delivered and consequently, the buyer rescinded the contract and made a demand on the bank under the guarantee. The bank alleged the refund guarantee was a fraud and sought to have it declared invalid and not binding.

The Commercial Court had to consider the issue of authority given that the bank was contending S had no authority to enter the guarantee on its behalf. The decision contains a detailed discussion of the different types of authority S might have had to give the guarantee in question, as well as some comment on the issue of ratification by the bank of its employee's actions.

Actual authority

The question of S's actual authority to give the guarantee was governed by Ukrainian law. The parties did not disagree on the effect of Ukrainian law so expert evidence was not adduced. However, the judge found as follows:

  • S had been the head of the Nikolaev department at the relevant time;

  • the bank's articles of association provided that a head of department had authority to carry out all legal actions in the name of the bank within the limits of the competence of his department without any special power of attorney;

  • the bank's departments were entrusted with work in foreign currencies and foreign economic activities including documentary letters of credit, collection of payments or bank transfer and other formats used in international banking practice;

  • however, no specific mention was made of refund guarantees which were not a method of making payment but a collateral contractual commitment.

Consequently, the judge held that S did not have the actual authority as the head of a department in the bank to enter on behalf of the bank into a refund guarantee which was a contingent commitment unlimited in time to pay a large amount of foreign currency that was scarce in the Ukraine and moreover governed by a foreign law in respect of which S had taken no advice.

Inferred actual authority

As a matter of Ukrainian law, if S could not issue the guarantee under the relevant provisions of the bank's articles of association, he would not otherwise have had the authority to issue the guarantee, except if he had been given that authority by the bank's Management Board and held a relevant power of attorney. However, the judge held that whilst it was unlikely that S entered into the guarantees without anyone else in the bank knowing about it or being involved, there was not sufficient evidence to show that proper procedures were followed before the guarantees were given or that the bank had formally authorised S to issue the guarantees by a decision of the Management Board and by providing him with a power of attorney. The fact was that the guarantees were given when the bank had no relevant written procedures in place and S might have been unfamiliar with guarantees of this kind, given that at the time, Ukrainian banks were trying to develop new services required by their customers in the post-Soviet era. However, the fact that the bank would try to accommodate its customers' requests did not mean that S had authority to give the guarantee in question.

Ratification

The buyer argued that the bank ratified S's actions because it knew he was giving the guarantees and did not disclaim them at the time. The judge referred to the case of "Yona International Ltd v La Reunion Fancaise SA" [1996] 2 Lloyd's Rep. 84, which held that whilst ratification may be implied from silence or inactivity, "it must be such as to manifest unequivocally an intention to adopt the act in question". In other words, there had to be a conscious decision to adopt an unauthorised act. Furthermore, the person ratifying his agent's conduct had to be in possession of all the material circumstances before he could ratify and he also had to be someone competent at the time of ratification to have entered into the contract in question.

In the present case, what was required was for the Chairman of the bank or the Management Board to have adopted S's act and whilst the bank's head office in Kiev apparently knew of the contracts between the Group and the yard and of the bank's lending to the yard, it was unclear whether this was known by the Chairman or Management Board. Furthermore, even if they knew of it, there was no evidence they knew of the terms of the contracts or specifically of the terms of the guarantee or that they were content to adopt the guarantee whatever its terms.

Ostensible authority

The buyer contended that the bank held out the Nikolaev Department and S as its head as having authority to enter into financial transactions that would normally fall within the scope of the authority of the main regional office of a major commercial bank, particularly one in the business of providing services to the shipbuilding industry. Reference was made to "Armagas Ltd v Mundogas SA" [1986] 1AC 717, where Lord Keith stated that "ostensible authority is general in character, arising when the principal has placed the agent in the position which in the outside world is generally regarded as carrying authority to enter into transactions of the kind in question".

In this case, the judge held there was no evidence that it was usual for officials of the bank, including in the regional offices, to be given specific authority to issue guarantees, nor was it within the ordinary scope of the authority of the main regional office of a major commercial bank to provide commercial guarantees. There was also no evidence that it was within the scope of the usual authority of an official in S's position to enter into a contingent commitment as large as the guarantee in question.

In conclusion, therefore, the Commercial Court held that S had neither actual nor ostensible authority to give the guarantee and that the bank did not ratify his issuing it and consequently, the buyer's claim failed.

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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