United States: You Can't Always Get What You Want: Watch Out For The Wording Of Your Guarantees

Introduction

The need for businesses to protect themselves against a counterparty defaulting is as great as it has ever been. A common way of doing that is taking security by acquiring a proprietary interest over assets, by way of a mortgage or charge. However, that is not always appropriate or possible. The alternative is a guarantee or a similar contract. English law generally refers to such agreements as 'contracts of suretyship'. One party, the surety, assumes responsibility for ensuring payment or performance by the counterparty in the underlying transaction.

There is no rigid classification of these types of agreements, which appear in many different - and sometimes complex - forms. Each contract falls to be construed by reference to its own terms. Labels applied by the parties will not be conclusive. One crucial question is whether the contract is a true 'on demand guarantee' or bond. If that is the case, then claims under the guarantee will not be affected by any disputes relating to the underlying contract. The beneficiary of the guarantee will not have to prove that the underlying contract has been breached, and the guarantor will not be able to rely on any defences that might be open to the counterparty - even where those defences are sound.

In Autoridad Del Canal De Panamá v Sacyr, S.A. & Others [2017] EWHC 2228 (Comm), the Commercial Court recently considered whether 'advance payment guarantees' imposed true 'on demand' liability on the guarantor. It found that they did not. The judgment highlights the need for careful drafting, as the particular contract had been overburdened with multiple clauses and obligations that ended up watering down the liability of the guarantor.

The Panama Canal project

Autoridad Del Canal De Panamá ("ACP") was the employer in a major construction and engineering project relating to the widening of the Panama Canal. Procurement for the project started in 2007. The project was awarded to a consortium of four EPC contractors, who together formed Grupo Unidos por el Canal S.A. ("GUPC"). On 26 June 2016, the final set of locks opened for the first time, marking completion of the works. 

The main EPC contract between ACP and GUPC was subject to the laws of Panama and provided for all disputes to be resolved by ICC arbitration proceedings seated in Miami, Florida. The parent companies of the four EPC contractors gave ACP a 'joint and several guarantee' of GUPC's obligations under the EPC contract. That parent company guarantee was also governed by the laws of Panama, and provided for ICC arbitration in Miami.

Cash flow difficulties and advance payments to the contractor

By late 2012, the consortium experienced cash flow difficulties and requested advanced payments from ACP. ACP agreed to advance US$ 150 million, to be used to pay specified suppliers and subcontractors. The main EPC contract was amended (through variation orders), which made GUPC liable to repay the relevant amounts. The parent companies of the four EPC contractors then also entered into an advance payment guarantee with ACP, undertaking that the advance would be repaid by no later than October 2014. The governing law and dispute resolution clause in this guarantee mirrored the provisions in the other project agreements (Panamanian law, ICC arbitration in Miami). 

The parties agree new English law advance payment guarantees

GUPC's cash flow difficulties continued into 2015. ACP agreed to further advances but required further guarantees for these sums. In June 2015, ACP and the parent companies entered into three further advance payment guarantees, on very similar terms (referred to together as the "APG"). These contracts were - for the first time - governed by English law and conferred exclusive jurisdiction on the English Courts. 

The result was that there were five relevant guarantees: the main parent company guarantee (governed by Panamanian law), the first advanced payment guarantee (also subject to Panamanian law) and three English-law APGs.

Demands under the advance payment guarantees

Towards the end of 2016, it was becoming clear that GUPC could not repay approximately US$ 288 million of advance payments by the deadline of 31 December 2016. GUPC was also unable to defer those repayments to 31 December 2018 by obtaining acceptable letters of credit. Both the Panamanian law guarantees and the APG applied to those repayments.  GUPC asked ACP to defer repayment of the US$ 288 million. ACP declined.  

By that stage, other disputes relating to the cost of and delays to the works had led to ongoing ICC arbitration proceedings in Miami under the Panamanian law project contracts. GUPC made an emergency application to the ICC tribunal, applying for an order that repayment of the US$ 288 million be deferred, and that the status quo between the parties be preserved until such time as the dispute relating to the works was resolved. GUPC was able to do this because a number of the Panamanian law contracts applied to the relevant advance payments:  GUPC argued that the incumbent ICC tribunal sitting in Miami had jurisdiction to make such an order.

The ICC tribunal agreed that it had jurisdiction, but it did not agree to make the order that GUPC wanted. The arbitrators held that GUPC had not shown a sufficiently strong prima facie case that under the Panamanian law contracts, repayment of the advances had to be deferred until the parties had resolved their disputes. The arbitrators also noted that they could not make any findings as regards the English-law APG, in view of the exclusive jurisdiction clause in favour of the English Courts.

The proceedings before the Commercial Court

Around this time, ACP commenced proceedings in the Commercial Court against the parent companies, seeking repayment of the US$ 288 million under the APGs. In the course of the proceedings, and once repayment had become due on the face of the APGs, ACP issued a number of demand letters requiring immediate payment. The parent companies resisted this, arguing that the APGs were not 'on demand' guarantees. Mr Justice Blair considered that point when deciding ACP's application for summary judgment.

An on demand guarantee or bond is a very different contract from a guarantee under which the guarantor has promised that he will 'see to it' that the underlying contract is performed. An on demand bond is similar in nature to a letter of credit. This is because offering credit is rather different from agreeing to step in if the counterparty to the underlying contract defaults. Such bonds need to be clearly worded. Difficulties however arise where agreements are elaborately drafted and include provisions one might expect to see in both types of guarantees. 'Hybrid' contracts may not be easy to put into one or the other category.

The legal test - 'on demand' or 'see to it'?

Blair J noted that references to the guarantor undertaking a primary liability, or to that liability being triggered 'on demand' were of limited value when determining the true legal nature of the contract, without more. Such expressions have become common features in guarantees of all kinds - and sometimes appear to have been 'thrown into' an agreement as a matter of course. A Court will also not be swayed by arguments that particular types of guarantees are given in one form or another. Taking advance payment guarantees as an example, the English Courts have noted they can be in either form (Gold Coast Ltd v Caja de Ahorros Del Mediterraneo [2002] 1 Lloyd's Rep 231). The starting point is for the Court to look at the instrument in question, without any preconception as to what it is. That said, there are certain presumptions that can be determinative, and which depend on the nature of the party giving the guarantee.

If the guarantor is not a bank or a financial institution, there is a presumption against the instrument being an on-demand bond. In IIG Capital LLC v Van Der Merwe [2008] EWCA Civ 542, the Court of Appeal described this as a "... strong presumption ...", and found that the judge had been correct in seeing whether sufficiently clear words had been used to displace it in a guarantee that had been given by two company directors in their personal capacity. On the facts of that case, the presumption had been displaced:  the directors had agreed to pay monies "expressed to be owing or payable", in an amount stated in a certificate to be provided by the beneficiary. The contract stated that such a certificate was conclusive evidence of the guarantor's liability, and that left no room for the directors to rely on any defences that the company may have had.

On the other hand, where a guarantee is given by a bank or a financial institution, the presumption goes the other way. This is called 'Paget's presumption', and it does require a little more than just looking at who the guarantor is. Paget's presumption is in favour of on demand liability. It applies where the guarantee (i) relates to an underlying transaction between parties in different jurisdictions, (ii) is issued by a bank, (iii) contains an undertaking to pay "on demand" (iv) does not contain clauses excluding or limiting the defences available to a guarantor. Blair J noted that a guarantee meeting all these criteria would "almost always" be construed as an on-demand bond.

Blair J's judgment gives some further insights into the approach that English law takes to identifying true on demand liability. By way of background, English law is perhaps more favourable to guarantors than one might expect.  A true guarantor (who is not under any 'on demand' liability) may be discharged from any liability under the guarantee where the underlying contract is amended without their consent. That is the so-called rule in Holme v Brunskill (1878) 3 QB 495. This rule applies unless the amendments are truly insubstantial. It may well also apply where the guarantor agrees in advance, in the guarantee itself, to any future amendments, or is aware of the amendments at the time they are made, but does not expressly agree to them. Care should therefore be taken to avoid inadvertently discharging the guarantor.

Amendments to the underlying contract can discharge the guarantor

In construction projects, difficulties can arise where the contractor experiences financial difficulties, the employer decides to pay a part of the contract price in advance, but does so without procuring the consent of the guarantor. Advance payments of the agreed contract price have been found to amount to an amendment of the underlying construction contract, thus discharging the guarantor (Calvert v The London Dock Company (1838) 2 Keen 638, 48 ER 774). An employer in that situation who (for whatever reason) cannot obtain the consent of the guarantor may do well to avoid any advance payments of the original price, and instead enter into a new, and separate, agreement with the contractor under which monies might be advanced as a loan.  Additional payments to a contractor made outside of the original construction contract do not trigger the rule in Holme v Brunskill (Aviva Insurance Ltd v Hackney Empire Ltd [2012] EWCA Civ 1716).

Guarantees sometimes include provisions seeking to exclude the operation of this rule, or limit the defences available to the guarantor generally. An instrument that contains such 'protective' clauses might appear to be a 'see to it' guarantee - why else would it have such clauses?  Blair J however noted that their presence may not be a significant factor, as protective clauses could have been included for other reasons, such as an abundance of caution. Their absence, however, could be a pointer towards an on demand instrument.

The judge also noted that a clause which entitles the beneficiary conclusively to certify amounts due and payable under the instrument (which was fatal to the directors' arguments in Van der Merwe):

"... may not in themselves point to the nature of the instrument, since they can be found in either kind, a clause which—if effective—requires payment against certification by the beneficiary, is likely to be inconsistent with the need for the beneficiary to establish the liability (other than through such certification) of the principal debtor in order to enforce the guarantee ..."

Analysis of the advance payment guarantee

Turning to the agreements before him, the learned judge acknowledged ACP's submission that it would not have agreed to anything other than an on-demand bond when signing these contracts. At that time, it was clear to all parties that GUPC's ultimate liability would have to be determined by arbitration proceedings, which might take many months or even years. ACP argued that it would have been wholly uncommercial to have accepted a 'see to it' guarantee in those circumstances, because that would allow the parent companies to rely on the same defences that GUPC was already running in the arbitration. This was, however, irrelevant to the issue of construction that had to be decided. While contractual interpretation under English law takes account of the factual matrix or background to the agreement, it does not attach weight to subjective declarations as to what the parties in fact intended.

ACP was obviously concerned to be able to claim for repayment of the advances without having to prove that GUPC was in breach of the main EPC Contract. The APG contained a number of provisions that, at first glance, looked to give ACP some comfort in that regard. It provided that each of the parent companies:

"(a) as primary obligor and not as surety, unconditionally and irrevocably, jointly and severally guarantees to [ACP] the payment by [GUPC] of the Guaranteed Amount as and when due pursuant to the [main EPC contract]; and

(b) if the Contractor is in breach of any of its obligations as set out in sub-paragraph (a), shall upon demand by the Employer from time to time, forthwith perform the obligations of which the Contractor is in breach in the same manner that the Contractor is required to perform such obligations according to the terms of the [main EPC contract]."

The reference to the parent companies being 'primary obligors' may have been intended to give rise to 'on demand' liability. 'On demand' guarantees are free-standing agreements that do not depend on the underlying contract, and give rise to so-called 'primary' obligations - as opposed to 'secondary' obligations that merely reflect the liability of the counterparty in the underlying contract. Looking at the above wording closely, however, this primary obligation on the guarantors was expressly linked to GUPC's performance under the main EPC contract. That casts doubt on whether the parent companies truly undertook independent 'on demand' liability. Blair J found that:

"As ACP says, this is a strong indication that the guarantors' liability is not secondary, in the sense of a "see to it" guarantee. The court accepts this—these provisions make it clear that liability under the APGs is primary, not secondary. However, as all parties also recognise, to say that someone is primarily liable begs the question of the content of that primary liability ... To make good its case, it is not sufficient for ACP to show that the defendants' liability is as primary obligor and not as surety. It has to show that the defendants' liability is triggered by a demand (together with the necessary calculations under the conclusive evidence clause which is an integral part of ACP's case on this point), and this is what the court has to decide."

Looking at the relevant wording, the guarantors had promised to be liable to pay the 'guaranteed amount' "... as and when due under the [EPC Contract] ...". Even though that obligation was expressed to be primary, it was entirely dependent on whether anything was in fact due under the contract. That was inconsistent with on demand liability. 

ACP also placed considerable reliance on a 'conclusive evidence' provision, which stated that:

"4.2 Determinations of interest rate and amounts under this Guarantee shall be made by the Employer, which determinations shall be conclusive and binding hereunder in the absence of manifest error. ..."

The judge found that on a fair reading of this provision, all that it empowered ACP to do was to fix the interest rate that would be applied to the guaranteed amount, but not the guaranteed amount itself. The amount payable would depend on GUPC's true liability under the EPC Contract, which was a matter to be determined in the ICC arbitration proceedings in Miami, according to the laws of Panama. Blair J did not agree with ACP that the reference to 'amounts' (plural) in the above provision carried any weight.  Elsewhere in the contract, the (principal) amount payable was referred to as the 'Guaranteed Amount', and that defined term had not been used here. 

Blair J also stated that if Clause 4.2 did apply to the principal amount, then all it would do was to fix the amount that would be payable, without making the guarantor liable to pay that amount. Such a distinction between liability and quantum has been upheld in previous cases: conclusive evidence clauses are strictly construed in favour of the guarantor.

The judge also noted that there had been no suggestion by ACP that any of the guarantees governed by Panamanian law (so the original parent company guarantee and the other advance payment guarantees) were on demand instruments. Much of the wording in the English law AGP had apparently been taken over from the Panamanian law contracts - including the 'conclusive evidence' provision that ACP had placed so much reliance on. In the Miami arbitration, ACP had apparently accepted that the other guarantees were 'see to it' instruments. 

With all that in mind, and considering that the defendants were not banks or financial institutions, the Commercial Court rejected ACP's argument that the contracts were 'on demand' bonds.

Conclusion

Blair J's decision is a good illustration of how careful and clear the drafting needs to be to succeed with imposing on demand liability on parties who are not banks (and, of course, in any event). It also shows that a multitude of contracts applying to the same subject matter - and subject to different governing laws and dispute resolution methods - can muddy the waters. The successive parent company guarantees and advance payment guarantees showed that ACP and the guarantors had a history of contracting on 'see to it' terms, and the wording in the only English-law agreement was simply not clear enough to change that.

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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