To avoid the above situation, we suggest that when agreeing to extend delivery dates by an addendum to the contract, the seller should include a provision which states that in the event that there is a delay in the delivery of the goods, the seller agrees to extend the validity of the refund guarantee within a number of days (to be agreed with the buyer) before its expiry. In such case, the seller would be certain on its obligation to extend the validity of the refund guarantee.

Introduction
Refund guarantees are commonly found in sale and purchase contracts. Under such guarantees, the seller’s guarantor (usually a bank) undertakes that when the buyer terminates the contract for good reason (for example, the seller’s repudiatory breach of the contract, or that the seller cannot deliver the goods), and if the seller for any reason fails to refund the advance instalments of the contract price paid by the buyer (for example, the seller slides into insolvency), the guarantor will refund those instalments to the buyer on the seller’s behalf. 

Given that delay in the delivery of the goods is often encountered, especially in the shipbuilding industry, the parties would often agree to extend the validity of refund guarantees beyond their stipulated expiry dates to afford continuing security for the buyers. However, there are cases where there was no such agreement on the extension of refund guarantees, or where the agreement was silent on when the seller should extend their validity. In such circumstances, could the buyer terminate the contract based on the seller’s failure to extend the refund guarantee, or failure to extend it within a reasonable time? This interesting issue is considered in Wuhan Ocean Economic and Technical Cooperation Company Ltd v Schiffahrts-Gesellschaft ‘Hansa Murcia’ mbH & Co KG [2013] 1 All ER (Comm) 1277 (“Hansa Murcia”).

Factual Background

The Refund Guarantee
In Hansa Murcia, the parties entered into a shipbuilding contract for the sale and purchase of a 900 TEU (Twenty-foot Equivalent Unit) container vessel. On 7 June 2007, the sellers provided a refund guarantee to the buyers which stated that:-

“This letter of guarantee shall remain in force until the vessel has been delivered to and accepted by [the buyers] or refund has been made by the seller or [the bank] or until June 30 2010, whichever occurs earliest… In case arbitration initiated by either seller or buyer before delivery of the vessel, the validity of this guarantee shall be extended to 60 calendar days after the final arbitration award is issued.”

Purported Extension and Termination
In December 2009, by an addendum to the contract, the parties agreed to the delayed delivery of the vessel. In the same addendum, the sellers undertook to extend the validity of the refund guarantee until 31 May 2012. The addendum did not expressly state the time within which the sellers were obliged to procure the extension of the refund guarantee. On 28 June 2010, two days prior to the expiry date of the refund guarantee, the buyers purported to terminate the contract. The buyers claimed that the sellers had failed to obtain an extension of the refund guarantee, and had evinced an intention of not so doing. As such the sellers were alleged to be in repudiatory breach of the contract which entitled the buyers to terminate it. On 29 June 2010, the buyers commenced arbitration proceedings. On the same day, before the expiry of the refund guarantee, the refund guarantee was extended by the bank.

The Tribunal decided that it was necessary to imply a term into the shipbuilding contract that the sellers should procure the refund guarantee within a reasonable time because the contract was silent on this point. The Tribunal further held that the sellers’ failure to extend the validity of the refund guarantee within a reasonable time had become so serious as to go to the root of the contract and constitute a repudiatory breach that entitled the buyers to accept that repudiation and terminate the contract. The sellers appealed against the Tribunal’s decision to the English High Court.

Legal Analysis

Implied Term to Extend the Refund Guarantee
The Court agreed with the Tribunal’s decision that a term should be implied into the contract that the sellers must procure the extension of the refund guarantee within a reasonable time (“Implied Term”) while the “reasonable time” is 14 days before the expiry of the refund guarantee.

A term implied by fact is a provision spelling out in express words what the contract read against the relevant background, would reasonably be understood to mean.[1] The Court agreed with the arbitrators that the parties would want to know in advance about their position after the expiry of the refund guarantee.  In that way, the buyers could have enough time to look elsewhere for security in the event of a breach of the shipbuilding contract, had the sellers been under no obligation to extend the guarantee. While the addendum was silent on the post-expiry arrangements, the Court readily found for the existence of the Implied Term.

Potential Recourse to Arbitration
The sellers argued that the only implied obligation they had was to extend the refund guarantee before its expiry. The sellers also argued that it was unnecessary to imply an obligation to the sellers to extend the refund guarantee within a reasonable time because the buyers could institute arbitration against the sellers to procure the extension of the refund guarantee, even after its expiry. Pursuant to the provisions of the guarantee, doing so would automatically extend its validity until 60 days after any arbitration award is published.

However, the Court did not consider that as a valid reason to negative a finding of the Implied Term. It was the sellers’ duty to procure the extension of the guarantee, without the need for any action on the buyers’ part. The buyers were entitled to an instrument from the bank which set out the extension of their guarantee rights, without any further risk on their part. The buyers’ risks would be increased if the Implied Term did not exist and they had to resort to arbitration: there might be arguments taken by the bank about the scope of the guarantee. The certainty to which the buyers were entitled under the addendum would be jeopardised.

No Repudiatory Breach by the Sellers
The Court held that the Implied Term was an innominate term (i.e. the buyers may terminate the contract if the breach of such term would deprive the buyers of substantially the whole benefit of the contract or go to the root of the contract[2]) because, the buyers would be at a risk of having no security, even if there were means of making it good (by instituting arbitration being the obvious example). The breach of the Implied Term could therefore deprive the buyers of substantially the whole benefit of the contract or would go to the root of the contract, if the buyers did not institute arbitration to extend the validity of the refund guarantee.

Nonetheless, the Court did not consider the breach of such innominate term by the sellers a repudiatory breach. As a matter of construction, the refund guarantee would be automatically extended whenever arbitration was commenced.  Therefore the Court did not agree that the buyers’ security was truly imperilled. The buyers could have waited until the expiry date of the refund guarantee and then instituted arbitration against the sellers.  Doing so would automatically trigger an extension and preserve the validity of the refund guarantee.

As the breach of the Implied Term did not deprive the buyers of substantially the whole benefit of the contract or would go to the root of the contract, the buyers were not entitled to terminate the shipbuilding contract as a result of the sellers’ breach.

Significance

Possible Finding of Repudiatory Breach
In Hansa Murcia, the breach was not held as repudiatory only by virtue of the automatic extension clause following institution of arbitration. If the refund guarantee had not stipulated such an automatic extension, the sellers would have been in repudiatory breach of the contract. This is because the buyers could not claim any refund after the expiry of the refund guarantee, which would be destructive to the buyer’s security. In such circumstances the buyers might be able to terminate the shipbuilding contract upon the sellers’ actual or anticipatory breach of their obligation to procure the extension of the refund guarantee. In this case, the Tribunal’s finding might become significant: the Tribunal found that the continuing breach became repudiatory when the sellers failed to procure the extension 7 days before expiry of the refund guarantee. 

Implied obligation to extend refund guarantees
The seller should aware that if there is delay in the delivery of the goods, in view of Hansa Murcia, even if there is no express agreement with the buyer, the Court is likely to imply an obligation to the seller to extend the validity of the refund guarantee within a reasonable period of time, and that 14 days before the expiry of the refund guarantee would be deemed by the Court to be a reasonable period. Even though the breach of such an implied obligation may not necessarily entitle the buyer to terminate the contract (because normally refund guarantees would contain an automatic extension clause), the seller would nevertheless be at the risk of being liable to damages as a result of their breach of the implied obligation.

For the buyer, it may consider making the seller’s obligation to extend the validity of the refund guarantee a condition precedent to the contract or making time of the essence, failing which the buyer may terminate the contract with immediate effect. This would guarantee the buyer’s entitlement to terminate the contract should the seller fail to extend the validity of the refund guarantee before its expiry.

[1] Attorney-General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988 [2] Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26; Woodar Investment Development Ltd v Wimpey Construction UK Ltd [1980] 1 WLR 277

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.