Introduction

The use of guarantees to secure charterers’ obligations to ship owners is not uncommon in the shipping industry. Many people share the perception that a guarantor is only liable to pay when the principal obligor defaults in his obligations. However, this only forms part of the picture under the law of guarantees. Signing a guarantee without understanding the true nature of your liabilities is dangerous as it can open the floodgate to liabilities.

Traditional categories of guarantee

Traditionally speaking, instruments pertaining to be a guarantee can be divided in two categories.

The first type of instrument is often characterised as being a “true guarantee” which imposes only a secondary obligation on the guarantor to “see-to-it” that the principal obligor’s obligations are met. In other words, upon the occurrence of the default event, the obligee must first seek remedy from the principal before going after the guarantor. Such instruments are often issued by parties who are not banks or financial institutions but who have other commercial relationship with the principal obligor. For instance, a parent company guarantee, where a parent company guarantees the liabilities of its subsidiary, usually falls under the category of “true guarantee”.

The second type of instrument sometimes takes the form of an “on-demand bond”, or “performance bond”. Such instruments are typically issued by banks or financial institutions. Although the “guarantors” are likely to be in a poor position to assess independently the true merits of an underlying claim, they are prepared to take on an obligation to pay against the documents. Under this type of instrument, the obligee can elect to seek remedy either from the principal obligor or the guarantor. Upon presentation of the required documents, the “guarantors” must pay against a compliant demand. However, if it turns out subsequently that in fact the principal obligor is not liable, the guarantor is entitled to recover its money from the payee.

How would the Court construe a guarantee

In a recent decision Rubicon Vantage International PTE Ltd v Krisenergy Ltd [2019] EWHC 2012 (Comm) (“the Rubicon case”), the English Court has provided useful guidance on the rule of construction related to a guarantee provided by a non-bank entity.

Case background

In this case, Rubicon (the Claimant) owned a vessel which was chartered to Kegot, a wholly owned subsidiary of the Defendant, the Krisenergy, a non-bank entity. According to the terms of the charter, Krisenergy provided to the Claimant a Guarantee which contained the following key terms:

3.       Any demand under this Guarantee shall be in writing and shall be accompanied by a sworn statement from the Chief Executive Officer or the Chief Financial Officer of the Contractor stating as follows:

(b)   the calculation of such sums together with any supporting documentation reasonably required to assess such demand; and

4.       In circumstances where the amount(s) demanded under this Guarantee are not in dispute between the Company and the Contractor, the Guarantor shall be obliged to pay the amount(s) demanded within forty-eight (48) hours from receipt of the demand.

5.       In the event of dispute(s) between the Company and the Contractor as to the Company’s liability in respect of any amount(s) demanded under this Guarantee:

(a)   the Guarantor shall be obliged to pay any amount(s) demanded up to a maximum amount of United States Dollars Three Million (US$3,000,000) on demand notwithstanding any dispute between the Company and the Contractor;

(b)   the Guarantor shall be entitled to withhold and defer payment of the balance of the sum demanded in excess of United States Dollars Three Million (US$3,000,000); and

(c)   the Guarantor shall be entitled to withhold and defer payment of any other disputed amounts claimed under this Guarantee,

until a final judgment or final non-appealable award is published or agreement is reached between Company and contractor as to the liability for the disputed amount(s).

Issues

There are two issues in this case relevant to the discussion of the rule of construction related to a guarantee:

1.       whether the guarantee is an on-demand guarantee only in relation to claims where liability has been admitted by Kegot; and

2.       a series of questions as to the proper construction of the guarantee’s provisions in terms of what constitutes a proper demand.

The Court’s decision: 1^st issue

In deciding the first issue, the court discussed two English Court of Appeal cases which set out the presumptions that are applicable in classifying a guarantee when appropriate preconditions exist. First, in Marubeni Hong Kong v Mongolian Government [2005] EWCA Civ 395 it was held that in a transaction outside the banking context, the absence of appropriate language to describe a demand bond or something of similar effect created a strong presumption against construing the document as an autonomous bond rather than merely as a see-to-it guarantee imposing only secondary liability.  

Second, in Wuhan Guoyu Logistics Group Co Lt v Emporiki Bank of Greece SA [2012] EWCA Civ 1629, the Court of Appeal held that where an instrument (i) related 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” or “written”); and (iv) does not contain clauses excluding or limiting the defences available to a guarantor, there is a presumption that the instrument is a demand guarantee.

In the end, it was held that the subject guarantee in this case was a mixture of both the “true guarantee” and the “on-demand bond” and the on-demand liability arises in relation to the first $3m worth of claims because (i) it was described as a parent company guarantee; (ii) as a matter of fact, it was provided by Krisenergy, the parent company of the principal obligor Kegot; (iii) based on the wordings of clause 4 and clause 5, the parties agree that Krisenergy was liable to pay any amount which Kegot was liable to pay but had not paid, provided that a compliant demand was made according to clause 3; and (iv) parties agreed that there were circumstances in which Krisenergy can be made liable to pay in response to a compliant demand notwithstanding the disputes between Rubicon and Kegot has not yet been resolved.

It is worthy to note that as suggested by the Court of Appeal, the correct approach in determining the extent of the on-demand obligation in Guarantee is to begin by considering the words which the parties chose to use to record their agreement, free from any antecedent presumption as to what meaning they are likely to have, or as towards a wide or narrow construction. The mere fact that the guarantor who submitted itself to an autonomous on-demand obligation which was not issued by a bank does not assist in determining the extent of liability it had undertaken.

The Court’s decision: 2^nd issue

Regarding the 2^nd issue in which the parties disputed as to whether a valid demand shall include (i) a sworn statement stating the calculation of sums together with supporting documentation or (ii) the actual supporting documentation, the court held that in a commercial contract, the court will determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant. The relevant person is one who has available all the background knowledge reasonably available to the parties. In the end, the court decided that actual supporting documents were required because a reasonable person would understand the parties to have intended a requirement that the demand be accompanied by actual supporting documentation.

Conclusion

To conclude, the Rubicon case reiterates that every word and phrase used in the guarantee and their meaning as a whole is of paramount importance in the determination of liabilities. Regardless of whether you are the guarantor or the person seeking to rely on the guarantee, in order to protect yourself, always read thoroughly before signing the guarantee. Seek legal advice when necessary to minimize ambiguities.

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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.