We consider two recent decisions in the context of construction contracts, both on shore and in the shipbuilding sector, which highlight the differences and consequences of different forms of guarantee. In the shipbuilding sector guarantees tend to secure instalments paid or due under the Contract by way of Advance Payment or Refund Guarantees.
There are two main types of guarantee: (i) an “on demand” guarantee and (ii) a “performance” guarantee. These have been considered by the English Courts and we provide a brief summary of the principles below.
- On demand guarantee - this is a separate contract whereby the guarantor is the primary debtor and the payment is made against, for example, a written demand. Whether a guarantor needs to comply and pay out under the guarantee simply depends on the terms of the guarantee. Its liability is entirely separate to any liability or performance under the underlying contract.
- Performance guarantee - this is where liability is secondary as any claim under the guarantee must have proved liability under the underlying contract.
Because “on demand” guarantees entail quick payment without reference to any dispute, the Courts have frequently been asked to determine which type of guarantee has been agreed to by the parties.
In IIG Capital LLC v Van Der Merwe and another  EWCA Civ 542, it was held that because the guarantor did not have recourse to the defences available to the underlying obligor, it was therefore not a true guarantee but a bond payable “on demand”.
In Meritz Fire & Marine Insurance Co Ltd v Jan De Nul NV and another  EWCA Civ 827, the Court of Appeal held that certain advance payment guarantees took effect as on demand bonds because, inter alia, they were irrevocable, unconditional and payable on demand.
In Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA  EWCA Civ 1629, where the Court of Appeal had to consider which type of guarantee the parties had entered into, the judge considered the commercial context of the transaction and used the ‘presumption’ set out in Paget’s Law of Banking (11th edition) to reach his decision, which is as follows:
“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” 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”.
In Autoridad del Canal de Panama v Sacyr CA and others  EWHC 2228 (Comm) at  Blair J confirmed these key principles.
Yuanda (UK) Ltd v Multiplex Construction Europe Ltd and another  EWHC 468 (TCC)
Multiplex appointed Yuanda as subcontractor to carry out façade works for the project under a JCT Design and Build (2011) subcontract ("the Subcontract"). Yuanda provided a guarantee based on the ABI (Association of British Insurers) Model Form of Guarantee Bond (the “Guarantee”) from the Australia and New Zealand Banking Group (the “Bank”) as security for its performance of the Subcontract.
There were delays to the Subcontract works and the parties were in dispute as to the cause of the delay. Multiplex demanded the sum of £7.5m from Yuanda in a letter dated 22 November 2019. Yuanda denied that it was responsible and claimed that, in fact, it was due sums from Multiplex for losses and expenses caused by the delays at a sum of £48.9m. On 17 January 2020, Multiplex brought a demand on the Bank under the Guarantee.
In response, Yuanda made an urgent application to Court on 20 January 2020 for an injunction preventing the Bank from paying out under the Guarantee. The Court had the task of deciding whether to order the continuation or the discharge of the injunction. The following key issues were considered:
- Was the Guarantee a performance guarantee or an ondemand guarantee?
- If it is the former, as a matter of construction, what are the requirements in order for the Multiplex to make a valid call on the guarantor (the Bank) which the Bank must pay?
Performance / on demand
The judge held that the Guarantee was a performance guarantee and that payment out was conditional on liability arising as a result of Yuanda breaching the subcontract. He examined the wording of Clause 1 of the guarantee bond which stated that the guarantor “shall satisfy and discharge the damages sustained by the Contractor as established and ascertained in accordance with the provisions of the…Contract and taking into account all sums due to or to become due to the sub-contractor”.
In this way it was clear that the Bank’s liability was secondary in nature to the primary liability of Yuanda under the Subcontract. The judge also pointed to the fact that the Guarantee did not contain the word “demand” and so did not use the language typically seen in an on demand bond.
Requirements for Multiplex to make a valid call on the Bank?
The judge held that the wording of clause 1 made clear that a breach was required by Yuanda. However, the damages had to be “established and ascertained”. The judge found that when Mulitplex issued a “certificate” unilaterally claiming that a sum was owed to it by Yuanda where no such contractual mechanism existed, did not mean that damages had been “established and ascertained” under the terms of the Subcontract.
However, it was also decided that it was not necessary for the issue to be finally determined by arbitration or court proceedings and that any liability by adjudication in accordance with section 8.2 of the Subcontract would be considered “established and ascertained”. The judge expressly rejected the argument that “taking into account all sums due or to become due” meant that the final account under the Subcontract had been either agreed / finally determined in court proceedings.
Shanghai Shipyard Co. Ltd v Reignwood International Investment (Group) Company Ltd  EWHC 803 (Comm)
Shanghai Shipyard Co. Ltd (“the Builder”) and Reignwood International Investment (Group) Company Ltd (“the Guarantor”) were parties to a guarantee (the “Guarantee”) which was given to secure a final payment of USD 170m by a buyer of a shipbuilding contract (the “Contract”). The Buyer under the Shipbuilding Contract did not take delivery of the vessel as it claimed it was not deliverable. The Builder made a demand on the Guarantor. The relevant preliminary issues were whether, on a true construction of the Guarantee:
A. The Guarantee was an on demand or a performance guarantee.
B. If the Guarantee was a performance guarantee, was the Guarantor entitled to refuse payment pending and subject to the outcome of the arbitration between
Builder and the Buyer:
(i) only if the arbitration has been commenced as at the date the demand was made; or (ii) regardless of when the arbitration was commenced.
The judge noted that there is often significant commonality in the language used between the two different types of guarantee. In this case, it was held that although the Guarantee contained wording that was indicative of a primary obligation on the part of the Guarantor (e.g. “the Guarantor hereby IRREVOCABLY, ABSOLUTELY and UNCONDITIONALLY guarantees…as the primary obligor…”), the Guarantee was a performance guarantee. He examined the second half of clause 4 which stated:
“…In the event that there exists dispute between [the Buyer] and the Builder as to whether: (i) [The Buyer] is liable to pay to the Builder the Final Instalment; and (ii) The Builder is entitled to claim the Final Instalment from [the Buyer], and such dispute is submitted either by [the Buyer] or by [the Builder] for arbitration…[the Guarantor] shall be entitled to withhold and defer payment until the arbitration award is published. [The Guarantor] shall not be obligated to make any payment to [the Builder] unless the arbitration award orders [the Buyer] to pay the Final Instalment.”
The judge considered that this part of clause 4 in the Guarantee should be considered to be a ‘material difference’ to other guarantees containing substantially similar wording which were held to be on demand guarantees (as was the case in Wuhan v Emporiki). This is on its face a surprising decision, since many of the guarantees found to be “on demand” have contained very similar provisions for delay in payment in the event of litigation being commenced between the parties. The only real difference is that in other cases the requirement to commence litigation has been subject to a time limit from the date of any demand, which was absent in this guarantee.
The judge emphasised the importance of the second element of the presumption in Paget’s Law of Banking, i.e. that the guarantor be a bank or other financial institution. He noted that the current edition of Paget suggested that where a guarantee is not given by a bank or other financial institution it would need “cogent indications that the instrument was intended to operate as a demand guarantee”. After examining the terms of the Guarantee looking at its particular context, it was held that the Guarantee did not “make the grade of a demand guarantee without the help of a presumption, and no presumption was successfully engaged”.
As to the second issue, the judge found that on the true construction of the Guarantee, the Guarantor was entitled to refuse payment under clause 4 of the Guarantee pending and subject to the outcome of an arbitration between the Builder and the Buyer, regardless of when
such arbitration is or may be commenced.
The cases above and preceding case law make clear that both the wording of the guarantee in question and its commercial context are crucial when establishing the nature of the obligation given by the guarantor; clear, unambiguous wording should be used. Following the decision in Shanghai Shipping, this is particularly the case where the guarantor is a parent company as opposed to a bank or other financial institution. This raises a large warning flag to parties accepting parent company guarantees in the belief that they are “on demand”, such that the wording needs to be looked at carefully.
It is also important to ensure that when drafting the expiry of the guarantee that it is flexible enough to accommodate for extensions of time for completion of the dispute resolution method under the underlying contract, if applicable. This could mean incorporating an expiry event (e.g. “six months after practical completion”) instead of an actual date so that the guarantee remains valid and is able to “move” with any extensions.