This distinction is important. On demand guarantees provide more effective security, because the guarantee is independent of the underlying contract, and payment is triggered by a simple compliant demand. A true guarantee is one that imposes a secondary obligation where the issuer/guarantor is to pay only when the principal obligor is liable to pay upon breach of the underlying contract, and this will first need to be established by the beneficiary
The case of Shanghai Shipyard Co Ltd. v. Reignwood International Investment (Group) Company [2020] EWHC 803 (Comm) provides further guidance on how Courts may classify and interpret guarantees.
Background
Shanghai Shipbuilding Co. Ltd (the “Builder”) and the Defendant, Reignwood International Investment (Group) Company (the “Guarantor”), entered into a shipbuilding contract dated 17 November 2011 (the “Contract”). An “Irrevocable Payment Guarantee” (the “Guarantee”) was provided to secure the final payment of US$170 million (the “Final Instalment”) under the Contract. The Defendant was the original buyer under the Contract but by a novation was replaced a new buyer that was an indirect subsidiary of the Guarantor.
The buyer did not take delivery of the vessel and refused to pay the Final Instalment, maintaining that the vessel was not in a deliverable state. On or around 23 May 2017 the Builder made a demand for payment under the Guarantee, and the Guarantor refused to pay.
The Guarantee provided that in the event of the buyer’s default in paying the Final Instalment the Builder was entitled to demand the sum from the Guarantor. On the other hand, if there was a dispute between the buyer and Builder as to the buyer’s liability to pay the Final Instalment, and the dispute was referred to arbitration, then the Guarantor’s position was it was entitled to withhold payment pending the outcome of the arbitration.
Arbitration was commenced under the Contract on 13 June 2019. The Guarantor sought a stay of the High Court proceedings pending the outcome of the arbitration between the buyer and Builder. These stay turned in two preliminary issues.
The Issues
The two issues the judge had to consider were:
- whether the guarantee was an on-demand or a ‘see to it’ guarantee; and
- Whether the Guarantor was entitled to refuse payment pending to the outcome of the arbitration between the Builder and the buyer, in respect of the buyer’s liability to pay, and the Builder’s entitlement to claim the Final Instalment.
The Decision
As for issue (i), the judge concluded that the Guarantee was a ‘see to it’ guarantee i.e. that the Guarantor’s obligations to pay under the Guarantee are contingent upon the extent to which the principal is liable under the underlying contract.
In reaching this conclusion the judge looked to the guidance given by the Court of Appeal in the case of Wuhan Guoyo Logistics Group v Emporiki Bank of Greece [2014] 1 Lloyd’s Rep 266 that “…while everything must in the end depend on the words actually used by the parties, there is nevertheless a presumption that, if certain elements are present in the document, the document will be construed in one way of another”. Such elements include, the four criteria, set out in Paget’s Law of Banking (“Paget’s Presumption”):
- The instrument has an international element in that it relates to an underlying transaction between parties in different jurisdictions;
- The instrument is issued by a bank;
- The instrument contains an undertaking to pay on demand (with or without the words ‘first’ and/or ‘written’); and
- does not contain clauses excluding or limiting the defences available to a guarantor.
In these circumstances the guarantee will almost always be construed as a on demand guarantee.
Notably, the judge stated that Paget’s presumption was not intended to be a mere tick box exercise against each of the four elements. The judge’s focus was on the fact that the instrument was not issued by a bank, financial institution or insurance company operating in the ordinary course of its business, and the three remaining elements of the presumption did not provide “cogent indications” that the instrument was intended to operate as a demand guarantee.
This conclusion is consistent with the decision of Marubeni Hong Kong and South China Ltd v Government of Mongolia [2005] 1 WLR 2497 that outside the banking context there is a strong presumption against classifying a guarantee as on demand.
As for the second issue (ii) above, the Judge construed the relevant clause of the Guarantee in favour of the Guarantor so that the Guarantor was entitled to refuse payment under the terms of the Guarantee, pending the outcome of any arbitration between the Builder and the buyer, in respect of a dispute as to the Buyer’s liability to pay the Final Instalment.
Commentary
This judicial guidance indicates that a guarantee issued outside of the banking context is unlikely to be classified as on demand in nature, and in the absence of “cogent indications that the instrument was intended to operate as a demand guarantee”, this presumption is unlikely to change.
