Performance Guarantees - Guidance

November 2004

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Owners and operators of vessels that are chartered out need to ensure that they are adequately protected against charterers' default. This is particularly the case when there is no previous experience of the charterer and/or where there is concern as to a charterer's ability to meet its obligations under the charterparty.

One way in which protection can be obtained is by means of a performance guarantee given by a third party guarantor.

Stories abound of owners who have accepted guarantees which have been found to be unenforceable due to drafting errors, for lack of consideration or for absence of a law and jurisdiction clause. There are even instances where the guarantee has been given by a company that does not exist.

The Club is always willing to advise on performance guarantees. This subject was discussed in a Sea Venture article "Charterparties: Validity of Performance Guarantees"*. That article covered a variety of issues concerning performance guarantees such as ensuring that the guarantor is solvent, selection of law and forum and consideration.

Further points for consideration include:

1. The guarantee should be stated to be unconditional and irrevocable, so as to avert any attempts on the part of the guarantor to avoid his obligations.

2. The guarantee should provide that the guarantor is binding himself as a primary obligor, and not merely as a surety, and the guarantor should also waive any right he may have to compel the recipient to take steps to enforce his claim against the charterer prior to enforcing the guarantee. This is to ensure that the guarantee is directly enforceable against the guarantor irrespective of any steps being or having been taken against the charterer.

3. The guarantee should cover performance of obligations to pay sums not only payable under, pursuant to or arising in connection with the charterparty, but should also expressly cover payment of sums that are awarded, ordered or adjudged to be due to the recipient pursuant to any arbitration award or court judgment(s) made against the guarantor and/or against the charterer.

4. The guarantee should be a continuing security and should not be discharged by any intermediate or partial payment made by either the charterer or the guarantor. It should also expressly provide that the guarantee shall not be discharged by any amendment or variation of the charterparty terms or any rescheduling of the charterer's original obligations. (Under English law, a guarantor may be discharged from all of his obligations under the guarantee if the original terms of the underlying charterparty contract are altered because such alterations were not present at the time that the guarantee was entered into.)

5. The guarantee should provide that the guarantor is prevented from benefiting from any defences, rights of limitation or set-off that may be available to the charterer. In other words, it should avoid the need for the vessel owner or operator to prove his case on the merits in order to obtain payment from the guarantor.

6. Checks should be made to ensure that the person signing the guarantee on behalf of the guarantor is properly authorised to bind the guarantor. This can be done by demanding sight of the original company resolution which gives that individual his authority.

7. It is also vital that the solvency of the guarantor is established prior to acceptance of the guarantee.

8. The guarantee should bind the guarantor's successors and assigns, be enforceable by the recipient's successors and assigns, and not be affected by the liquidation or bankruptcy of the charterer or by the charterer petitioning for relief.

This list is by no means exhaustive; guarantees should always be drafted to suit the individual requirements of each particular circumstance. The Club is available to assist with such drafting and to provide advice on specific issues relating to or arising out of performance guarantees.

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Where an owner and charterer are negotiating a performance guarantee, the owner will not be dealing with the bank direct - he will be relying on the charterer to obtain the guarantee in the required form. To ensure that this will happen an agreement on the part of the charterer to procure a bank guarantee in an agreed form is required. This is to be given prior to the charterparty being entered into and binds the charterer to procure a bank guarantee in the terms set out in the agreement. 

An example of such an agreement between owner and charterer is provided.