Charterparties: Validity of Performance Guarantees

It is common for shipowners to require prospective charterers to provide a performance guarantee from a third party as a precondition of fixing. Owners should keep the following important factors in mind when considering whether to accept a performance guarantee:

1. Solvency of the prospective guarantors.

A legally enforceable guarantee is worthless if the guarantor is assetless. Owners should always, therefore, check the solvency of any party offering a guarantee before making a commercial decision to accept or reject the offer.

2. Undertakings to procure guarantees from third parties.

This was the subject matter of a recent High Court case The "Anangel Express" ([1996] 2 LLR. 299) in which the relevant facts were as follows.

The owners agreed to charter their vessel to KSH Schiffahrt ("KSH") under a time charter dated 18 May 1993. All fixture communications between the owners and KSH were passed through a chain of three brokers before reaching a company called Zaco (KSH's agents). Early in the fixture negotiations, the owners demanded a performance guarantee from Newco AG ("Newco") who were the sellers of the cargo which was to be carried under the charter. Whilst various discussions took place between owners' and charterers' brokers about the terms on which it should be provided, Newco were not advised that the owners required a guarantee from them. When the fixture recap was drawn up by KSH's brokers it contained the following undertaking by KSH, "Charterers agree to performance guarantee to be as per Owners wording on Newco letter headed paper and signed by Newco .... same up to 1.5 m. U.S.$". Newco were only informed of the owners' requirement after the recap had been sent and then entered into negotiations with KSH which were never formally concluded. The Court found that, whilst Newco was in fact prepared to provide a performance guarantee to the owners, one was never executed and the matter was forgotten by the owners until KSH defaulted on its charterparty obligations.

The Court ruled that, when the charterparty was concluded, the owners had only a promise by KSH to obtain a guarantee from Newco and not an enforceable guarantee from Newco. Even if there was a legally binding agreement between KSH and Newco (which the Court doubted), that a guarantee would be provided to the owners, the owners could not enforce this as they were not a party to it. The owners were, therefore, left with their claim against KSH under the charterparty.

This case demonstrates why owners should ensure that they obtain enforceable guarantees executed by the guarantor and should never proceed on the basis that their charterers have undertaken to obtain a guarantee from the guarantor.

3. Selection of law and forum.

It is essential that any guarantee clearly states what law governs it and identifies the forum in which any disputes arising out of or in connection with it will be determined. If a guarantee is silent as to the choice of law and/or forum, the guarantor can seek to take advantage of this to argue for a jurisdiction and law which are more favourable to him. This could result in delay, additional costs and, in some instances, unenforceablity of the guarantee.

4. Direct recourse against the guarantor.

Under English law, a party who guarantees the debt of another party only assumes a secondary liability. This means that the guarantor is under no obligation to pay until the party whose obligations he has guaranteed fails to honour his primary liability. Strictly speaking, therefore, owners who take a true performance guarantee from a third party must proceed against their charterers and fail to obtain payment before they can proceed against the third party guarantor. To avoid this inconvenience, it is recommended that performance guarantees contain a term to the effect that the guarantor's liability to the owners under the guarantee is not subject to any requirement that the owners should first have proceeded against any other party under any other contract.

5. Evidence in writing.

A guarantee is one of the few contracts which English law requires to be evidenced in writing. Members are strongly recommended to ensure that all guarantees are in writing and signed by an authorised signatory of the guarantor.

6. Consideration.

Under English law, all contracts must be supported by valid consideration. This means that each party to an agreement must both obtain a benefit and incur a burden for the agreement to be enforceable. This is not a problem in the context of a charterparty since the owners will receive hire/freight (benefit) and allow the charterers to use the vessel (burden) whilst the charterers will gain the use of the vessel (benefit) and have to pay hire/freight (burden). In the context of performance guarantees, matters are further complicated by the concept of past consideration which effectively means that an agreement to perform something which a party is already obliged to perform is seldom considered to be valid consideration.

It is important not to forget the role of consideration in the context of performance guarantees because a guarantee which is supported only by past consideration may be unenforceable. It is strongly recommended that the performance guarantees should be obtained before or at the same time as the charterparty is concluded and are expressed to have been given in consideration of the owners' agreement to fix the vessel to the charterers. If a performance guarantee is obtained after the charterparty is concluded, it is necessary to ensure that it is given for some consideration other than the owners' earlier agreement to fix the vessel to the charterers; otherwise it may be unenforceable.

If Members are in any doubt about the scope of the wording and/or the enforceability of any performance guarantee which is offered to them, they should contact the Club for advice and assistance at the earliest possible moment.

Click here for link to December 2004 Steamship website article on Performance Guarantees - Guidance