A recent judgment in the English high court has added yet more clarity to the nature of refund guarantees issued in support of shipbuilder’s obligations to refund advance payments following cancellation of shipbuilding contracts.

Mrs Justice Carr, sitting in the Commercial Court of the Queen’s Bench Division, gave judgment in favour of the buyer, on the obligation of the Bank of China to pay under two refund guarantees issued to it in respect of the repayment by Rongcheng Xixiakou Shipyard of advance payments made in respect of Hulls XXK06-38 and XXK06-39.

Interesting case background plots

The case has some interesting background sub-plots involving submission by the buyer to the jurisdiction of the local Chinese court in Qingdao (the Qingdao Maritime Court) in relation to a case brought by the builder against the buyer and the engine manufacturer in which the builder successfully alleged fraud by the buyer and the engine manufacturer/supplier in delivering refurbished second hand engines and passing them off as new. Based on its judgement in favour of the builder in that case, the Qingdao Maritime Court issued orders preventing Bank of China from paying out under the refund guarantees. The proceedings were brought by the builder in the Chinese court notwithstanding that the building contracts were governed by English law and contained submissions to arbitration.

Interestingly the buyer argued in the English court that the builder had been at pains to emphasize in the Chinese court proceedings that its claim was a claim in tort and not one of breach of the building contract and therefore that the buyer had not been judged to be in breach of contract (which might otherwise have been a consideration in determining its right to cancel the contracts and claim refund of its advance payments). In fact there does not seem to have been any relationship between the dispute over the quality of the engines and the fact that the builder failed to deliver either of the ships before the contractual termination dates.

Justice’s comments

Although Mrs Justice Carr’s comments on the submission by the buyer to the jurisdiction of the Chinese courts on the dispute re the engines, the recognition by the court of the Chinese court’s judgement and the effect of the stay orders issued by that court on Bank of China’s obligation to pay under the refund guarantees are very interesting, she was able put them to one side in determining the essential question of the nature of Bank of China’s obligations under the refund guarantees and its defences to meeting its obligations.

Two key points

These are the two points we want to highlight here:

  1. We can do no better that set out what Mrs Justice Carr has written:“Performance bonds create an independent obligation to pay on demand by way of primary obligation on the party giving the guarantee and not by way of surety. They are irrevocable undertakings to pay a specified sum to the beneficiary in the event of a breach of contract rather than a promise to see to it that the contract will be performed. [sic.] Thus the various equitable defences available to a surety are not available to the issuer of a performance bond [sic.] The issuer of a performance bond is as a general rule not concerned with the rights or wrongs of any underlying dispute between the beneficiary and the account party. His obligation to pay in accordance with the terms of the contract is entirely independent of the ultimate contract between the account party and the beneficiary, In practice performance bonds are treated as substitutes for cash.”
  2. We think we would all recognise that from a buyer’s perspective its intention (and its understanding) is that a refund guarantee should have exactly the characteristics of the performance bond which Mrs Justice Carr describes. In all honesty, we think it is also what legal counsel to issuing banks will have consistently advised their clients is the intended and likely effect of the common form of refund guarantee they issue.

Would it not then be better to stop referring to refund guarantees and instead refer to refund bonds?

In practice the name of a thing will not prevail over its substance and in the end everything depends on the precise wording of the document. But lawyers could perhaps be more helpful in drafting these instruments to ensure that they deliver the intention of the parties. Calling them performance bonds would be a start.

Mrs Justice Carr refers to a 2012 case in which Longmore LJ cites Paget’s Law of Banking as giving some important pointers as to the nature of this type of instrument under the heading Contract of suretyship v demand guarantee: “Where an instrument (i) relates to an underlying transaction between parties in different jurisdictions, (ii) is issued by a bank, (iii) contains an undertaking to pay “on demand” (with or without the words “first” and/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.”

This guidance was approved in a 2002 case even though (as Longmore LJ noted) the fourth element was absent. As with the guarantees issued in the Caja de Ahorros case the refund guarantees issued by Bank of China contained the standard clauses denying it the defences given to classic guarantors by law. As in that precedent case Ms Justice Carr was able to distinguish these and find that their presence in the refund guarantees did not prevent them from being true performance or “on demand” guarantees. Armed with this string of court decisions is it not time that refund guarantees adopted all four of Paget’s elements for on demand guarantees and remove the lingering doubt introduced by having exclusion clauses appropriate to ordinary forms of guarantee?

Finally, in this short commentary, it is good to note that the court was able to confirm that the existence of the common proviso that defers an issuing bank’s obligation to pay under its refund guarantee in the event that a dispute between the builder and the buyer as to whether the builder is obliged to repay instalments until after a judgement or award is made in favour of the buyer and directs such repayment to be made does not impact on the underlying nature of the guarantee – it still remains an “on demand” guarantee.

This case and the cases cited in it (plus the many arbitral decisions that have been given since the spate of cancellations of ship orders from (mainly) Chinese ship yards began) should now close off almost all the avenues for disputing and delaying payments under refund guarantees. Nonetheless there is no getting away from the fact that so much depends on the precise drafting of the refund guarantees and the matrix of facts surrounding any particular situation.