In Caterpillar Motoren GmbH & Co K.G. ("Caterpillar") v Mutual Benefits Assurance Company ("MBAC") [2015] EWHC 2304, the Court considered the construction of an advance payment guarantee and a performance bond. Mr Justice Teare summarily assessed the claim and held that, on their true construction, both bonds were “on demand” bonds.

Background

Caterpillar entered into contracts to deliver two power plants in Liberia. In addition, it entered into two sub-contracts with International Construction & Engineering Inc ("ICE") for the provision of construction services. In accordance with the sub-contracts, ICE procured from MBAC, a Liberian insurance company, an advance payment bond ("APB") and a performance bond ("PB") in favour of Caterpillar. The APB was intended to provide security in the event that the further activities intended to be financed by an advanced payment were not carried out by ICE. The PB was intended to provide security in the event that the further obligations of ICE were not performed.

Caterpillar made advance payments to ICE but disputes subsequently arose and Caterpillar purported to terminate the sub-contracts. Caterpillar demanded the return of the advanced payments and a further sum by way of liquidated damages but ICE disputed Caterpillar's claims. Caterpillar demanded payment from MBAC under the bonds. MBAC refused to pay the sums demanded so Caterpillar issued proceedings and an application for summary judgment. The Court was asked to determine whether the bonds were "on demand" bonds so that MBAC’s liability to pay arose on the making of a demand by Caterpillar or whether, as MBAC argued, they were conditional bonds/“true guarantees” such that MBAC was only liable if it was established that ICE was liable to Caterpillar in the sums claimed.

MBAC submitted that the Court should follow the general principles governing the construction of contracts which require the Court to identify the meaning which a document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

The Court of Appeal has previously given guidance to “commercial men” as to how instruments of the type in question are to be construed (Wuhan Guoyu v Emporiki Bank [2013] 1 AER 1191). In that case, "Paget's Presumption" was applied which provides that 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 there will be a presumption that it will be construed as an “on demand” bond or guarantee. Caterpillar submitted that the Court should construe the bonds by application of Paget’s Presumption. Counsel for MBAC argued that the Paget Presumption did not apply to MBAC because it was an insurance company and not a bank.

The Decision

Mr Justice Teare found that there is no conflict between the general principles governing the construction of contracts and Paget's Presumption for the construction of such instruments. Where the factors identified in Paget’s Presumption exist there is a presumption that the reasonable man would understand the instrument to be an “on demand” bond. The background and language of the instrument is then examined to see whether the reasonable man would consider the presumption to have been rebutted.

In respect of the APB, Mr Justice Teare found that MBAC had undertaken to "pay forthwith on demand" and "without reference to the contractor". Whilst the inclusion of the word "guarantee" and a reference to a failure by ICE to perform its obligations in the instrument could suggest that the parties intended that MBAC would pay only where ICE had actually failed to perform its obligations, it was necessary to look at all provisions of the APB. At clause 2 of the APB, MBAC agreed that it was bound by Caterpillar's decision as to whether any money was payable by ICE or whether ICE had defaulted and MBAC was not entitled to ask Caterpillar to establish its claims but "shall pay ... forthwith on demand". It was agreed that "any such demand ... shall be conclusive and binding notwithstanding any difference" between Caterpillar and ICE. Nothing in the remainder of the APB undermined this.

In respect of the PB, whilst certain provisions were suggestive of a true guarantee, that suggestion was inconsistent with other clauses which provided that MBAC was to pay Caterpillar once it had "declared" that ICE was in default. MBAC was to pay "unconditionally" and "without demur" "the amount of damages claimed by" Caterpillar. Any such declaration was then referred to as a "demand", which was "conclusive" as regards the amount due. Further, the inclusion of a clause regarding prompt payment was consistent with MBAC's liability deriving from Caterpillar's demand rather than from proof that ICE was liable to it.

Mr Justice Teare held that it was “clear beyond doubt” from the wording of the bonds that they were intended to take effect as "on demand" bonds as opposed to true guarantees. The same conclusion was reached by applying the Paget Presumption - whilst the fourth part of the test was not met, there was nothing in the background or the language of the instruments which was capable of rebutting the presumption.

The fact that MBAC was an insurance company and not a bank was “not a material distinction”. In this case, it does appear that arguing that Paget's Presumption did not apply because it was not a bank was a bad point for MBAC to take. It was an insurance company in the business of issuing these types of instruments and therefore it is difficult to see how it could have hoped to avoid the application of Page's Presumption.

The case provides an important warning for all financial institutions issuing "on demand" bonds that clear language should be used in drafting security documents especially in circumstances in which "on demand" bonds would attract a higher cost. When drafting and negotiating "on-demand" instruments, it is advisable to avoid the use of terms such as "guarantees", "guaranteeing performance" and other provisions relevant to guarantees.