As the global financial crisis extends into its fifth year, the use of guarantees to back contractual obligations is increasingly commonplace to secure the performance of long term obligations or asset poor counterparties.

Not all guarantees are created equally. It is crucially important to understand the type of guarantee being offered and the asset worthiness of the guaranteeing party before accepting it. Failure to do so may result in the acceptance of a guarantee that is no more than a piece of paper against which enforcement is hopeless.

We will consider how the English Courts have recently dealt with “on-demand” and “performance” guarantees.

On-demand?

An on-demand guarantee is perhaps the most straightforward of guarantees. Liability will usually be triggered by a written demand for payment, made in good faith. Once the demand is made, the guarantor is bound to pay.

In Meritz Fire & Marine Insurance Co Ltd v (1) Jan de Nul & (2) Codralux SA [2011] the defendants had entered into ship-building contracts with Huen Woo Steel Co and Meritz, the Korean insurer, issued advance payment guarantees to the defendants in respect of payments made by them to Huen Woo Steel. The Court of Appeal considered whether it was necessary to decide the merits of the underlying dispute before Meritz’s obligations under advance payment guarantees were triggered. The answer was no. The Court held that the guarantee given was similar to a bond and liability to pay was triggered by a demand made in good faith.

Some on-demand guarantees will crystallise on the expiry of a time limit to commence arbitration or court proceedings. If no proceedings are commenced within time, then the ability to trigger the obligation to pay will be the same as in Meritz. Accordingly, a party giving an on-demand guarantee which contains wording concerning the commencement of proceedings must, if it wishes to dispute the payment, commence proceedings within time otherwise the ability to challenge the obligation to pay will be lost.

In Wuhan Guoyo Logistics Group Co Ltd & Others v Emporiki Bank of Greece SA [2012], the Court of Appeal considered the wording of a payment guarantee issued on behalf of the Buyers under a Shipbuilding contract.

The document was called a “payment guarantee”, and contained elements of both on-demand and performance guarantees. The guarantee was given in respect of the buyers’ obligation to pay punctually. Clause 1 stated that it guaranteed “the due and punctual payment by the Buyer”. Payment by the guarantor was required to be immediate “upon receipt …. of your first written demand”. Clause 7 provided that the Banks’ obligations were not affected by any dispute between Buyer and Seller.

The Court considered whether the document was a standard guarantee (i.e. where liability depends on the Buyers’ liability to pay), or whether it was an “on demand” guarantee, and could be called on irrespective of the position under the Shipbuilding contract.

It was held that the guarantee was an on-demand guarantee and therefore (as in Meritz) acted as a bond against which payment had to be made, bringing payment guarantees with this wording into line with the decision in Meritz.

Performance?

A performance guarantee promises that the contract will be performed. The guarantors’ liability will only be triggered once a breach of the underlying obligations has been established and will only be to the extent of the liability of the original party to the contract.

As a matter of English law, in order to establish a binding guarantee, the formalities of the Statute of Frauds 1677 need to be met, in particular that there is a signed memorandum containing the Guarantee. It will also be necessary to show that the person/ entity signing the guarantee had the authority to sign on behalf of the guarantor.

The English courts have in recent decisions adopted a commercial approach to the formalities required under the Statute of Frauds, reflecting the methods of fixing contracts, especially in shipping, and attempts by parent companies to deny the existence of a guarantee.

In the recent cases of Stellar Shipping v Hudson Shipping [2010] and Golden Ocean v Salgoacar Mining [2012], the English courts took a wide view of what a signed memorandum was for the purposes of the Statute of Frauds. In Golden Ocean, the Court considered the email exchanges which contained the guarantee and held that the correspondence was sufficient to amount to a signed memorandum.

Conclusion

When faced with an offer of a guarantee to secure contractual obligations it is important to consider the asset worthiness of the guaranteeing party and the likely ease of enforcing any judgment under the guarantee in circumstance were the guarantor does not pay. It is also vitally important to ensure that there is clarity about the type of guarantee being offered (is it on-demand or performance?) and to observe any deadlines contained within the guarantee.

Failure to pay hire a breach of condition?

A recent Commercial Court decision flouts the orthodox view that a failure to pay hire was not a breach of condition. In Kuwait Rocks Co v AMN Bulkcarriers Inc (the “Astra”) [2013], the Judge in a lengthy obiter (i.e. non-binding judicial comments) decision reviewing the authorities on breach of condition, found that the obligation to make punctual payment of hire under an amended NYPE 1946 form of charterparty, was a condition. According to the Judge owners may be able to terminate the charter on the basis of repudiatory breach in circumstances where a charterer has missed a hire payment. This contrasts with the orthodox view which was that the obligation to pay hire was not a condition and therefore more would be needed to establish a repudiatory breach.

The decision is problematic as it leaves owners, when presented with a default, in a less clear position than they had been when considering whether to terminate the charter. Further, while it may bind arbitral tribunals, it does not have to be followed by another Judge in the Commercial Court. As such, another judge considering similar defaults may reach a different view. Accordingly, until the Court of Appeal considers the position, owners should be wary of relying on the Judge’s comments and terminating on the basis of a repudiatory breach unless there is clear evidence that charterers do not intend to be bound by the charterparty, which is in addition to their failure to pay hire.