Guarantees are a feature of the landscape of construction and engineering projects. Where a guarantee is used to secure a contractual obligation, the guarantee relates to that obligation. What this means is that if there is a material alteration to a contract, to which the guarantor has not consented, the guarantor is released from liability because the guaranteed obligation has changed (in a way that may increase the risk to the guarantor of the guarantee being called upon).
Because of this, guarantees usually include “anti-discharge” provisions, which state that the guarantor will continue to be bound as guarantor even if the parties to the underlying contract agree to vary its terms. But what happens if the underlying contract is varied to such a great extent that it goes beyond the “purview” of the guarantee? Is the guarantor still bound, or can it escape liability due to the extent of the variation. A recent decision of the English Court of Appeal considered this issue.
In brief, the relevant facts were:
- A ship builder entered into contracts with buyers to manufacture and sell two semi-submersible drill rigs for the sum of around US$500m, with payments to be made incrementally, against milestones. The rigs were required to be built by particular dates, and liquidated damages were payable for late completion. The rigs were to be leased by the buyers to Petrobras, the Brazilian state-owned oil and gas company.
- The buyers provided a parent company guarantee to the builder for payments to be made to the buyer as work was performed. The guarantee was not an “on demand” or similar guarantee, although it did say that the guarantor’s obligations were those of a “primary obligor” and “not merely as surety”. The guarantee contained an “anti-discharge” provision, which stated that the guarantor’s liability was to continue even if the dates for payment to the builders were extended, or the contracts between the buyers and the builder were amended.
- The builders were late in constructing the rigs, and encountered difficulties with their funders. As a result, the builders and the buyers renegotiated the milestone payments, so that the making of milestone payments would be deferred, and made in a number of smaller increments over a period of time including after the rigs were delivered to the buyers. The guarantor did not explicitly consent to these amendments.
- The builder was unpaid by the buyers, and therefore sought payment from the guarantors under the parent company guarantee.
- The guarantor refused to pay up. It said that the underlying contracts between the buyers and the builder had been materially varied (by changing the dates for delivery and payments), and that these variations to the contracts’ terms went beyond the purview of what the guarantee contemplated (thus rendering the “anti-discharge” provision in the guarantee inapplicable).
- The builder, for its part, said that the guarantor’s defence was untenable, and sought summary judgment against it on the basis that the guarantor was clearly liable for the amounts owed to the builder, because the “anti-discharge” provision of the guarantee rendered the guarantor liable even if the terms of the underlying contracts had been varied.
The court’s decision
The Court of Appeal held that the builder was not entitled to summary judgment, and that the issue of the extent of the guarantee’s operation (or “purview”) would need to be determined at trial, in light of all of the evidence. The court did not regard the question of the guarantee’s “purview” to be so clear-cut that it could say either way whether the “anti-discharge” clause in the guarantee was of operation. The contracts between the builder and the buyers still remained “contracts for the building of rigs and not cathedrals”, i.e. the nature of the enterprise guaranteed was still as originally contemplated, albeit subject to heavily revised payment and delivery schedules. However, the fact that the subject matter of the contracts remained unchanged did not conclusively mean that the variations to the contracts came within the purview of the guarantee.
Although not coming down against “anti-discharge” provisions in guarantees, the case described above raises serious issues over their legal effectiveness. It is one thing for a guarantee to say that it will continue to operate if (as is common) variations are agreed to the underlying construction or engineering contract to which the guarantee attaches. But what if those variations or amendments go beyond what could reasonably have been contemplated when the guarantee was provided? And, more importantly, if guarantors do raise “beyond the purview” arguments, how does one actually determine whether a contract amendment is within or without the scope of what has been guaranteed? As the above case demonstrates, often there are no simple answers to these questions.
Two solutions may be suggested:
- Guarantors should be notified of or (better still) their consent obtained to significant contractual amendments, even if those amendments appear to fall within the ambit of the guarantee’s “anti-discharge” provision. If a guarantor does voice objection to proposed contract amendments, it may be possible to tailor the amendments to meet the guarantor’s legitimate concerns, or even to negotiate the provision of a new or amended guarantee to cover the amendments to the construction or engineering contract in question.
- “Anti-discharge” provisions should, if possible (i.e. if guarantors will accept it), be drafted in broad terms, so as to indicate (in the case of where a buyer’s / owner’s obligations are guaranteed) that the purview of the guarantor’s liability extends to any enlargements or changes (however substantial) to the nature of the works, or to any deferments, restructurings, increases or decreases to the payments and timing of the payments to be made under the relevant contract.