The recent case of Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA highlights the difference between guarantees and on-demand bonds, the difficulties in drafting those documents and the implications of failing to get the drafting right.
Both a guarantee and an on-demand bond are used to guard against the possibility of non-performance of a contractual obligation, though the protection offered by each differs.
A guarantee creates a secondary obligation under which a surety guarantees the performance of a primary obligation by one party to another under an underlying contract. The surety’s liability is therefore dependant on the performance of the primary obligation in the underlying contract.
On the other hand, an on-demand bond imposes a primary obligation on a surety to pay the beneficiary of the bond on demand for payment (contrast a ‘performance’ bond, however, which is usually akin to a guarantee). The surety’s payment is not contingent on performance in the underlying contract or proof of loss; usually a simple statement to the effect that an obligation in the underlying contract has been breached and that loss has been suffered by the beneficiary, without having to prove either, is sufficient to trigger payment.
The difference between guarantees and bonds can be difficult to determine, and is often complicated by the confusingly terminology used.
Wuhan relates to a shipbuilding contract under which the buyer was to procure its bank issue a “Payment Guarantee” (as it was so called under the shipbuilding contract). The Payment Guarantee was in respect of the payment of the second instalment of the price, which itself was payable (a) within a certain time following receipt by the buyer of a written demand for payment and (b) on production of a certificate relating to the cutting of the first section of steel for the ship.
The question of the buyer’s liability to pay the second instalment was determined at arbitration. For the High Court the question to be considered was whether the Payment Guarantee was a guarantee, as so called, or rather an on-demand bond. The High Court held that it was a guarantee. On appeal, however, the Court of Appeal held (unanimously) that the Payment Guarantee was an on-demand bond and overturned the earlier decision.
Particular attention was given to the presumption set out in Paget’s Law of Banking (approved in the Court of Appeal, firstly in a 2002 judgment):
“Where an instrument (i) relates to an underlying transaction between the 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.
In construing guarantees it must be remembered that a demand guarantee can hardly avoid making reference to the obligation for whose performance the guarantee is security.”
Additionally, a number of positive factors in support of the Payment Guarantee being an on-demand bond (such as references in the document to payment having to be made “immediately” and on the seller’s written demand, and the limit of guarantee being equal to the second instalment plus sixty days interest which implies no great delay in payment – as there would be in dispute – is envisaged) were considered relevant.
The presumption in Paget’s, coupled with the supporting positive factors, led the Court of Appeal judges to conclude that the document is an on demand guarantee.
Longmore LJ stated that “while everything in the end must depend on the words actually used by the parties, there is nevertheless a presumption that, if certain elements are present in the document, the document will be construed one way or the other”.
The focus should therefore not necessarily be on the intricacies and finer details of the drafting, but rather on the commercial agreement. Indeed, the document was found to be an on-demand bond rather than a guarantee despite there being, in the drafting, six ‘pointers’ in favour of the latter and only four in favour of the former. Therefore, labelling a document a guarantee (like in this instance) for example will not, in itself, be sufficient to overturn a presumption of being an on-demand bond.
Ultimately, this case highlights the difficulties encountered with, and the often contentious natures of, bonds and guarantees. To avoid arguments, having to rely on presumptions, and so on, the message is obvious: keep the drafting clear and consistent. Many of the issues faced in this case, which can be avoided, derived from inconsistencies in the drafting which suggested the document could be either an on-demand bond or a guarantee.