The English High Court recently held a Chinese guarantor liable for its obligations under a guarantee even though it had not been registered and approved by China's State Administration of Foreign Exchange (SAFE)—and therefore could have been seen as void under Chinese law.

The case concerns claims for demurrage under a voyage charter entered into between Emeraldian Limited Partnership, the ship owner, and Wellmix Shipping Limited, the charterer, for the carriage of iron ore purchased by Guangzhou Iron & Steel Corp Ltd (GIS), which in turn guaranteed the performance of the charterer under the voyage charter by issuing a letter of guarantee to the ship owner. The guarantor did not obtain SAFE approval as required under Chinese law prior to issuing the guarantee. When berthing of the vessel was delayed due to repairs carried out to the berth, the owner sued for demurrage against the charterer as first defendant, and the guarantor, as second defendant.

The ship owner succeeded in the first claim against the charterer. The second claim against the guarantor raised issues of illegality and authority with regard to the guarantee. In particular, the Court had to consider: (1) whether the guarantor, being a Chinese company listed on the Shanghai Stock Exchange, was liable under a guarantee that was null and void under Chinese law, as a result of being issued without prior approval from SAFE; and (2) whether the signatory of the guarantee had authority to issue the letter of guarantee on behalf of GIS.

Illegality

Choice of Law

The charter between the ship owner and the charterer was expressly governed by English law and subject to English jurisdiction. The guarantee, however, contained no governing law clause. Relying on Rome Convention Article 3.1 as common ground to determine the applicable contract law, the Court held that since GIS purported to guarantee obligations of the charterer under the charter, which was expressly governed by English law and subject to English jurisdiction, it was reasonable and objective for the Court to infer that the parties to the guarantee impliedly chose English law as the applicable law.

At paragraph 171 of the judgment, the Court further held that even if no choice of law can be implied, English law would still have applied on the basis that the guarantee was most closely connected with England. This position seems controversial because the Court might be challenged as not to apply the general presumption in Article 4(2) of the Rome Convention—i.e., a contract is most closely connected with the country where the party, who is to effect the performance which is characteristic of the contract, has its central administration. In other words, the applicable law would have been that of China, where GIS had its central administration.

English Public Policy

The Court further considered whether it would be contrary to English public policy for the Court to order the parties to enforce the guarantee, knowing that by doing so it would be enforcing an obligation which was unlawful in a friendly foreign state.

The evidence introduced to the Court as to Chinese law demonstrated that where SAFE approval was required under SAFE regulations for issuing an overseas guarantee, in the absence of such approval the guarantee was null and void. Nevertheless civil liability in respect of the guarantee could still be imposed on the guarantor, creditor and debtor according to their respective fault. Even if the guarantee was null and void, that civil liability arising from the guarantee was still enforceable where the guarantor was at fault. If the guarantor and creditor were both at fault, the portion of liability borne by the guarantor shall not exceed half of the liability in question. The Court therefore held that it was not contrary to English public policy to enforce GIS’s guarantee because GIS was liable under Chinese law, despite the fact that the guarantee itself was null and void and that the civil liability arising thereof may not in a strict sense be classified as guarantee liability in nature. In enforcing the guarantee, the Court should have regard to English law as governing law rather than Chinese law.

Article 3.3 of the Rome Convention

The Court rejected GIS’s argument that it should give effect, in accordance with Article 3.3 of the Rome Convention, to the SAFE regulations as mandatory rules of Chinese law. The Court took the view that Article 3.3 of the Rome Convention did not apply in the present case, as it was not a situation where all other elements relevant to the situation were connected with China. The Court in particular pointed out two factors which were relevant: (i) the obligations of the charterer were governed by English law and (ii) the ship owner was a Liberian company.

The Court therefore applied English law and held GIS 100% liable under the guarantee although the Court admitted that the final amount of liability could arguably be reduced to 50% of the total amount guaranteed because both the guarantor and the ship owner could be regarded as being at fault for failure to obtain the SAFE approval and under that circumstance GIS would only bear civil liability for 50% of its guarantee liability under Chinese law.

Authority

As to the issue of actual authority, the Court agreed that Chinese law governed the relationship between the signatory of the guarantee and GIS. The Court, however, drew adverse inference against GIS due to its failure to give full disclosure with regard to documents relevant to the signatory’s authority, the circumstances in which the guarantee was signed, and the dealings between GIS and the charterer, finding that the signatory of the guarantee had the necessary authority to sign it and bind the guarantor.

Conclusions

The case illustrates the importance of including appropriate governing law and jurisdiction provisions in a guarantee if the parties do not intend the guarantee to be governed by the law governing the main or underlying contract. It also stresses the importance for foreign creditors to exercise due diligence before accepting a guarantee provided by a Chinese entity where SAFE approval is required under Chinese law. Without such approval, there is a risk that the value of the guarantee could be potentially reduced to the extent that civil liability imposed on the Chinese entity is significantly lower than the guaranteed liability.

Note that SAFE recently introduced significant changes to the existing foreign security regime by issuing a Notice on the Administration of Provision of Foreign Security by Onshore Institutions (30 July 2010). However, the Notice would not have changed the analysis in the UK case.