Crossing the Rubicon - can you guarantee that you understand the terms of your guaranteed obligations?

Crossing the Rubicon - can you guarantee that you understand the terms of your guaranteed obligations?

Crossing the Rubicon - can you guarantee that you understand the terms of your guaranteed obligations?

Julius Caesar proclaimed “let the die be cast” as he crossed the Rubicon river, precipitating the Roman Civil War and the imperial era of Rome.  The recent Rubicon case (Rubicon Vantage International Pte Ltd v Krisenergy Ltd [2019] EWHC 2012 (Comm)) highlights that the die may not, in fact, be cast for guarantors.

Summary

This interesting case involved extensive consideration of the drafting of a guarantee, the underlying framework from recent case law and whether the obligations thereunder were guarantees or on demand obligations. Based on the drafting, a non-bank guarantor was found to be liable to pay sums under the guarantee even though the underlying amount was in dispute.

The facts

Rubicon (R) and Kegot (K), a wholly owned subsidiary of Krisenergy (P), entered into a bareboat charter.  As part of these arrangements, P provided a “parent company guarantee” (the Guarantee) in favour of R.  Various works were carried out on the chartered vessel and R sent a series of four invoices to K, totalling approximately US$1.8m.  K disputed the invoices and did not make any payment. R then served a demand on P under the Guarantee for the US$1.8m. R commenced proceedings against P and made a second demand.  Litigation ensued.

It was accepted by the parties that the Guarantee was, at least in part, an on demand instrument.  This is crucial because, as summarised below, an “on demand” instrument is very different from a “true” guarantee.

What has been guaranteed?

“True” guarantee:

  • the guarantor promises to be directly answerable for the payment of a debt owed by the debtor to the counterparty, or the fulfilment of the debtor's contractual obligation(s) owed to the counterparty, in each case in the event of the debtor's actual default. 
  • Its basic function is to provide surety for performance, particularly where the debtor becomes insolvent

The liability of the guarantor here is a secondary liability because the obligation need not be met until the debtor actually defaults. This is sometimes referred to as a “see to it” guarantee.

On demand instrument:

  • the issuer of this type of instrument assumes a direct obligation to the beneficiary, who is entitled to payment under the instrument upon submitting an honest statement that the debtor is in default under the underlying contract and the beneficiary has suffered a loss
  • there is no requirement for the beneficiary or any other person to prove the breach of the underlying contract (as is normally the position in relation to “true” guarantees)
  • the issuer typically checks to ensure that the demand complies with the terms of the instrument (that is, valid on its face) before it makes its payment to the beneficiary
  • the issuer is required to pay the beneficiary even if the debtor disputes that it has failed to perform the underlying contract

An on demand instrument is an independent, autonomous instrument which imposes a primary contractual obligation (or primary liability) on the issuer to pay a specified sum of money on the presentation of a written demand which complies with the terms of the instrument.  Put another way, an on demand instrument is an indemnity, i.e. a promise to pay money on the happening of a specified event

A “guarantor’s” obligations under a document will depend on whether that document operates as a “true” guarantee or an on demand instrument.  This requires the lawyers and, occasionally, the courts to determine whether that document, on its proper construction, imposes a primary or a secondary obligation.

This task is not made any easier by the often interchangeable use of terms like “guarantee”, “indemnity”, “on demand”, “irrevocable” and “unconditional” all within the same document.  Moreover, what a document is called (e.g. a “guarantee”, an “on demand bond”, a “standby letter of credit” or a “performance bond”) will not in and of itself determine which obligations the guarantor has assumed.  Not surprisingly, this can result in confusion, misunderstanding and sometimes litigation between the parties.  The nature of the guaranteed obligations will depend on the precise wording of the document in question.

Guiding principles

Some guiding principles were laid down in the relatively recent case of Marubeni Hong Kong v Mongolian Government [2005] EWCA Civ 395 in which the Court of Appeal held that there is a presumption against construing a document as an on demand instrument where it is not given by a bank or other financial institution (the “Marubeni presumption”). 

In a similar vein, the Wuhan Guoyu case (Wuhan Guoyu Logistics Group Co Lt v Emporiki Bank of Greece SA [2012] EWCA Civ 1629) confirmed that where an instrument:

  • relates to an underlying transaction between the parties in different jurisdictions,
  • is issued by a bank,
  • contains an undertaking to pay “on demand” (with or without the words “first” and/or “written”), and
  • does not contain clauses excluding or limiting the defences available to a surety (e.g. customary “waiver of defences” wording);

...it will almost always be construed as a on demand instrument.

The Rubicon decision

Returning to the Rubicon case, the court examined the document and agreed with R and P that the Guarantee operated, to some extent, to impose autonomous, independent liabilities because:

  • subject to receipt of a compliant and honest demand, P was required to pay any amount which K was liable to pay under the bareboat charter, but had not paid
  • in some circumstances P was also liable to pay in respect of a compliant and honest demand even if there was an unresolved dispute between R and K over some of the bareboat charter payments

P had already accepted primary liability.  So there was no need for the court to consider the Marubeni presumption. 

The die was cast.  P had crossed the Rubicon into the land of primary liability.

The court had to determine 3 issues:

  1. whether the Guarantee was an on demand instrument in relation to claims where K had admitted liability but was disputing the quantum or also where it was disputed whether a liability existed
  2. how to interpret the Guarantee's provisions relating to the requirements for a valid demand, and
  3. whether or not R had served a compliant demand

Issue #1: claims for admitted liability only

  • The judge (Nicholas Vineall QC (sitting as a deputy High Court judge)) held that the Guarantee covered disputes relating to both liability and quantum.  The Guarantee was clear in stating at clause 4 that undisputed amounts due were to be paid within 48 hours of demand.
  • Clause 5 of the Guarantee said that, where there was a dispute “as to the Company’s liability in respect of any amount(s) demanded”, the Guarantor would be obliged to pay on demand any amount(s) demanded up to a maximum US$3m notwithstanding the dispute, pending a final judgment or final non-appealable award as to the liability for the disputed amount(s).
  • As such
    • if the amounts were not disputed either as to liability or amount, P had to pay them within 48 hours of receipt of valid demand pursuant to clause 4, and
    • if liability to pay was disputed, then P was still required to pay up to the US$3m of limit of liability set out in clause 5
  • The operation of clauses 4 and 5 was predicated on the assumption of a valid demand which brings us nicely into the next issue.

Issue #2: valid demand requirements

  • Clause 3 of the Guarantee set out the requirements for a making a valid demand.  This was complicated by unclear drafting.  The clause read:

“Any demand under this Guarantee shall be in writing and shall be accompanied by a sworn statement from the Chief Executive Officer or the Chief Financial Officer of the Contractor stating as follows: (a) that the amount(s) demanded are properly claimed and due and payable in accordance with the terms of the Contract; (b) the calculation of such sums together with any supporting documentation reasonably required to assess such demand; and (c) that the Company was duly notified of the amount(s) demanded in accordance with the terms of the Contract.”

  • Paragraph (b) presented the problem. The judge had to ascertain what a “reasonable” person would have understood the parties to have meant, i.e. a person who has available all the background knowledge which would have been reasonably available to the parties (Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50)
  • It was held that such a person would have understood paragraph (b) to mean that the demand should be accompanied by the calculation of the sums demanded and by any supporting documentation reasonably required to assess the demand.  The judge did not agree with R’s counsel that all that was required was a sworn statement that the demand was accompanied by supporting documentation reasonably required to assess such demand (even if that supporting documentation is not provided)

Issue #3: was the demand compliant?

  • Yes. The supporting documents provided enabled P to assess the demand as well as the calculation.  P could find out quickly from K whether R’s claim was admitted or disputed, and form a provisional view as to whether the claims underlying the demands were bona fide

Comment

Jonathan Porteous, head of Banking & Finance at Stevens & Bolton, comments:

  • The common problem we see with guarantees is that documents which are really intended as secondary liabilities i.e. the guarantor is only liable to the extent the guaranteed party is liable, contain language which suggests they are primary liabilities, Often this language is not negotiated. This case was a little different in that the guarantee expressly envisaged what would happen where liability was disputed i.e. the guarantor had to make a payment anyway.  Most guarantees do not do this.
  • This is a case where the judge paid careful attention to the drafting, and paid less attention to any presumptions based on whether the guarantor was a bank or a non-bank.  So care will be needed for every guarantor to make sure the wording in the document they sign does not transform their guarantee into an on demand obligation.

Contact our experts for further advice

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