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Performance Bonds Prove Powerful in Absent Fraud
Ravi Aswani
This article by Ravi Aswani first appeared in Lloyd's List on 9 March 2011.
Meritz Fire & Marine Insurance Co Ltd v Jan de Nul NV [2010] EWHC 3362 (Comm)
Shipbuilding is an industry which felt the impact of the credit crunch with particular force. The recent decision of the Commercial Court in Meritz Fire & Marine Insurance Co Ltd v Jan de Nul NV illustrates the practical problems in relation to securing payments which can arise in the event of something going wrong.
The facts of the case were slightly complicated but by no means out of the ordinary. The defendants (“A”) had entered into three shipbuilding contracts with “B”. B was required under those contracts to provide advance payment guarantees. B underwent a corporate restructuring. It merged with another company C, which then transferred its shipbuilding business to another company D. The shipbuilding contracts underwent some alleged variations, specifically the deferral of delivery dates. D unfortunately experienced financial difficulties – it transpired that these three contracts were the only business on its books. A terminated the contracts (there was no dispute that it was within its rights to do that) and sought refund of all payments made. To compound the difficulties, D then entered into insolvency.
The claimant (“E”) had entered into advance payment guarantees by which it guaranteed the repayment of monies paid by A to B (“the Guarantees”). E sought a declaration as to non-liability to pay under the Guarantees on the following bases. Firstly, E contended that the Guarantees when properly looked at were contracts of suretyship rather than performance bonds (i.e. a secondary and not primary liability). Secondly, E contended that variations to the contracts as well as the corporate restructuring had the effect of discharging liability (on the assumption that they were not performance bonds but contracts of suretyship). Thirdly, E contended that A was unable to make a valid contractual demand under the Guarantees to trigger payment.
The sums in question which E sought to avoid liability to pay were over US$20 million in total.
Beatson J dismissed the claim in its entirety. His reasoning on each of the three contentions advanced by E was as follows:
On the proper construction of the Guarantees, Beatson J took the approach that they had to be construed as a whole as commercial documents. There were features in the case which could be used to support either side’s construction but ultimately the Guarantees were indeed performance bonds. Beatson J placed particular emphasis on the fact that the Guarantees displayed three of the four features which the editors of the leading text (Paget’s Law of Banking, 13th edition (2007)) stated would lead an instrument almost always to be construed as a demand guarantee. The underlying transactions were between parties in different jurisdictions. There were no clauses excluding or limiting defences available to E. The Guarantees were irrevocable and unconditional. The requirement was payment on demand. Although not issued by a bank but by an insurance company, it nevertheless was providing financial instruments for a fee. The Guarantees were subject to the ICC’s Uniform Rules for Demand Guarantees. They required a demand in a specific form certifying conformity with all requirements but not proof of the underlying facts – and indication of primary liability. The obligation to pay was triggered on the demand being made in the specified form.
Beatson J went on to consider whether, if the Guarantees were in fact contracts of suretyship, whether E had been discharged from liability as a result of the corporate restructuring and variations in the shipbuilding contracts. He considered that the corporate restructuring did not involve any specific breach of duty and that any forbearance in not suing the various entities which could have possibly been sued did not discharge E from its liability under the Guarantees. E also did not take any opportunity to challenge the restructuring in the Korean Court, which it could have done. In relation to the alleged deferral of delivery dates, Beatson J preferred to address this by reference to E’s affirmation of the Guarantees after the dates of the contested factual matters.
In relation to the final question of whether A was able any longer to make a contractual demand triggering liability under the Guarantees, Beatson J reasoned as follows. There was a short answer to this point based on the wording of both the shipbuilding contracts and the Guarantees. The shipbuilding contracts gave A the right to terminate and demand repayment on “an insolvency event” which was defined to include “the dissolution or liquidation” of B. The Guarantees gave A a guarantee of the repayment of the advance payments upon a demand with a signed statement certifying that the demand for refund was made in accordance with the clause from the shipbuilding contract giving A the right to terminate and demand repayment. Thus, the guarantees provided for payment in the case of dissolution of B. It could not make any difference if that dissolution happened as part of some corporate restructuring which put a new entity in its place as the shipbuilder, i.e. C or D. That would in fact deprive the Guarantees of utility in a set of circumstances where they would be particularly needed. Furthermore and in any event, the evidence on Korean Law was that once the merger was effective, A could still honestly and validly self-certify in accordance with the Guarantees. Absent fraud, that was the end of the matter.
What lessons can then be learnt from this case? The following practical points emerge:
Performance bonds are of course documents which must be honoured by the party issuing them without any regard to the underlying transaction (absent any considerations of fraud). For this reason they are powerful commercial documents. Meritz Fire certainly provides a reminder that they should not be entered into lightly or without thorough due diligence and scrutiny of the wording.
Sadly, insolvency and other problems preventing delivery under a shipbuilding contract are far from uncommon. As well as the usual due diligence checks which may take place from a commercial perspective, in legal terms a guarantee itself could usefully address questions such as the guarantor’s liability to pay in the event of insolvency or corporate restructuring, and most significantly of all, whether the guarantor’s liability is a primary one or a secondary one. Whilst of course one cannot always account for all eventualities, had this specific point been made a little clearer in the present case, it is unlikely that it would have reached the Commercial Court in an expensive contest between two leading commercial QCs. A party issuing a guarantee (i.e. a document creating a secondary liability) which becomes aware of any potentially materially variations should also exercise care in considering its position in relation to such variations before going on to take any action which might subsequently be classed as affirming the guarantee.