Making demands of parents – interpreting see-to-it and on-demand guarantees4 June 2020

Determining which category a guarantee falls into has been the subject of much judicial consideration over the years, and the latest English judgment on this matter is Shanghai Shipyard Co. Ltd. v Reignwood International Investment (Group) Company Limited & Ors^¹, in which the Commercial Court revisited the principles established in Wuhan Guoyo Logistics Group v Emporiki Bank of Greece². Of particular interest in this latest decision was the emphasis given to the question of whether the instrument was issued by a financial institution to determine whether it was an on-demand guarantee.

Background

Shanghai Shipyard Co. Ltd, as Builder, was the beneficiary of a “guarantee” provided to it by Reignwood International Investment (Group) Company Limited (“the Guarantor”) dated 17 November 2011. The guarantee was provided in relation to a shipbuilding contract entered between the Builder and the Buyer, an indirect subsidiary of the Guarantor, who was an SPV. The purpose of the guarantee was to secure payment of the final instalment for the vessel due from the Buyer to the Builder of US$170m.

The guarantee provided that in the event of such default, the Builder could demand the sum from the Guarantor, who was obliged to pay it immediately on receipt of the demand. However, the guarantee also provided that if there was a dispute between the Buyer and Builder as to the Buyer’s liability to pay the final instalment, and the dispute was referred to arbitration, the Guarantor could withhold payment of the guarantee until the outcome of the arbitration.

The Buyer refused to take delivery of the vessel or to pay the final instalment. A dispute ensued between the Builder and the Buyer over whether the final instalment was payable, and the Builder proceeded to make a demand under the guarantee. The Guarantor refused payment pending the outcome of arbitration between the Builder and the Buyer.

The principal issue in this case was whether the guarantee was characterised as an on-demand or a see-to-it guarantee.

The presumption established in Wuhan Logistics

The Court of Appeal decision in Wuhan Logistics is the leading judgment on characterising on-demand guarantees. Longmore LJ explained that determining this issue ultimately depends upon the language used within the instrument, but that if the relevant instrument satisfies four criteria then there will be a presumption that the guarantee is on-demand (referred to by Longmore LJ as “Paget’s presumption” as the criteria had already been suggested in Paget’s Law of Banking). The four criteria require that the 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’)^³; and
• does not contain clauses excluding or limiting the defences available to a guarantor.

The decision

In Shanghai Shipyard Robin Knowles J highlighted the importance of approaching the language of the guarantee in line with the guidance given by the Court of Appeal in Wuhan Logistics. In particular, he reiterated that a consistency of approach by the courts would allow all parties to know where they stand. However, he also emphasised that “Paget’s presumption” was not intended to be a tick box exercise against each of the four elements but should instead be used to help reach an understanding of the nature of the instrument in question.

In this case, the guarantee was given by a parent company, albeit one which had described itself, in other proceedings in Singapore, as offering investment services. Further, at the hearing the Builder’s counsel emphasised that in the shipbuilding industry, the function of a guarantee can be the same whether issued by a bank or a parent company. Although the judge accepted that there was some force in this submission, he focussed on the fact that the guarantee had not been issued by a bank and that as a result it fell outside of the presumption. He noted that the current edition of Paget’s textbook has added the words “or other financial institution” to element (ii) of the presumption and that the presumption for an on-demand guarantee has been held to apply to a bond issued by an insurance company in the ordinary course of its business. However, Robin Knowles J did not consider that these “amplifications” of element (ii) applied in this case.

The judge went on to hold that the fact that an instrument was not issued by a bank, financial institution or insurance company in the ordinary course of its business was material and that this was underlined by the fact that the three remaining elements of the presumption did not necessarily form a powerful combination.

Lastly, applying further commentary from Paget’s textbook, Robin Knowles J stated that where an instrument is not given by a bank or other financial institution, “cogent indications” that the instrument was intended to operate as an on-demand guarantee will be required. Robin Knowles J held that in this case the guarantee lacked indications of the strength or quality required to meet this “cogent indications” threshold.