21 June 2018

Guarantees and on-demand bonds

Awareness of the key difference between an ordinary guarantee and an on-demand bond or guarantee is crucial, as became clear in the High Court in the case of Ultrabulk A/S v Jagatramka, where the defendant found himself bound to repay a much larger sum than was still owed under the original debt.

The ordinary guarantee, which is a secondary obligation dependent upon the underlying primary obligation of the party being guaranteed, contrasts with an on-demand bond or guarantee, which is a primary obligation, usually to pay a fixed sum of money, regardless of the extent of the liability of the party being guaranteed.

There has been a wealth of litigation in the English courts (and indeed elsewhere) in the last 10 years as to whether a particular (usually badly drafted) instrument falls into the first category or the second category. What the document is called is largely irrelevant – what matters is its construction and substance, so the correct drafting is vital.

A number of these cases (Marubeni Hong Kong and South China Ltd v Mongolian Government [2005] 1 WLR 2497 at [30], IIG Capital LLC v Van Der Merwe [2008 EWCA Civ 542 at [9] and, most recently, Autoridad del Canal de Panama v Sacyr SA [2017] EWHC 2228 at paragraph 81(4)) have held that there is a presumption against construing an instrument as an on-demand bond if it is not given by a bank or other financial institution.  This, of course, puts the burden of proof onto the claimant beneficiary in cases where the guarantor is another type of entity or an individual.

In the case of Ultrabulk v Jagatramka, the personal guarantor’s ‘guarantee’ was scrutinised by the court.  Ultrabulk, the claimant, was a Danish company engaged in the business of operating and trading ships. It entered into two co-operation agreements in 2007, both with Gujarat NRE Coke Limited (Gujarat).

Over the next six years, Gujarat became indebted to Ultrabulk to the tune of US$4,259,397. Both parties came to an agreement in 2013 that Gujarat would pay the outstanding debt in instalments by 31 December 2013.

Mr J, the chairman and managing director of Gujarat, entered into a document called a personal guarantee at the same time, stating that he was aware of the debt to Ultrabulk in the sum of US$4,259,395 (defined in the guarantee as ‘the Gujarat Liabilities’) and guaranteeing that, if Gujarat did not pay the Gujarat Liabilities by 31 December 2013, he would “on [Ultrabulk’s] first written demand ….pay a sum equivalent to the Gujarat Liabilities plus the interest.”

In June 2015, Ultrabulk demanded the sum of US$4,259,395 plus interest under the guarantee, which Mr J failed to pay.

Mr J raised various arguments as to why he was not liable, all of which were dismissed by the court.  His seventh (!) defence was that, even if the guarantee was enforceable, Gujarat had already paid US$1.95m towards the guaranteed liabilities and therefore he should be liable for only US$2.31m plus interest.

In other words, he was arguing that liability under the guarantee was secondary to that of Gujarat’s liability. Ultrabulk, to the contrary, argued that Mr J’s obligation was to pay a sum equivalent to US$4,259,395 plus interest (i.e. ignoring the partial repayment of the debt) and that the guarantee therefore provided for a primary liability akin to that under a performance bond.

Unfortunately for Mr J, the court found that the instrument signed by Mr J provided for an on-demand bond and that, if such a demand was validly made, Mr J was bound to pay “a sum equal to US$4,259,395”, not Gujarat’s actual outstanding liability at that time.

These were the parts of the guarantee which led the court to that conclusion:

  • Mr J agreed to pay “a sum equivalent to” the “Gujarat Liabilities” which were defined as being simply US$4,259,395.  He did not agree to pay a sum of money to be determined by reference to Gujarat’s actual liability at the material time.
  • He “unconditionally and irrevocably” guaranteed that if Gujarat did not pay the Gujarat Liabilities by 31 December 2013, he would, on demand, pay a sum equivalent to the Gujarat Liabilities. Such language, in the court’s view, was indicative of a primary liability.
  • He “irrevocably confirms that he will not contest and/or defend any application and/or proceedings to enforce” the guarantee. Again, in the court’s view, such language was consistent with a primary liability and inconsistent with his liability being coextensive with that of Gujarat.

As we have said before, this is an area of English law (and, we believe, the law in many other countries) where great care has to be taken with the drafting/reviewing to ensure that the desired outcome is achieved.

This is true if you are (or are representing) a guarantor, even if that guarantor is not a bank or other financial institution. Where you are (or are representing) a bank or financial institution, extra care needs to be taken, as the presumption referred to above will apply.

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About the Author
Harry Bengough, Partner, Head of Banking and Finance Team
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