Bonds and guarantees: an update
There have been a number of recent cases in relation to bonds and guarantees. Nicholas Gould provides an update as to what they mean.
Interpretation - on demand or guarantee?
The case of Vossloh Aktiengesellschaft v Alpha Trains (UK) Ltd1 concerned a security document given by a parent company of the Vossloh Group. The guarantee related to the number of trains sold to the Alpha Group. The beneficiary claimed that the words “principal debtor and not merely as surety, as a separate, continuing and primary obligation” meant that the obligation was a primary obligation and not a secondary guaranteeing obligation.
The Judge did not agree. A mere assertion of a breach or failure to pay money was not sufficient. Reading the guarantee as a whole, it required there to be a default by the principal in performing the underlying contract or in making a payment of the sum due.
There is a presumption that an instrument is not a performance bond unless it is issued by a bank in the form of a banking instrument. Alpha had not rebutted that presumption. The mere use of the expression “on demand” was insufficient to establish that the guarantee was in fact “on demand”. Alpha Trains therefore had to establish liability in respect of the sum due before making a call on the bond.
In Carey Value Added, S.L.B Groupo Urvasco SA,2 the High Court had to consider whether a security document was truly an on demand bond or a secondary guarantee obligation. The expression “all obligations of the Obligors under or in connection with the transaction documents” were co-extensive with the borrower’s liability. The guarantor was therefore responsible as primary obligor for any failure of the borrower. This did not amount to an immediate unconditional on demand bond.
The case of Kookmin Bank v Rainy Sky SA & Others,3 considered the interpretation and scope of “all such sums due”. Six almost identical on demand advance payment bonds had been provided as security for obligations undertaken by a Korean ship builder in relation to six ship building contracts. The ship-builder later became insolvent, and so the beneficiary sought repayment of instalments that had been made. The bond was in respect of “all such sums due to you under the contract”.
The call on the bond was resisted on the basis that demands for instalments made were not sums due. The Court disagreed, holding that the word “such” should not be ignored. This word referred back to the sums in relation to the pre-delivery instalments under the ship building contract, as the purpose of the bond was to guarantee their repayments and nothing else.
When is a primary obligor a bondsman or merely a guarantor?
In Wuhan Guoyeu Logistics Group Co Ltd & Others v Emporiki Bank of Greece SA,4 the security document contained the phrase “as primary obligor”. Construing the document as a whole, it was a guarantee and not an on demand bond. The primary obligation was to pay the sum actually due in respect of the underlying contract, not to pay on first demand without demonstration of a debt.
On demand unconditional bonds – resisting a call
It is important to remember that for an injunction to be granted, an applicant will need to show that it has a “seriously arguable” case, and also to follow the guidelines in American Cyanamid Ethicon5. This general principle for injunctions needs to be considered in the context of resisting on demand bonds, and further the identity of the party that can be effectively restrained.
In addition, it might also be possible in limited circumstances to rely on the terms of the underlying contract, although the on demand bond is a primary obligation in its own right.
Exceptions: fraud and underlying contract
In Permasteelisa Japan KK v (1) Bouyguesstroi (2) Banca Intessa Spa6 Ramsay J held that a permanent injunction could only be provided in order to prevent a call on an on demand bond in very limited circumstances. One of the following has to be demonstrated:
A “seriously arguable” case in respect of fraud; or
A “positively established” breach of the underlying contract within the parties. Positively established means more than “seriously arguable”.
In the case of Sirius International Insurance v FAI General Insurance7 the House of Lords held that it was possible to grant an injunction where the underlying contract expressly restricted a party’s right to call upon a letter of credit. On demand bonds are sufficiently similar, and Ramsay J held in Permasteelisa that the same principle applied.
The party to the fraud
The other question to consider is that if fraud is to be established then which party must have knowledge of the fraud:
The Bank – an injunction will only be granted against a bank if there is a seriously arguable case that the person calling on it did not honestly believe the validity of the cause (United Trading v Allied Arab Bank8). The purpose of obtaining an injunction against a bank is to stop them paying money under the security documents.
The Beneficiary – the court will only grant an injunction against a beneficiary if there is a “seriously arguable” case that the beneficiary could not honestly have believed in the validity of its own call on the document (Intraco Ltd v Notis Shipping Corporation Bhoja Trader9).
Third parties by Freezing Order – the court may impose a freezing order on the money flowing from the performance guarantee (see once again Bhoja Trader, this time para 258).
Relationship with the underlying contract
The security in Simon Carves Ltd v Ensus UK Ltd10, was an an on demand bond. It was held that the terms of the main contract governed when the bond was to expire. There was a “very strong case” that the bond had expired, and therefore the injunction continued. This is a rare case of an injunction continuing in relation to a call on an on demand bond; in this case because the underlying contract arguably demonstrated that the bond had expired.
Here, Mr Justice Akenhead confirmed that unless fraud is established, the court will not prevent a bank from paying out on a demand bond provided the conditions of the bond itself have been complied with (such as formal notice in writing). However, fraud is not the only grounds upon which a call on a bond can be restrained by injunction. The same principles apply in relation to a beneficiary seeking payment under the bond. There is no legal authority that permits a beneficiary to make a call on the bond when it is expressly disentitled from doing so.
If the underlying contract clearly and expressly prevents the beneficiary from making a demand under the bond, it can be restrained by the court from making a demand under the bond. The court did not need to make a final determination on whether the underlying contract prevented payment at the interim injunction stage. It only needed to satisfy itself that the party resisting the demand had a “strong case”. It cannot be expected that the court at that stage will make in effect what is a final ruling.