Guarantees and on demand bonds: The difficulties that conflicting governing law provisions can cause parties to a project when trying to resolve disputes. Arbitration? Court?
Lyndon Smith, Partner
The recent case of Autoridad del Canal de Panamá v Sacyr S.A. and others  EWHC 2228 (Comm) demonstrates (i) the importance of consistency in the drafting of surety instruments by parties to construction contracts, and (ii) the care that needs to be taken when determining the governing law provisions, jurisdiction and dispute resolution clauses to be used in contract documentation.
Problems were encountered in Autoridad del Canal de Panamá v Sacyr S.A. and others as a result of the main contract and a series of financial guarantees being subject to Panamanian law and providing for the resolution of disputes by International Chamber of Commerce (ICC) arbitration, but a number of advance payment guarantees (“APGs”), procured by the contractor, being subject to English law and the exclusive jurisdiction of the English court.
The case arose from a construction project for the widening of the Panama Canal.
Autoridad del Canal de Panamá (“ACP”) was the employer and it contracted with a consortium of mainly European construction contractors to carry out the works. The consortium then assigned the contract to a company incorporated in Panama, called Grupo Unidos por el Canal S.A., because Panamanian labour regulations required such an arrangement.
The main contract governing the design and construction was subject to Panamanian law and provided for disputes to be referred to ICC arbitration with its seat in Miami.
As is common with many large-scale construction projects, the performance of the contractor’s obligations under the main contract was secured through a series of financial guarantees and these were governed by Panamanian law and subject to ICC arbitration.
During the carrying out of the works the contractor encountered cash flow difficulties and this led them to enter into a number of APGs with the employer.
In contrast to the previous guarantees, the APGs were governed by English law and provided for the exclusive jurisdiction of the English courts.
Disputes arose between the parties in relation to the financial guarantees under Panamanian law. The contractor filed a request for arbitration under the main contract in relation to these. They sought a declaration that repayment of the sums that were the subject of the guarantees was not due and/or payable under Panamanian law.
At a similar time, the employer brought proceedings in the English courts seeking the repayment of US$290m, plus interest, which had been paid to the contractor by the employer under the APGs.
The employer argued that the APGs should be construed as on demand bonds and therefore the court could issue a summary judgment without considering defences from the contractor under the main contract. This was in contrast to a “see to it” guarantee.
The distinction between on demand bonds and “see to it” guarantees was of great importance in this case, the reason being that liabilities under “see to it” guarantees are coextensive with the liabilities of the principal debtor, whilst on demand bonds place a primary obligation on the issuer to pay.
With on demand bonds, the beneficiary simply triggers immediate payment by outlining that it is demanding payment. A prompt payment is made provided that the demand is not fraudulent. In contrast, the beneficiary of a “see to it” guarantee must prove the contractor’s breach of the underlying contract in order to receive the funds that are the subject of the guarantee.
Due to the simple nature of on demand bonds, they are typically used in international projects and are less prevalent in the UK. For employers, on demand bonds provide high security as the funds are readily accessible. In practice, an on demand bond is autonomous from the underlying contract whereas “see to it” guarantees are attached to the contract.
In Autoridad del Canal de Panamá v Sacyr S.A. and others, the court reviewed the language used in the APGs. In particular, it focused on the clause in which the contractor agreed to perform the obligations “according to the terms” of the main contract. The clause also outlined that payment of the guaranteed amount would be made to the employer by the contractor “as and when due pursuant to the Contract”.
Although the employer argued that it was entitled conclusively to determine the amounts of principal and interest that were due, “conclusive evidence” clauses in the guarantees covered only interest and not the principal.
This analysis of the language used in the APGs resulted in the court finding that these were not on demand bonds. Therefore the contractor was not liable under the APGs to make repayment upon demand. Proof was necessary to determine whether the advance payments were overdue which meant that the employer’s application for summary judgment was refused.
Stay of court proceedings to allow for arbitration?
The contractor also sought to have the court proceedings stayed on the basis that the APGs were not autonomous but attached to the main contract, meaning that disputes surrounding the APGs should be referred to ICC arbitration.
The contractor relied on section 9(1) of the Arbitration Act 1996 which states:
“A party to an arbitration agreement against whom legal proceedings are brought (whether by way of claim or counterclaim) in respect of a matter which under the agreement is to be referred to arbitration may (upon notice to the other parties to the proceedings) apply to the court in which the proceedings have been brought to stay the proceedings so far as they concern that matter.” (Emphasis added)
The arguments before the court focused on the meaning of “in respect of a matter”.
It was the contractor’s position that the issues raised by the APGs overlapped with those to be determined in the arbitration. The employer, on the other hand, argued that the “matter” was whether the contractor was liable to the employer under the APGs and the APGs comprised English law exclusive jurisdiction clauses. Therefore the employer argued that this was not a matter which the parties had agreed to refer to arbitration.
The court agreed with the employer that the English courts had jurisdiction. Therefore the contractor’s application to stay proceedings was dismissed.
Autoridad del Canal de Panamá v Sacyr S.A. and others reinforces the importance of the need for parties to draft clear, concise and consistent surety instruments. If it is the intention of a party to create an on demand bond, then they should avoid references to guarantees or the underlying contract.
In addition, parties to construction contracts should always ensure consistency across all contract documents when considering (i) the choice of law and jurisdiction, and (ii) the choice of dispute resolution mechanisms. If it is the parties’ intention for disputes to be resolved by arbitration, and this is what is allowed for in the contract documentation at the outset, then all subsequent agreements should be consistent with that so there are no conflicting dispute resolution provisions.