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18 April 2012
Types of guarantee
The Meritz Fire case
It is an unwelcome fact that a guarantee designed to provide security for the performance of the obligations of a debtor sometimes turns out to be far from secure. Where the nature and extent of a guarantee is ambiguous, courts are often called on to determine the scope and validity of the security.
In a typical construction contract, the shipyard's obligation to repay instalments is secured by a refund or advance payment guarantee issued by a bank. The payment obligations of the buyer, often a special purpose offshore company, will be guaranteed by its parent company. However, what seems simple and straightforward when these guarantees are negotiated can become less so when it comes to enforcement against a resistant guarantor.
Types of guarantee
Under English law a distinction is drawn between a guarantee and an indemnity. Under a guarantee the promise given by the guarantor is that the debtor will perform its obligations under the secured contract. If the debtor fails to do so, the guarantor is liable to the same extent as the debtor under the contract. Where the security given is an indemnity, the obligation of the guarantor is to pay if the debtor fails to do so. The purpose of an indemnity is to provide security for the debtor's payment obligation, whereas a guarantee is designed to secure the performance of contractual obligations.
It may be thought that if the primary purpose of providing security is achieved then it does not matter whether the surety given is described as a guarantee or an indemnity. However, under English law, the distinction is all too important because there are specific and important rules that apply to guarantees but not to indemnities. Furthermore, these rules are strictly applied and, if breached, may result in the guarantor being discharged from any liability even where the transgression is minor.
The Meritz Fire case
The distinction between guarantees and indemnities was recently considered by the Court of Appeal in Meritz Fire & Marine Insurance Co Ltd v Jan De Nul Nv.(1) Under a shipbuilding contract the builder's obligation to repay instalments had been secured by advance payment guarantees issued by an insurance company, Meritz. As a result of a corporate restructuring, the shipbuilding contracts had been novated from the original builder to a new company. Shortly afterwards, the buyers terminated the contracts and demanded repayment of the instalments. The builder was declared bankrupt and the buyers sought to recover their instalments by demanding payment under the advance payment guarantees.
Meritz denied that it was obliged to refund the instalments to the buyers. Its main argument was that it had not consented to the novation of the shipbuilding contract. Meritz claimed that the surety provided by it was in the nature of a guarantee and that, as a consequence, the rule in Holme v Brunskill(2) applied. Under this rule, where the underlying contract is varied without the guarantor's consent, then the guarantee is discharged. Where an underlying contract has been novated, be it to a new yard, or, as is more common, to a new buyer, the Holme decision will almost invariably apply. That means that the guarantor will be discharged from liability where the novation has occurred without its consent or affirmation. The rule does not apply to indemnities because the guarantor's obligations under an indemnity are not dependent on the terms of the underlying contract and thus its obligations will not change where there is a variation or novation of that contract.
The court held that the Meritz advance payment guarantees were indemnities and not guarantees. This is not an entirely surprising decision. Despite the name by which they are commonly described, under a refund guarantee or advance payment guarantee the guarantor promises to repay the sums to the buyer if the builder fails to do so. The guarantor does not promise that the builder will actually perform its obligations under the shipbuilding contract.
Another important element of guarantees under English law is that, in order to be enforceable, they must be in writing and signed by the guarantor.(3) However, many guarantees are issued in the form of a SWIFT transmission and the question is whether such guarantees meet the requirement of being signed.
In the recent decision of WS Tankship II BV v Kwangju Bank Ltd(4) the Commercial Court again considered the extent to which a buyer under shipbuilding contract could claim under a refund guarantee issued by a bank. Most of the bank's numerous defences were based on its primary assertion that the guarantees were true guarantees, not indemnities. On this basis, the bank argued that as the refund guarantees were in the form of SWIFT transmissions, and thus not signed, they were not enforceable.
The court had little difficulty in finding that the refund guarantees were not in fact guarantees but contracts of indemnity and did not need to be signed. However, the judge went on to consider what the position would have been had the SWIFT refund guarantees been true guarantees. His view was that, in modern times, authentication by sending a SWIFT was equivalent to authentication by signing. Thus, if the name of the issuer of a true guarantee sent by SWIFT appears in the message header then it will be deemed to be a sufficient signature. This is a welcome decision and one that will give considerable comfort to beneficiaries receiving guarantees by SWIFT.
When negotiating indemnities or guarantees, whether as a beneficiary or a guarantor, the wording needs to be carefully drafted and the distinction between the different types of sureties need be borne in mind. It should also be remembered that the burden of proving a valid right of demand under a contested guarantee or indemnity rests with the beneficiary.
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