What’s in a guarantee?

1 October 2019

Rating system:
Reading time (1-10 minutes): 4 ½

Sophistication level (1 (idiot) – 10 (expert)): 7

Entertainment value (1 (turgid) – 10 (side-splitting)): 4

Background

This recent case is a reminder that if you are asked to give what you think is a guarantee you need to be careful what it actually says.

Companies, particularly parent companies, are often asked to guarantee the performance of contractual obligations owed by other companies in their group. You may well remember my September 2012 legal briefing explaining the difference between a guarantee and an on-demand bond.

If you give a guarantee and there is a dispute between the parties to an agreement in relation to a liability you have guaranteed, you only have to pay under the guarantee when that dispute has been resolved (whether by agreement or by court order). Whereas if you enter into an on demand bond you have to pay on demand even if there is a dispute.

You usually only get on demand bonds from banks or other financial institutions. There is a presumption in English law (known as ‘the Marubeni presumption’, in case you were interested) that if there is any ambiguity as to whether a document is a guarantee or an on-demand bond then unless the party providing the document is a bank or financial institution it should be treated as a guarantee only.

Recent case

In this recent case Kegot (short for Kris Energy (Gulf of Thailand) Limited) took a charter of a floating storage and unloading facility from Rubicon (full name Rubicon Vantage International PTE Ltd) for use in an oil field in Southeast Asia. Kegot’s parent company Krisenergy (a little bit short for Krisenergy Ltd) provided a ‘Guarantee’ to Rubicon of Kegot’s obligations.

Clause 4 of the Guarantee said that where “the amount(s) demanded under this Guarantee are not in dispute between [Kegot] and [Rubicon]”, then Krisenergy ‘as guarantor’ had to pay the amount demanded within 48 hours. Clause 5 went on to say that where there was a dispute between Kegot and Rubicon ‘as to [Kegot’s] liability in respect of any amount(s) demanded under this Guarantee’, Krisenergy is obliged to pay the amount demanded up to a maximum of US$3m ‘notwithstanding any dispute between [Kegot] and [Rubicon]’.

A clause in the charter agreement itself said that ‘…where an item billed is disputed in good faith, it is not payable until any dispute has been resolved’.

Rubicon invoiced Kegot for around US$1.8m, which Kegot disputed, so Rubicon sued Kegot. Rubicon also made a demand against Krisenergy under the ‘Guarantee’. Krisenergy refused to pay. It said that as there was a liability dispute between Kegot and Rubicon it didn’t have to pay under the Guarantee unless and until that dispute was resolved. It admitted that because of the way it was worded the Guarantee document was at least in part an on-demand bond, and that therefore the Marubeni presumption itself didn’t apply. But it argued that any court should have to apply a similar presumption analogous to the Marubeni presumption in deciding the meaning of clause 5. So it said that even though clause 5 was worded like an on-demand bond it should be construed very restrictively because it was not a bank or financial institution. It argued that because of this the words ‘a dispute…as to…liability in respect of any amount(s)’ in clause 5 should only be read to mean a dispute as to the actual amount of the liability (ie how it was calculated), and not a dispute as to whether there was any liability in the first place. Although this would be an extremely restrictive reading of clause 5, it argued that if there was the slightest vestige of ambiguity it should be read this way.

The guarantee was expressed to be subject to English law and jurisdiction, so this case was heard by the Commercial Court in the UK.

What did the Commercial Court say?

The court said that Krisenergy had to pay the amount demanded within 48 hours. It said that the Marubeni presumption only applied in deciding whether a particular document is an on-demand bond or a guarantee. Because everyone seems to have admitted that at least some parts of the Guarantee did make it an on demand bond, the Marabeni presumption didn’t apply. It didn’t have to apply an analogous presumption in deciding what exactly clause 5 meant. So whilst clause 5 arguably had a smidgeon of ambiguity, it was not enough to rule against it being an on-demand bond.

The court said that the clause in the charter mentioned above was irrelevant, as it only applied between Rubicon and Kegot. The Guarantee was a separate document, and just because there was a clause in the charter protecting Kegot against having to pay Rubicon any disputed amounts didn’t mean that Krisenergy should have the same protection. A guarantor under a genuine guarantee would have such protection, because it is only liable to pay if and when the party it is guaranteeing is liable to pay under the terms of its own agreement. But someone giving an on-demand bond does not have this protection. They have to do what their on-demand bond says and they only have whatever protections they may have built into their on-demand bond.

Comments and tips

Be careful if you are asked to give guarantees. Always read them carefully. They may be called ‘guarantees’, but depending on how they are actually worded they could end up with you having to pay up under the ‘guarantee’ even if the underlying liability is disputed.

Case: Rubicon Vantage International PTE Ltd v Krisenergy Ltd [2019] EWHC 2012 (Comm)