Does a guarantee provide the reassurance its name implies? When a transaction goes wrong, the injured party may have the benefit of a bank guarantee. It could be excused for thinking that its losses will be covered, to the extent of that guarantee. However, in these tough economic times, banks and financial institutions are carefully scrutinising the terms of their guarantees and may seek to deploy a variety of arguments for refusing to be bound by them.
The trend in the courts has been to take a robust approach in such cases, and flimsy arguments for refusing to pay out are given little credence. However, the law of guarantees is complex and it is not unknown for a beneficiary of a guarantee to lose out on technical grounds.
Tankship v Kwangiu
Almost every argument in the book was deployed in the recent case of WS Tankship II v Kwangju Bank, decided by the Commercial Court on 25th November. The dispute related to guarantees relating to shipbuilding contracts and two of the main contentions advanced by the bank were about the nature of the guarantee and variation of the underlying contract.
On demand or conditional
Most guarantees are either on demand or conditional. (A conditional guarantee is also known as a “see to it” guarantee.) Sometimes these are referred to as primary and secondary liabilities. A primary liability requires the guarantor to pay on demand, whereas a secondary liability requires proof of the underlying event(s).
The court decided in Tankship that on demand guarantees were in place. Although the documents referred to payment “if… the buyer should become entitled to a refund of the advance payments…”, it was the further reference to payment “on demand” that triggered the bank’s obligation to pay. Further, a reference to an arbitrator’s award settling the amount of liability (if the builder disputed the buyer’s claim) was not an implication of secondary liability; it merely provided an alternative to payment of the amount of the demand.
The variation defence dates back to the 19th century case of Holme v Brunskill, recently referred to in a construction context in Hackney Empire v Aviva Insurance. The rule in Holme v Brunskill provides that a guarantor is not bound to pay where the underlying contract has been varied (unless the guarantor consents to the variation or the variation is patently insubstantial or incapable of adversely affecting the guarantor). However, in the case of a primary liability, this defence has no substance because such liability is independent of the underlying contract.
Several other arguments were put forward, but they all failed. However, in the current climate, beneficiaries of guarantees should be ready to face arguments against enforcement and for the language of the guarantee to be strictly tested. As ever, careful drafting up-front is the best remedy.