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On-demand bonds or guarantees: clarity and commercial certainty at last?

Our previous blog post considered whether JCT bonds were on-demand instruments or guarantees. The issue of bonds and guarantees came up again recently in a slightly different context. Our client asked us to advise on its demand for payment under a “performance bond“. The client explained that the performance bond was an on-demand instrument and that it had followed the requirements of the bond exactly in making its demand. This seemed to be relatively straightforward, so what was the problem?

Hybrid bonds

The problem lay in the fact that the instrument contained language characteristic of both a guarantee and an on-demand instrument, and the bondsman (an insurance company) had refused to pay out. The bondsman said that the “performance bond” was in fact a guarantee and that, as the underlying (guaranteed) contract had been varied without its consent in a way which was prejudicial to it, it was discharged from liability. This is a familiar problem and one with which individual judges in different courts have had to grapple in recent years. Perhaps unsurprisingly, the various decisions have been somewhat inconsistent and as a result it has become extremely difficult to predict how this type of “hybrid bond” will be interpreted by the courts. A far from ideal situation for our clients.

Is this about to change following the Court of Appeal decision in Wuhan Guoyu Logisitics?

In overturning the first instance decision in Wuhan Guoyu Logistics Group Co Ltd and another v Emporiki Bank of Greece SA, and deciding that the “hybrid bond” in that case was an on-demand bond, the Court of Appeal commented that “something has surely gone wrong if this comparatively simple question of construction requires such lengthy consideration… The commercial community deserves better than this.”

While admitting that it did not find this case particularly easy, in particular because there were pointers in different directions, the court thought that “it would be absurd” to conclude that it was a guarantee on the sole basis that the hybrid bond had six pointers in favour of it being a guarantee and four pointers in favour of it being an on-demand bond:

“But if the law does not permit boxes to be ticked in this way commercial men will need some assistance from the courts in determining their obligations. The only assistance which the courts can give in practice is to say that, while everything must in the end depend on the words actually used by the parties, there is nevertheless a presumption that, if certain elements are present in the document, the document will be construed in one way or the other.”

According to the Court of Appeal, this assistance is to be found in Paget’s Law of Banking (13th edition, 2007), at paragraph 34.4:

“Where an instrument (i) relates to an underlying transaction between the parties in different jurisdictions, (ii) is issued by a bank, (iii) contains an undertaking to pay ‘on demand’ (with or without the words ‘first’ and/or ‘written’) and (iv) does not contain clauses excluding or limiting the defences available to a guarantor, it will almost always be construed as a demand guarantee.”

At last we have a clear statement from the Court of Appeal that, alongside the Marubeni presumption (that is, where an instrument is issued outside the banking context there is a strong presumption that it is a guarantee), we have another presumption: that an instrument will be construed as an on demand instrument if it contains those elements identified in Paget’s Law of Banking.

But wait a second, our client’s bond does not fall within the first two elements (the parties are both UK based entities and it is not issued by a bank), yet it does fall within the last two elements: not an uncommon position for many of our clients. It has three pointers in favour of it being a guarantee and three pointers in favour of it being an on-demand bond. How would a court construe the hybrid bond now? Are the pointers in favour of it being an on-demand bond enough to rebut the Marubeni presumption?

“Everything must in the end depend on the words actually used by the parties”

I welcome the Court of Appeal’s commercial approach to interpreting hybrid bonds of this nature, but presumptions can only go so far. The one lesson that can be learned from Wuhan and the cases that preceded it is that the only way to achieve absolute certainty in determining obligations under on-demand bonds and guarantees is to make sure that the instrument in question reflects the commercial deal. If an on-demand instrument is required ensure that “on-demand” language is used. Don’t mix and match “guarantee” and “on-demand” wording. As the Court of Appeal acknowledged, everything must in the end depend on the words actually used by the parties.

One thought on “On-demand bonds or guarantees: clarity and commercial certainty at last?

  1. A useful article but one which raises no real new ground. I continue to be surprised at the practice of so many employers in the process engineering side where on demand bonds for performance as well as advance and retention are closer to the norm, in mixing in classic secondary guarantee provisions – such as variations not affecting the obligation etc – into an on demand bond which should be all of one page and no more. Such additions, invariably expressed as “for the avoidance of doubt”, do not help the Employer one iota and merely fuel the above debate, and thus run the risk of creating rather than avoiding that very doubt. On demand bank guarantees are considered by the Courts as akin to standby letters of credit and thus outside the usual rules on guarantees. Some employers (or perhaps rather their advisers) would do well to have a look at such a standby letter of credit; they may be surprised at its brevity.

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