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The Court of Appeal and advance payment bonds: such sweet sorrow

When I first read the Court of Appeal’s decision in Kookmin Bank v Rainy Sky SA, I couldn’t believe it. Surely I had misunderstood the facts? So I read it again, and everything was as I had thought. Was I missing something?

The situation seems simple enough. An employer makes an advance payment to a contractor and receives an on-demand bond in return. The contractor defaults and the employer calls on the bond. The bank pays out.  After all, banks don’t question a valid demand – and there was no suggestion that, on its face, this demand was invalid.

So why was this case different? Presumably the contractor was in financial difficulty and was unable to meet its liability under the bank’s counter-indemnity. In any event, the bank chose to fight the claim. The Court of Appeal (by a majority) has now come down in its favour.

The Court of Appeal’s interpretation

Which brings us to the main point. The bank’s argument was a narrow one. It turned on the meaning of the phrase “such sums” in clause (3) of the bond.  In short, did “such” refer to:

  • only the specific circumstances of repayment described in clause (2); or
  • all cases where a refund was due under the contract, as contemplated by clause (3)?

The parties agreed that, as a matter of construction, the relevant provisions could be read either way.

The basis of the Court of Appeal’s decision seems to be that the employer’s interpretation would rob clause (2) of any purpose or effect. However, clause (2) was there merely to record the background against which the bond was provided, not to define the bank’s obligations under it.  Of course, it should have listed all the scenarios where a refund would arise, but it was “only” an introductory paragraph, akin to a recital. We are all sometimes guilty of laziness when drafting recitals. Perhaps we will need to be more careful in future.

Commercial purpose is important

More seriously, the clear commercial purpose of the bond was to reimburse the employer if the contractor defaulted for any reason. Chartbrook v Persimmon led us to believe that, in cases of ambiguity, the court would favour an interpretation which made commercial sense over one which did not. In this case, however, the Court of Appeal seems to have taken a more traditional (indeed, puritanical) line. They apparently concluded that the parties “must be taken to have intended” that the bond would not cover the very scenario for which it was most likely to be needed, namely the contractor’s insolvency.

With respect, this is ludicrous. This was obviously sloppy drafting; nothing more, nothing less. If the Supreme Court was justified in rewriting the parties’ bargain in Chartbrook, it is difficult to see why the Court of Appeal could not do the same here. The pay when paid exclusion in William Hare Ltd v Shepherd Construction Ltd was a different matter; exclusion clauses are always construed strictly against the party seeking to rely on them, and Shepherd themselves had drafted the offending provision.

The law reports are littered with Court of Appeal decisions which can be justified at an academic level, but which defy business common sense. Rainy Sky is, sadly, another one to add to the list. We will need to wait and see whether the Supreme Court will have the last word on the subject.

5 thoughts on “The Court of Appeal and advance payment bonds: such sweet sorrow

  1. The Court of Appeal’s last word comes from Thorpe LJ. Unfortunately, it is “trepidation”. The Judgment which affects the result seems to have been handed down as little more than a “stab in the dark”. If that is so, surely the Lord Justice should have followed those who clearly are experienced in the field (including the Judge at first instance) and found in line with the majority rather than “expressing an opinion in a field that is completely foreign”.

  2. I note that the case was decided upon by the vote of a Judge who found himself in “an invidious position” in a field that was “completely foreign” to him and expressing an opinion “with considerable trepidation.” This may help explain John’s disbelief….

  3. Couldn’t agree more John, I too had to re-read to see what I had missed, only to find that I had understood the issue first time round, just couldn’t follow the quixotic decision.

    Shipbuilding Contracts and RGs are commonly drafted by the Yard/issuer, who are not native English speakers, as indeed are not the Buyers in most cases. They are frequently sloppily drafted, but the intent is usually discernible. However, now we will all have to slow deals down and incur clients extra cost policing these context-establishing recital paragraphs. Waste of time and a result which damages English law’s hard-won reputation for commercial relevance, even if reversed on appeal.

  4. John, David, James and Martin may all take some comfort in the fact that this decision was overturned on 2 November 2011 by the Supreme Court, who restored the first instance judge’s decision.

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