This blog post explores the different ways of drafting guarantees and how this interacts with the obligations of parties within the shipping industry.

What is a guarantee?

A contract of guarantee is an undertaking given by one party (the guarantor) to another party (the beneficiary) to pay the principal obligor’s debts or to perform their obligations set out in the underlying contract. A guarantor has a secondary obligation to the beneficiary and therefore the guarantor will typically only be obliged to act where there has been a breach of the underlying contract. Whilst the commercial reasons behind a guarantee are often straightforward, the use of the word “guarantee”  including the fact that the term “guarantee” is also frequently used to refer to other arrangements, such as contracts of indemnity (the difference between these terms is explored further below), and the differing ways in which guarantees are drafted, often leaves scope for ambiguity. Such ambiguity can be problematic for a beneficiary trying to enforce the provisions of their agreement.

When might a guarantee be required?

Guarantees are prevalent within a variety of arrangements within the shipping industry entered into between parties including shipowners, shipbuilders, charterers and financiers. Guarantees can be drafted widely to encompass a broad range of obligations or focus on a particular obligation, and can be limited or extensive in their duration. A party may insist on the provision of a guarantee for a series of commercial reasons including; (i) to encourage the primary obligor to meet their contractual obligations; (ii) to give the beneficiary additional comfort that it will be able to fully enforce its claims should a contractual breach occur; and (iii) to encourage the supervision of the primary obligor by a parent company.

There are several types of guarantee that may be entered into between parties. The below examples are common within the shipping industry:

(A) Refund guarantee

A refund guarantee is a common feature of a shipbuilding contract. A buyer may start paying the contract price in installments before taking delivery of the vessel. They may therefore require the builder to provide a refund guarantee (often from a bank or insurance company), so that they can recover these payments if the vessel is not delivered as per the terms of the contract.

(B) Corporate guarantee

Parties to a charterparty or a shipbuilding contract may enter into a corporate guarantee, whereby the obligations of the charterer or the shipbuilder are guaranteed by their parent company. This can provide additional comfort to an owner or buyer that they will be able to fully recover any funds due to them should they have to enforce a claim.

(C) Personal guarantee

Alternatively, a personal guarantee may be provided (for example, by high net worth individuals) over the obligations of a shipbuilder or a charterer.

Guarantees: common questions  

Have I entered into a guarantee or an indemnity?

Both a guarantee and an indemnity involve a contractual undertaking given by a party to pay the beneficiary based on the failure of the principal to perform their contractual obligations. These are both a form of a contract of suretyship. In the case of a guarantee, the obligor has a secondary obligation to the beneficiary, which is based on an underlying contract between the principal obligor and the beneficiary. The obligor has an obligation to “see to it” that the obligations of the principal obligor in the underlying contract are met. Where there is an indemnity, the obligor has an autonomous primary obligation to the beneficiary. This means that the obligor has stand-alone obligations that are not dependent on an underlying contract between the beneficiary and another party.

The rights and obligations of the parties will differ depending on which arrangement the parties have entered into. Deciphering whether parties have entered into a contract of guarantee or a contract of indemnity will be a matter of construction. The court will look beyond the title of the document to determine the intention of the parties.

Will a variation of the underlying contract discharge my guarantee?

A guarantee does not exist as an autonomous agreement but hinges on the underlying contract between the parties. This is referred to as the principle of co-extensiveness. Therefore, as the guarantor has a secondary obligation to the beneficiary, a variation of the underlying contract may discharge the guarantee. In the case of Triodos Bank NV v Dobbs [2005], it was held that where there is a secondary obligation, any variation must fall “within the general purview of the original guarantee”. If the variation does not fall within this “general purview”, it could discharge the guarantor’s obligations. The case of CIMC Raffles Offshore (Singapore) Ltd v Schahin Holding SA [2013] highlighted that this discharge could still take place even where the guarantee included guarantee preservation language. A beneficiary should therefore seek to ensure that guarantee preservation language is as specific as possible, whilst also being mindful that – depending on the amendment made to the underlying contract – this may not always save them from a discharge of the guarantor’s liability.

If the underlying contract is void or otherwise comes to an end, this may also discharge the guarantor’s obligations. Additionally, certain acts or omissions by the parties to the underlying contract which would have a prejudicial effect on the guarantor may render the guarantee void. Circumstances could include a failure of the principal obligor under the underlying contract to register their security properly.

Unlike for a guarantee, an indemnity acts independently from any underlying contract, and would therefore be unaffected by any variation or end to the underlying contract. Parties may opt to enter into an agreement containing a provision providing for both a guarantee and an indemnity in order to safeguard against the repercussions of the discharge of the guarantee.

Have I entered into a performance bond or a guarantee?

A performance bond is an undertaking often given by a bank or insurance company and provides that the issuer will pay the beneficiary on their demand if a certain event occurs. This undertaking acts independently from the underlying contract. For example, an owner may require a charterer to provide a performance bond, which may be triggered if the charterers fail to pay their hire payments. These instruments are typically on a first demand basis.

A performance bond may be convenient for a beneficiary as on their first demand they can receive a payment from the issuer. They may benefit from demanding payment from the issuer without the time and expense of proving that there has been a breach. Afterwards, however, an issuer may decide to challenge this payment (for example on the grounds of wrongful call).

Where there is ambiguity as to whether a provision relates to a performance bond or a guarantee, the court will look to where the trigger in the provision lies. Is it the demand from the beneficiary that triggers the payment? Or, is it the breach of the underlying contract that triggers the payment? The answer to this question could have significant implications for both the guarantor and the beneficiary.

In Marubeni Hong Kong and South China Ltd v Government of Mongolia [2005], insufficiently clear language meant that a letter was treated as providing a secondary obligation. This case created a strong presumption that outside the banking context, where there is insufficient wording to indicate that a performance bond has been entered into, the agreement is likely only to provide a secondary obligation.

The court in Wuhan Guoyu Logistics v Emporiki Bank [2012] explored the distinction between a guarantee and a performance bond in the banking context. In this case, the document in question was construed as placing a primary obligation on the guarantor. The judgement explained that where (i) a bank provides for an “on demand” payment, (ii) the document does not limit the defences available to the bank, and (iii) the document relates to an underlying contract involving parties in different jurisdictions, then there is a presumption that the document is likely to be a performance bond.

More recently, Rubicon Vantage International Pte. Ltd v Krisenergy Ltd. [2019] explored this issue in a shipping context. This case involved a charterer who failed to pay the shipowner’s invoices. The shipowner had entered into an agreement which included a hybrid of both primary and secondary obligations. The court considered whether the liability of the charterer must be established in order to enforce the primary obligation under the guarantee. The court determined that liability did not need to be established in relation to the underlying contract. This case highlighted that the Marubeni principle of interpreting primary obligations restrictively outside the banking context only applies to determining whether there is a primary obligation, not its scope.

These cases demonstrate that the line between primary and secondary obligations is not clear-cut. Before entering into an instrument of this nature, parties should be alive to the wording they have chosen to ensure that it unambiguously reflects their commercial intentions.

 How can I ensure my guarantee is enforceable?

A guarantee may be unenforceable under certain circumstances. Unlike indemnities, guarantees carry certain formality requirements. Most forms of guarantee must comply with s.4 of the Statute of Frauds 1677, which requires that the guarantee is made in writing and signed by the guarantor (or under the authority of the guarantor). English law has adopted a modern approach on what constitutes a “signature” such that a signature block in an email can be sufficient. As with any contract under English law, the parties must have capacity to enter into the guarantee.

Where a party has provided a personal guarantee, it may be necessary to ensure that there has been no undue influence on the guarantor to enter into the guarantee. If the guarantor is a company, an additional consideration is whether the company has sufficient corporate benefit to enter the guarantee. Under s.172 Companies Act 2005, a company’s directors have a duty to act in the best interests of the company. If the directors do not fulfill this duty, the guarantee could potentially be set aside by the court upon the application of the shareholders or a liquidator, risking personal liability for the company’s directors.

Where the guarantor is a non-UK resident, local advice may be required, for example to ensure that any security under the guarantee is enforceable. In order to make enforcement more straightforward in this respect, it may also be advisable for the guarantee and the underlying contract to be based on the same governing law.