The recent decision of the Court of Appeal in Shanghai Shipyard Co Ltd v Reignwood International Investment (Group) Company Ltd  The EWCA Civ 1147 has clearly demonstrated the importance for parties to a shipbuilding contract to have a clear understanding of the legal nature of guarantees in English law. The key question is often whether the guarantor is bound to pay a claim, whether the validity of this claim has been established beforehand by agreement between the parties to the shipbuilding contract or, in the absence of agreement, by the through litigation or arbitration.
If the document is written as a sight guarantee, the guarantor is obligated to pay regardless of any dispute under the shipbuilding contract. Demand guarantees are usually issued by a bank, for example a repayment guarantee whereby a bank guarantees the shipyard’s obligation to repay down payments. The bank has no interest in the underlying litigation and will usually hold a guarantee from the shipyard to cover its liability under the guarantee. On the other hand, if a guarantee has to be issued by a parent company, for example to guarantee the buyer’s obligation to pay down payments, it is usually a “see” guarantee: the parent company has an interest in the outcome of the underlying dispute and does not wish to pay a disputed claim until it has been proven in litigation or arbitration proceedings.
In order to protect a shipyard from the consequences of the obligation for its guarantor to reimburse a disputed debt, it is customary for the reimbursement guarantee to provide that the guarantor’s obligation to pay may be deferred, in the event of opening of a debt. ‘arbitration proceedings, until the issuance of an arbitration award. At first glance (and in the opinion of the trial judge in this case), this may appear to transform a sight guarantee into a see-to-it guarantee, by submitting the document at the end of a sentence arbitration, and therefore dependent on the underlying dispute. However, the Court of Appeal confirmed that this is incorrect, and therefore a dangerous assumption for a buyer to make.
The consequence is that if the parties to a shipbuilding contract agree on the provision of reciprocal guarantees, the guarantee of the parent company taking over the wording of the reimbursement guarantee, the parent company is then exposed to the same potential liability. that the guarantor of reimbursement, that is to say, may be obliged to pay a claim, even if it is invalid. One can think that the consequences are not serious, because the parent company would always have the protection of being able to defer the payment until following the outcome of an arbitration. However, in order to obtain the right to defer the payment obligation under a demand guarantee, the wording of the guarantee which provides for this protection must be strictly observed. If this is not the case, as happened in this case, the protection is lost and the request must be satisfied immediately, regardless of its validity.
Shanghai was the builder of a drilling vessel for Opus (under a contract based on the CMAC standard construction contract (Shanghai form)). Reignwood was the guarantor of Opus’ bonds. Opus refused to take delivery of the completed vessel, claiming it had a number of significant flaws and was undeliverable. Shanghai rejected claims that the vessel was not in a deliverable condition and claimed the final installment from Opus on January 11, 2017. Opus did not pay, and made a warranty claim to Reignwood on May 23, 2017 .
Shanghai initiated warranty proceedings against Reignwood in September 2018. Reignwood initiated arbitration, on behalf of Opus, against Shanghai on June 3, 2019 under the shipbuilding contract.
At first instance, the High Court judge held that the guarantee was a guarantee “to watch” so that liability under the guarantee only arose if the buyer was required to pay the first installment. Reignwood could refuse to pay under the guarantee until the dispute over whether the last installment was payable was resolved. It did not matter that the arbitration did not begin until after the warranty claim.
The Court of Appeal reversed the judge’s decision, concluding that it was a sight guarantee and that Reignwood was therefore obligated to pay on the demand. She could not invoke the contractual clause to delay payment because the arbitration had not been started before the request was made.
The Court said that there should not be any preconceptions about the nature of the instrument solely from the identity of the guarantor, i.e. simply because Reignwood was not a bank , one could not say that the guarantee was more likely to be a ‘guarantee. The wording of the contract is the key factor. The business context of the guarantee was neutral as to the nature of the guarantee, but there was some language that strongly indicated that it was a guarantee on demand.
The first of these was the use of “ABSOLUTELY and UNCONDITIONALLY”, which indicated that the obligations of the guarantor were not conditioned on the responsibility of the buyer. In addition, clause 1, which sets out the principal guarantee obligation, stipulated that Reignwood had contracted “as principal debtor and not just as a deposit“.
The guarantor’s obligation to pay was triggered “immediately” upon “receipt by us [the guarantor] of your [the yard’s] first written demand. “Payment on demand is a classic feature of a demand guarantee. Furthermore, it would not be appropriate for a surety guarantee to require immediate payment, as the guarantor would need time to assess its there was an underlying obligation to pay Another clause expressly provided that the obligations of the guarantor were not to be affected by any dispute under the Construction Contract.
Clause 4 of the guarantee caused some confusion as to what type of guarantee it was. It allowed Reignwood to defer payment in the event of a dispute between the purchaser and the builder, until an arbitration award was rendered. The Court of Appeal held that, contrary to the judge’s opinion, this supported the thesis that it was a guarantee on demand. The deferral of payment did not convert the guarantor’s obligation from primary to secondary. With the secondary obligation in a surety bond, the surety would not be bound by any arbitration award and could challenge a finding of the Tribunal that the buyer was liable. Article 4 did not allow it; the surety remained obligated to pay on issuance of a document but changed that from the written request to the arbitration award.
The final question was whether Clause 4 required that the dispute be referred to arbitration before the obligation to pay on demand was suspended. The Court of Appeal ruled that it does. To dispose otherwise would be to remove Shanghai’s accumulated right to valid demand payment, and clearer language would be needed to remove such accumulated right.