- Bank Guarantees: "Primary Obligor" Wording Does Not Create a Demand Bond
- July 2, 2012 | Authors: Rod J. Cowper; Mark Deem
- Law Firm: Edwards Wildman Palmer LLP - London Office
Guarantees of performance are often required in commercial transactions. A crucial distinction must be made between guarantees which enable a claim to be rejected on the basis of defences to the underlying liability (a "true guarantee") and those which do not. In the latter case (a "demand bond") the guarantor is liable, regardless of whether there is a defence to the underlying liability.
English Courts have shown a strong preference to interpret performance guarantees given by banks as being demand bonds. In Wuhan Guoyu Logistics Group Co Ltd & another v Emporiki Bank of Greece SA  EWHC 1715 (Comm) a bank "irrevocably, absolutely and unconditionally... as the primary obligor and not merely as surety" promised to pay immediately "upon receipt by us of your first written demand". In earlier cases such wording has been viewed as a significant indicator of a demand bond and is often said to have been included for that purpose.
Notwithstanding that wording, however, the Commercial Court held that the bank had given a true guarantee and not a demand bond because the amount payable was defined by the underlying contract.
There is a strong presumption that a guarantee of performance which is not given by a bank is not a demand bond, although that presumption is rebuttable if the terms of the instrument are sufficiently clear.
By contrast, the Courts have strongly favoured interpreting performance guarantees given by banks as demand bonds. Indeed, a passage in a leading textbook repeatedly referred to with approval (albeit often qualified) in judgments concluded that a bank guarantee given in connection with an international transaction "will almost always be construed as demand guarantee" if it contains an undertaking to pay on demand and does not contain clauses excluding or limiting the defences available to guarantor. In fact, the presence of such a provision has not prevented courts concluding that an instrument was a demand bond: Gold Coast Limited v Caja De Ahorros Del Mediterraneo  EWCA Civ 1806, a Court of Appeal decision in relation to a bank guarantee; and Trafalgar House Construction (Regions) Ltd v General Surety & Guarantee Co Ltd  AC 199, a House of Lords decision in relation to a performance guarantee given by a professional surety.
B made a shipbuilding contract with W. The price was to be payable in instalments and W required a bank performance guarantee to be given in relation to the second instalment, which was payable after completion of cutting of the first 300 MT of steel plate. That instalment was not paid and W claimed under the performance guarantee. The bank resisted that claim on the basis that the instalment had not in fact become due in accordance with the shipbuilding contract since, it was alleged, the steel had not in fact been cut.
The guarantee provided
"(1)... We hereby irrevocably absolutely and unconditionally guarantee, as the primary obligor and not merely as the surety, the due and punctual payment by the buyer of the 2nd instalment of the Contract Price... as specified in (2) below.
(2) The instalment guaranteed hereunder pursuant to the terms of the Shipbuilding Contract, comprises the 2nd instalment... payable by the buyer within five New York banking days after completion of cutting of the first 300 MT of steel plate...
(4) In the event that the buyer fails to punctually pay the second instalment guaranteed hereunder... we shall immediately pay to you... the unpaid 2nd Instalment...
(7) Our obligations under this guarantee shall not be affected or prejudiced by any dispute between you as the Seller and the Buyer under the Shipbuilding Contract or by the Seller's delaying constructional delivery of the vessel due to whatever causes..." [The remainder of clause 7 is not quoted in the judgment but the judge expressed his view that they "appear to me to be intended to ensure that the Seller is not at risk of having the guarantee rendered inoperative because one or more of the classic reasons (variation or extension of time) why at common law a guarantor may be discharged"].
Christopher Clarke J held that this was not a demand bond. He concluded that the key provision was the guarantee of due and punctual payment of the Second Instalment: "it is not a guarantee of what is not due" and, accordingly, if there was a defence to the claim for the Second Instalment, that was also a defence to a claim on the performance guarantee. The performance guarantee was not a demand bond.
The "primary obligor" wording did not alter that conclusion. In WS Tankship ll BV v The Kwangju Bank Ltd & Others  EWHC 3013 (Comm) a different judge of the Commercial Court (Blair J) had indicated that the distinguishing feature of a demand bond was that it imposed a primary not a secondary liability. However, Christopher Clarke J relied on an earlier decision of Blair J (Carey Added Value SL v Grupo Urvasco SA  EWHC 1905 (Comm)), in which he had decided (in a case outside the banking context) that "primary obligor" wording was not a decisive indication that an instrument was a demand bond.
Here, the bank had assumed a primary obligation, but it was an obligation to pay the amount that was due under the shipbuilding contract. It was not necessary for a demand or any proceedings to be taken to enforce the shipbuilding contract because the bank's obligation was a primary obligation. However, it was an obligation to pay the amount due under the shipbuilding contract.
Equally, the fact that the performance guarantee was payable on demand did not make the guarantee a demand bond because what the bank had to pay on demand was "the second instalment", which the judge decided referred back to the underlying obligation. This was not, the judge concluded, a case in which the description of the underlying obligation simply identified the underlying contractual events which triggered the right to call on the performance guarantee. (This was a reference to a number of previous cases (including decisions of more senior courts) which had reached that conclusion and as a result categorised the guarantee as a demand bond.)
The Court's focus on the core guarantee obligation is logical and persuasive. It remains to be seen whether subsequent judges (including the Court of Appeal) will conclude that it represents too radical a departure from earlier decisions.
In the meantime, those drafting bank guarantees intended to operate as demand bonds will need to address this expressly in light of the fact that wording of the type used in this guarantee did not have that effect. It is to be noted that Christopher Clarke J identified the decisive factor in the WS Tankship case as being that payment under that performance guarantee was made against a demand, supported by signed statement, that the sum was due.