Demand Guarantee or Suretyship Guarantee – Have corporate guarantors lost the benefit of the doubt?

Whether a guarantee issued by a guarantor in order to secure contractual obligations of a main debtor constitutes a regular suretyship guarantee, triggering liability for the guarantor (in accordance with the principle of co-extensiveness) only if the main obligation is outstanding and enforceable, or a demand guarantee (or demand bond), requiring the guarantor to pay already upon a formally compliant demand regardless (subject to fraud) of whether the main debtor has become liable towards the beneficiary, continues to occupy the courts. This is most likely because the wording of (parent company) guarantees governed by English law is notoriously ambiguous with regard to the fundamental legal character of such instruments: Due to the anxiety of beneficiaries to fall into the traps of the overbroad protective rules for the benefit of guarantors provided by English law, the former often strive to use terminology that avoids the sole classification of the instrument as a “true” guarantee.

Until recently, case law did however at least offer one helpful and rather straightforward orientation for this contentious issue: In particular, courts have heavily relied on presumptions depending first and foremost on the status of the guarantor: If the latter is a financial institution (in particular a bank or an insurance company), the guarantee would, in accordance with the famous ‘Paget’s presumption’ (from Paget’s Law of Banking), be deemed to be a ‘demand guarantee’ if it related to an underlying transaction between parties in different jurisdictions, contained an undertaking to pay on demand (with or without the words ‘first’ and/or ‘written’) and did not contain clauses excluding or limiting the defences available to a guarantor.

An equally strong presumption applied until now in the opposite direction whenever the guarantee had been issued by an undertaking outside the banking context (eg corporate guarantees submitted by a parent company): In this event, a long line of precedent relied on a ‘strong presumption’ that the instrument was to be received as a regular suretyship guarantee imposing only secondary liability conditional upon liability of the main debtor (see eg Marubeni Hong Kong and South China Ltd v Government of Mongolia [2005] EWCA Civ 395, paras 23, 30; see also Chitty on Contracts, Vol II (33th ed 2019) para 45-009: ‘there is a strong presumption that a guarantee concluded other than by a bank is not a demand or independent performance bond’, with further references to case law). The gist of the case law appeared to be that a rebuttal of this presumption would require clear wording that payment obligations under the guarantee were independent of the existence of the enforceability of the underlying main obligation. Boilerplate terminology according to which the guarantor shall be ‘unconditionally and irrevocably’ liable as a ‘primary obligor and not as a surety’ and must pay immediately after a valid demand has been made was in the past not considered as sufficient to displace the presumption of a regular (true) guarantee (illuminating inter alia Autoridad Del Canal De Panamá v Sacyr, S.A. & Ors [2017] EWHC 2228 (Comm) paras 90 ff.; IIG Capital Llc v Van Der Merwe [2008] EWCA Civ 542 para 32).

In its recent decision in Shanghai Shipyard v Reignwood International Investment [2021] EWCA Civ 1147, however, the Court of Appeal (allowing the appeal from a decision of Knowles J) was having none of this. Though lip service is paid in the judgment of the Court to the importance of the particulars of the individual case (in particular the characteristics of the shipbuilding industry), Popplewell LJ seems to have left no doubt that presumptions about the nature of the instrument in question should generally no longer be derived from the identity of the guarantor and it ought accordingly not make a difference whether a bank or a non-bank had issued a guarantee if the respective wording were the same (paras 31 f). This view seems first and foremost to have been based on the argument that the nature of the business carried out by the guarantor (whether banking, other financial business or commercial trading activity) does not matter for the beneficiary as long as the counterparty risk arising out of the main transaction is tackled by a satisfactory commercial and financial strength and probity of the guarantor (paras 27-29). Though the latter may indeed be the case, the Court of Appeal nevertheless seems to ignore the fact that the status of the guarantor as an external bank or a parent company of the main debtor makes (apart from the much higher experience of banking institutions with all kinds of collateral) a key difference if the diverging commercial interests of these two types of guarantors (and hence the overall commercial background of which all involved parties are or should be aware of) are duly taken into account: An external bank may even prefer to issue a demand guarantee instead of a suretyship guarantee in order to avoid being drawn into legal conflicts of the parties of the main transaction given that the latter may create potential defences of the main debtor against a recourse claim by the bank in case of an (unjustified) draw down. The interests of a parent company on the other hand are largely congruent with those of the main debtor: In particular, the parent company has with a view to a consolidated balance sheet of its corporate group not much to gain by enforcing recourse claims against its subsidiary subsequent to a draw down on the guarantee by the beneficiary.

It is equally astonishing that the Court of Appeal characterised wording in the disputed instrument that expressly linked the payment obligations of the guarantor to ‘the event that the [main debtor] fails to punctually pay the final installment in accordance with the [main] Contract’ as ‘neutral because they are equally capable of doing no more than is necessary in a demand guarantee to identify the matters which the [beneficiary] must state in good faith state in order to make a valid demand (…)’ (para 36, emphasis added). The standard wording in bank guarantees on first demand on the contrary reveals quite clearly that necessary references to the main obligation can be made without giving any impression that a valid demand might be conditional upon an existing and enforceable primary obligation arising under the secured main transaction.

Last month, the UK Supreme Court had to restore another orthodox (and commercially sound) precedent that had beforehand been overturned by the Court of Appeal (see Triple Point Technology v PTT Public Company Ltd [2021] UKSC 29). It is to be hoped that the Supreme Court will get the opportunity to do so again in this case. Until then, corporate guarantors should beware that any ambiguities left in the wording of their parent company guarantees will no longer necessarily work in their favour.

Patrick Ostendorf is a professor of commercial law at the HTW Berlin and of counsel at Orth Kluth Rechtsanwälte, Berlin.