This alert looks at payment instruments under English law in light of the recent Rubicon Vantage International Pte. Ltd. v. Krisenergy Ltd. [2019] EWHC 2012 (Comm) case. In a commercial context, such payment instruments are commonly referred to indiscriminately as ‘guarantees’ and that term will be used generically in this alert. Although often a critical component to security in a commercial context, guarantees can take many (misleading) forms.
A key issue that commonly arises, and on which this alert focuses, is whether a guarantee imposes what English law terms ‘primary’ or ‘secondary’ payment obligations.
Primary obligation
If the guarantee imposes a primary obligation, typically the guarantor will have no choice but to pay against a compliant demand, as under English law such a guarantee operates to give rise to autonomous obligations. Subject to the wording that the parties have agreed in the guarantee, a compliant demand may be nothing more than a written demand saying “I demand you pay me US$X.”
Such type of payment instrument is better referred to as an ‘(on) demand’ or ‘performance’ bond. It has the advantage that in the event of a dispute about whether there is an underlying liability, the party with the ability to make a demand should (assuming the guarantor is good for the money) have the benefit of fighting any dispute with money in its pocket, rather than first having to fight, obtain an arbitration award or court judgment and then possibly having to chase its money in enforcement proceedings.
Secondary obligation
By contrast, if the guarantee imposes a secondary obligation it might be described as a ‘see to it’ or ‘true’ guarantee. The difference between a see to it (or true) guarantee and an on demand (or performance) bond is that the guarantor’s payment obligation under the former type of payment instrument is not autonomous.
Instead, the guarantor is ‘seeing to it’ that the principal obligor’s obligations are met. Thus, in the event of a dispute about liability, the party with the benefit of the guarantee will be chasing its money as it will first need to establish that the principal obligor has a liability. Potentially this will mean a significant disadvantage in terms of time and money for the party seeking payment from the principal obligor and/or the guarantor.
What type of guarantee have I got?
Under English law, commercial parties have two relatively recent Court of Appeal decisions to determine whether the guarantee creates a primary or secondary obligation. These offer some, but not exhaustive, guidance.
The first case holds that in a transaction outside the banking context involving a guarantee not containing language appropriate to describe an on demand (or performance) bond, there is a strong presumption that such a guarantee creates only a secondary liability and not a primary liability. Thus, something described as a ‘parent company guarantee’ will, absent clear wording, likely be construed as creating a secondary obligation only (i.e., that the document will likely be a see to it guarantee) under English law. This is the so-called Marubeni presumption.
By contrast, if the guarantee (1) is given by a bank, (2) relates to an underlying transaction between parties in different jurisdictions, (3) contains an undertaking to pay “on demand” and (4) does not contain clauses excluding or limiting the defences available to a guarantor, then there is a presumption that such a guarantee creates a primary obligation (i.e., that the document will likely be an “on demand” bond) under English law. This is the so-called Wuhan presumption.
The difficulty with these presumptions is that often the guarantee contains factors which point to different conclusions. Thus, for example, it is common to see “on demand” wording (suggesting a primary obligation), but also wording stating that the guarantee is not affected by variations or amendments to the underlying contract (suggesting a secondary obligation) which strike at point 4 of the Wuhan presumption. Further, the fact that such documents are often headed with, for example, nebulous phrases (from a legal perspective) such as ‘payment guarantee’ and are not always issued by banks, adds further uncertainty.