Legal Case Summaries

Article

Note: In 1993, Sea Emerald SA (Buyer), a Panamanian shipping company, entered into a contract for the construction, sale, and purchase of a refrigerated cargo vessel with the "shipyard named after 61 Communars" (Seller), a Ukrainian shipyard. The contract was governed by English law, provided for arbitration of disputes, and allowed for rescission by Buyer if "delivery was delayed for 180 days or more." It further stipulated that "[u]pon rescission [Seller] was...promptly to refund to [Buyer] the full amount of 'all sums paid by [Buyer] or by order of [Seller] on account of the Vessel prior to such rescission, unless [Seller] proceeds to Arbitration.'" The contract also provided for a mandatory refund guarantee, " '[Seller] will furnish [Buyer] within latest 30 days from the date of signing of this Contract a refund Guarantee to be issued by Seller's Bank, the State Commercial Industrial Bank - Nikolaev Branch...[T]he furnishing of this Guarantee is to form an integral part of this Contract. No payment whatsoever under this Contract, or the various imported equipment contracts, shall become due and payable prior to the provision of a proper refund Guarantee.'"

The format of the refund guarantee was provided by Buyer's president, Mr. Laskaridis, who described it as " 'a simplified version of the refund guarantees we had from the Japanese bank' " that had delivered other guarantees to it in connection with other purchases. The president stated "that although he is not a lawyer but an engineer, he had simplified it himself 'so that it could be very short and very understandable and dispensing with what might cloud the issues.' " Two guarantees were at issue. One guarantee was signed by Mr. Skock (Bank Employee), head of the Nikolaev Regional Department of the State Commercial Industrial Bank (Bank) and contained "the name of the Bank and the branch typed at the top [and]...company stamps by the signatures" and read in part, "[i]n consideration of [Buyer's] payment of the instalments under the [Contract], [Bank], at the request of [Seller], hereby irrevocably and unconditionally guarantee the payment to you by the Builder of the total maximum sum of USD - 9,900,000 ... or any amount to be paid to the Builder as the first, second, third and fourth instalments under the Contract and any supplement, amendment, charge [sic] or modification made thereto together with interest thereon at the rate as provided for the Contract and any supplement, amendment, charge or modification made thereto from the date of payment to refundment." The court noted that "Neither the English nor the Russian version of the Guarantee was dated, and neither was on headed paper. No expiry date for the Guarantee is specified. The English version (at least) had typing errors."

In July 2006, the Ukrainian government ceased financing Seller whereupon Buyer declared Seller to be in default and rescinded the contract. Buyer brought arbitration proceedings against Seller and was awarded US$17,258,000. Buyer also demanded that Bank honor its guarantee, but it refused, "stating that [Bank] had reasons to consider the Guarantee to be 'a fraud.' Whatever precisely was meant by that, it is not suggested in these proceedings that [Bank Employee's] signature on the Guarantee is a forgery." Bank sought a declaration in the Ukrainian court system that the guarantee was invalid, but the Supreme Court of the Ukraine eventually ruled that it did not have jurisdiction. Buyer had meanwhile initiated proceedings in the English court to have the guarantee enforced. The Queen's Bench Division, Commercial Court, in a judgment by Smith, J., ruled that the guarantee was invalid.

Buyer argued that Bank Employee had actual authority under a provision of the Bank's Articles of Association as Head of a Department. The Judge, however, did not agree that broad authority was conferred on the Head of a Department in foreign accounts when there was no such authority for domestic accounts. The Judge stated "it was, at the least, not usual for Departments to issue guarantees of any kind at the relevant time. I should have found it difficult to believe that the Provision is to be interpreted as authorising the Head of a Department to enter on behalf of the Bank into a commitment such as the Guarantee: a contingent commitment unlimited in time to pay a large amount of scarce foreign currency, and moreover one governed by a foreign law about which, as I conclude from the evidence of [General Directors of Seller], [Bank Employee] took no advice."

The Judge also rejected Buyer's argument that authority was to be inferred. The Judge gave weight to testimony that it would have been unusual for a Ukrainian bank at the time to confer authority or for branches to do so, testimony that Mrs. Kovtun, an "accountant and the Deputy Head of the Bank's Currency Operations Department in Kiev", was unaware of the guarantees, although she would have been if they were genuine, and that the bank had no copies of the guarantees in its files. The Judge also noted that there were no records of fees or annual charges: "The Bank therefore relies upon the fact that it has no documentation recording or reflecting the guarantees or any potential liability under them in order to support its contention that they were not properly issued and were not issued with its authority."

Buyer urged that "it is unlikely that [Bank Employee] would have taken it upon himself to enter into commitments of this size unless he had authority to do so."

The Judge stated, "I am persuaded by the Buyer, despite the lack of documentation about the refund guarantees and the fact that no contingent liability under them was reflected in returns made by the Department, that it is unlikely that [Bank Employee] entered into them without anyone else in the Bank being involved. However, that is not enough to show that before the guarantees were given proper procedures were followed and the Bank had formally authorised [Bank Employee] to issue them by a decision of the Management Board and by providing a power of attorney. After all, even if proper procedures required that the Department be authorised with similar formality to lend money in excess of its own borrower's limit (and there is no proper basis for assuming that similar formality was required), it does not follow that in its early years, the formal procedures were followed within the Bank.

"In my judgment there simply is not sufficient evidence to conclude that the Bank took the unusual course of conferring on [Bank Employee] authority to enter into the refund guarantees (and in particular the Guarantee) and that it executed a power of attorney for that purpose. I should have come to this conclusion in any event but it is, to my mind, supported by the evidence of Mrs Kovtun, including what she said about the returns made to Head Office of off balance sheet liabilities. I accept her evidence that she knew nothing of the guarantees and that if she had known of them, she would have completed the returns differently. I recognise that, given that [Bank Employee] was not acting secretly, it is in any event rather surprising that Mrs Kovtun did not hear about the guarantees, but it would be the more remarkable if formal procedures had been followed.

"This is not to attribute any improper motive to [Bank Employee]. The commitments were given when the Bank had no relevant written procedures in place and he might well have been unfamiliar with guarantees of this kind. He might understandably have wished to support a customer who was earning important foreign currency. As I understood Mrs Kovtun's evidence, this was a period when the Bank, and other banks in the Ukraine, were learning to develop new services required by their customers in the post-Soviet era. When customers approached the Bank for a new service, the customer was not simply turned away, but the Bank would try to accommodate the customer's request, and might consult Head Office as to how it might do so. None of this, however, assists the Buyer to establish that [Bank Employee] had authority to give the Guarantee."

Buyer further argued that even if Bank Employee did not have actual authority, "the Bank ratified what [Bank Employee] did, because it knew that he was giving this and other refund guarantees...and did not disclaim them." The Judge, noting that ratification "involves a conscious decision to adopt an unauthorized act", rejected Buyer's argument and stated, "It would be necessary to show that the [Bank's] Chairman or Management Board knew of the Guarantee and, as it seems to me, to show either that they knew the terms of the Guarantee or at least to show that they were content to adopt the Guarantee whatever its terms. [Buyer] has not shown that either the Chairman or the Management Board had such knowledge."

The Judge also rejected Buyer's argument that Bank Employee had ostensible or apparent authority to provide the guarantee. Though the Judge acknowledged that such authority would be sufficient, the Judge stated that "[t]he relevant question is more specific: whether the Bank held [Bank Employee] out as having authority to enter into a refund guarantee of the kind and in the amount of the Guarantee." To prove this, "[i]t would be necessary, at the least, for the Buyer to show that it was within the ordinary scope of their authority to provide a refund guarantee to cover potential liability by the supplier to the customer for money paid to him", but Buyer failed to do so.

Finally, the Judge concluded that, even if Bank Employee did have authority to issue refund guarantees, the only refund amount allowable under the contracts was US$1,300,000.

Comment:

The court's decision reads like a brief from the bank. The perspective is simply wrong. While there is a legitimate interest in protecting banks from fraudulent activities by their employees acting alone or in collusion with others, there is a similar interest in protecting those who deal with banks in relying on the apparent authenticity of their banking activities that otherwise appear to be legitimate, particularly when the activity is by a person vested with significant administrative responsibility by the bank itself.

In this case, a head of a regional branch or a department signed and issued a document that appeared to guarantee a transaction. In determining its authenticity, the court assumed that the employee did not act in a fraudulent manner and without "improper motive." It noted the confusion in the transition from the Soviet system during the beginning of the post Soviet era. As stated by the Judge, "When customers approached the Bank for a new service, the customer was not simply turned away, but the Bank would try to accommodate the customer's request, and might consult Head Office as to how it might do so. None of this, however, assists the Buyer to establish that [Bank Employee] had authority to give the Guarantee."

Why this information does not help the buyer is a mystery. When a bank employee vested with significant administrative responsibility engages in a banking activity, the recipient of that activity should not be required to study the administrative structure of the bank or its by-laws in order to determine whether or not it can rely on its apparent undertaking. The risk of apparent heads of departments acting outside of the apparent scope of their administrative responsibilities or not having received the necessary approvals should rest with the bank and not the victim. The burden of proof that the authority conferred was not apparent or should have been understood as not apparent by a reasonable business person seeking the same services should rest with the bank. Relevant to this inquiry would be the actual knowledge of the victim.

The decision, unqualified as it is, however, is dangerous. As a result of this decision, all recipients of bank guarantees subject to English Law would be well advised to obtain a legal opinion from counsel, presumably for the bank, that they are validly issued. This decision falls in a long line of UK cases about independent undertakings that reach silly results based on impeccable reasoning and a lengthy list of authorities.

[JEB/plc]

Text of Refund Guarantee:

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