Article

Factual Summary: Indonesian Government Coal Company granted rights to develop designated coal reserves to Indonesian Grantee which, in turn sold its concession to Japanese First Contactor. First Contractor sold its rights to Second Contractor by means of a novation. Subsequently, Second Contractor sold its rights to Third Contractor, also by novation and Third Party Contractor took over the mining venture in consideration of a promise to pay Second Contractor US$4.5 million in five installments. Managing Director and Guarantor Company executed a Guarantee in favor of Second Contractor.

After making two installment payments, Third Contractor discovered that the novation had not been approved by Government Coal Company and questioned the validity of the novation. Subsequent negotiations led to the sale of Government Coal Company to Managing Director and other partners for US$2.5 million.

Pursuant to the terms of the Second Novation, the dispute between Second Contractor and Third Contractor was submitted to binding arbitration at the Singapore Arbitration Centre. An award was made in favor of Second Contractor for US$3.5 million plus interest in the amount of US$289,972.75 plus costs. Various negotiations regarding settlement of the award failed to result in a signed agreement. Guarantors and Third Contractor then sought a declaration that they were not liable to Second Contractor under the Guarantee. Second Contractor counterclaimed for payment under the Guarantee. Subsequently, Second Contractor applied to enforce the award in the same manner as a judgment and was granted leave. An application to set this leave aside was dismissed and, in a consolidated action, the High Court, Ang, J., entered judgment against Third Contractor for all sums and against Guarantors on their Guarantee. On appeal, the Court of Appeal, Leong, JA, Chan, and Rajah, in an opinion by Chan, C.J., affirmed the trial court, dismissing ICP and Guarantors' appeal, but varied amounts and costs in accordance with the guarantee in the Second Novation.

Legal Analysis

1. Classification of the "Guarantee"; Applicable Limitations Period; Accrual of Limitations Period. Second Contractor/Beneficiary argued that the Guarantee was "payable on demand" or a demand guarantee, with the consequence that a cause of action under it would accrue on making of a demand. The trial judge, having concluded that the action accrued on the default, in effect rejected this argument. The trial judge had focused on clause 2 of the Guarantee. The appellate court concluded that the Guarantee was a demand guarantee and that the trial judge erred in deciding that the action accrued when there was a default on the underlying transaction.

It noted the statements in Clauses 1 and 5 referring to payment on demand. It emphasized that "[t]he reference in [clause] 2 of the Guarantee to that guarantee being enforceable against each of the Guarantors "without any demand being made on or proceedings taken against [Third Contractor/ Principal]"" It also stated the reference in Clause 4 "under which the Guarantors agreed to pay all the outstanding amounts due under the Second Novation Agreement "whether or not any guarantor [knew] of the occurrence of such non-payment and/or [of] the said notice having been given to [Third Contractor/ Principal]", merely meant that the liability of the Guarantors was not dependent on whether they had any knowledge of [Third Contractor/Principal]'s default on the instalments due under the Second Novation Agreement."

2. Acceleration Clause. Guarantors argued that Clause 4 of the Second Novation Agreement had the effect of accelerating its obligations, causing the limitations period to begin to run at that time and making the action time-barred. Although noting that its decision regarding the character of the demand guarantee had rendered this argument meaningless, the appellate court concluded that the clause did not operate as an acceleration clause. It reasoned that such an interpretation would result in greater liability under the Guarantee than under the underlying contract, a violation of what it described as "the principle of co-extensiveness", namely that "that the guarantor's liability is co-extensive with the principal debtor's liability".

3. Extent of Liability of Guarantors. Beneficiary/Second Contractor argued that its judgment enforcing the arbitral award against Third Contractor/Principal should be definitive as to the amount owed by Guarantors. This principle was stated in In Re Kitchin, (1881) 17 Ch. D 668. The appellate court summarized the Kitchin Principle as "a judgment or an award against a principal debtor is not binding on the guarantor and is not evidence against the guarantor in an action by the creditor against the guarantor based on the judgment or the award." The appellate court rejected this argument and ruled that this principle was good law and applicable in Singapore.

4. Indemnity. Second Contractor/Beneficiary argued that the Guarantee had the effect of an indemnity based, in part, on the provision in Clause 2 of the Guarantee that provided that the Guarantors "... irrevocably and unconditionally guarantee[d], not as surety only but as a primary obligor and jointly and severally with [Third Contractor/Principal]..." performance and payment and the Second Novation Agreement provided that Guarantors "shall forthwith as a condition precedent to [the Second Novation] Agreement, execute a deed of guarantee and indemnify [sic] in the form and substance of Annexure D to [the Second Novation] Agreement in favor of [Beneficiary/Second Contractor]. [emphasis added]"

The appellate court noted that "[t]he "principal debtor" clause (which is also referred to as a "primary obligor" clause) is a common feature of modern guarantees. It is also sometimes used together with words such as "indemnity" or "indemnify" to describe the guarantor's liability. The purpose of incorporating a "principal debtor" clause in a guarantee is typically to preserve the guarantor's liability in the event that the principal debtor's obligation is, for some reason, discharged or unenforceable" Noting that its meaning is a matter of construction, the appellate court preferred the "dominant view" that such a clause would not of itself convert a contract of guarantee into a contract of indemnity. The appellate court noted that in determining the meaning of the clause, it looked to "the terms of the Guarantee, read with the Second Novation Agreement, to determine whether the Guarantors had indeed undertaken to indemnify [Beneficiary/Second Contractor]." Its conclusion was "In this connection, the Guarantee was replete with the words "[g]uarantor" and "guarantee" (with the latter used both as a noun and, more importantly, as a verb). The words "primary obligor" were used only once in the Guarantee, and that was in cl 1. The words "indemnity" and "indemnify" did not appear in the Guarantee at all, and the latter term (viz, "indemnify") appeared only once in cl 9 of the Second Novation Agreement. In our view, the overall effect of the Guarantee was that it was not an indemnity, nor did it make the Guarantors liable as principal debtors to [Beneficiary/Second Contractor]. The Dominant View was apt to apply to the Guarantee."

The appellate opinion then considered whether the Guarantee was a ""performance guarantee", as opposed to a "payment guarantee"". The distinction was explained by reference to Lord Reid who in Moschi v. Lep Air Services Ltd [1973] AC 331 stated "there are at least two possible forms of agreement. A [guarantor] might undertake no more than that if the principal debtor fails to pay any instalment he will pay it. That would be a conditional agreement. There would be no prestable obligation unless and until the debtor failed to pay. There would then on the debtor's failure arise an obligation to pay. If for any reason the debtor ceased to have any obligation to pay the instalment on the due date then he could not fail to pay it on that date. The condition attached to the undertaking would never be purified and the subsidiary obligation [of the guarantor] would never arise.

On the other hand, the guarantor's obligation might be of a different kind. He might undertake that the principal debtor will carry out his contract. Then if at any time and for any reason the principal debtor acts [contrary to his contract] or fails to act as required by his contract, he not only breaks his own contract but ... also puts the guarantor in breach of his contract of guarantee. Then the creditor can sue the guarantor, not for the unpaid installment but for damages. [The guarantor's] contract being that the principal debtor would carry out the principal contract, the damages payable by the guarantor must then be the loss suffered by the creditor due to the principal debtor having failed to do what the guarantor undertook that he would do."

Interestingly, the appellate opinion concluded that the Guarantee contained elements of both types of guarantees and concluded that the distinction was immaterial in any event because only the payment clause had been breached.

Comment

1. What if the Guarantee is a Demand Guarantee? The appellate opinion concludes that the trial court improperly gauged the accrual of the period of limitations by failing to give effect to the consequence of it being a demand guarantee, namely that it would begin on making a demand and not on the breach of the underlying transaction. Although we do not have the full text of the Guarantee, that conclusion is not so obvious. The excerpts, for example, do not indicate that the Guarantee is for a fixed amount and there is no reference to an expiry date. They do contain numerous references to the underlying transaction, on the other hand. However, assuming that the word "demand" is given per se effect, one must ask what are the consequences of this conclusion.

In LC jurisprudence, the question would be whether the undertaking was independent and not whether it contained a certain phrase. If it was independent, then certain consequences would follow. One would relate to when the statute of limitations would accrue.

Up to this point, there is no difference with the appellate court's analysis. However, the appellate court discussed several peripheral issues in a manner that basically ignored the independent character of the undertaking. In considering whether there was an acceleration clause, its focus was on the terms of the underlying contract and its correlation to the Guarantee. Such a notion is alien to independent undertakings. While underlying transactions can have acceleration clauses, the question for an independent guarantee is one of anticipatory repudiation. Where the refusal makes it apparent that the Guarantor does not consider itself obligated on any installment, the refusal amounts to an anticipatory repudiation of all installments regardless of whether the undertaking so stated. There need be nothing equivalent to an acceleration clause.

The appellate opinion also took up the issue of what amount is owed. In an independent undertaking, that amount is to be determined by the terms of the independent undertaking and nothing else. It is not clear from the appellate opinion whether or not that principle applies and the discussion makes it clear that guarantee jurisprudence is muddled on that point.

2. The Danger of Guarantee Jurisprudence for Independent Undertakings. This opinion is a classic illustration of the danger of using guarantees. While they may work well in most situations (i.e. where there is no drawing), the problem is what happens when there is one. Do they hold up? The answer is, on the whole, they are problematic. The reason is that they are easily confused with dependent guarantees. Even when a court decides that they are "demand" guarantees, it does not necessarily follow that it will treat them consistently as independent. It is opinions such as this one that are causing sensible and practical business persons to shift to standbys. A guarantee is a lawyer's device. A standby is a banker and business person's device..

Excerpts from the Text of the PT Jaya Guarantee:

1. Each Guarantor hereby irrevocably and unconditionally guarantees, not as surety only but as a primary obligor and jointly and severally with ICP, until all the money as specified in clause 3.1 and/or in ... clause 7.1 [of] the [Second Novation] Agreement [has been] fully paid,

a) the due, prompt and faithful performance by ICP of all its obligations under the [Second Novation] Agreement and

b) the due and punctual payment by ICP of the money payable by ICP under the [Second Novation] Agreement in the manner and at the time fixed under the [Second Novation] Agreement.

In addition to the above, ... each Guarantor guarantee[s] to pay in [a] lump sum payment to [Kristle] in the event that ICP has gone bankruptcy [sic], or has been dissolved or merged, or has [its property] ... attached by any person, or [a] substantial part of its business has been assigned, or [a] petition for reorganization, composition or else for special liquidation of ICP is filed.

Each Guarantor shall, upon demand by [Kristle], cause forthwith to pay the moneys, and such payment shall be made in accordance with clause 3.1 ... and clause 7.1 ... of the [Second Novation] Agreement.

2. This Guarantee shall be a continuing guarantee and shall remain in full force and effect so long as any m[o]neys remain owing under the [Second Novation] Agreement, and may be enforced against each Guarantor without any demand being made on or proceedings taken against ICP.

3. ...

4. Each Guarantor hereby agrees that if any event of non-payment under and pursuant to clause 3.1 ... and clause 7.1 ... of the [Second Novation] Agreement occurs, the ... Guarantors shall (whether or not any guarantor knows of the occurrence of such non-payment and/or [of] the said notice having been given to ICP) pay all the money balance payable under the [Second Novation] Agreement.

5. In addition to but not [limited] to the [Guarantors'] guarantee of payment of fees and all other sums payable under the [Second Novation] Agreement, each Guarantor hereby undertakes and agree[s] to pay, on demand by [Kristle], all costs, charges and expenses (including legal fees on a full indemnity basis) incurred by [Kristle] in connection with the enforcement of this Guarantee.

Any provision of this Guarantee prohibited by or unlawful or unenforceable under any applicable law actually applied by any court of competent jurisdiction shall to the extent required by such law, be severed from this Guarantee and rendered [ineffective] so far as is possible without modifying the remaining provisions of this Guarantee. Where however the provisions of any applicable law may be waived, they are hereby waived by the Guarantor[s] and [Kristle] to the full extent permitted by such law to the end that this Guarantee shall be a valid and binding continuing guarantee enforceable in accordance with its terms.

Excerpts from the text of the Guarantee in Habibullah Mohammad Yousuff v. Indian Bank [1999] 3 SLR 650 quoted in the opinion:

17 Though as between us [ie, Habibullah] and the customer [ie, the principal debtor in Habibullah] we are sureties only for the customer, yet as between us and you [ie, Indian Bank] we and each of us shall be deemed to be principal debtors for all the moneys the payment of which is hereby guaranteed and accordingly shall not be discharged nor shall our liability be affected by any fact or circumstance or any act[,] thing[,] omission or means whatsoever, whereby our liability would not have been discharged if we had been the principal debtors.

18 For the consideration aforesaid and as a separate and independent situation:

(i) we hereby agree that all sums of money which may not be recoverable from us on the footing of a guarantee whether by reason of any legal limitation[,] disability or incapacity on or of the customer or any other fact or circumstance, whether known to you or not shall nevertheless be recoverable from us or each of us on demand as though we and each of us were the sole and principal debtors;

(ii) we hereby irrevocably and unconditionally undertake to indemnify you in full and keep you fully indemnified against all loss[,] damage[,] liabilities[,] costs and expenses whatsoever which you may sustain or incur as a result of or arising [from] your loan advances[,] credit or other banking facilities granted to the customer.

[JEB/gdb]

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