Article

Prior History: [2009] EWHC 2624 (Comm); [2010] EWCA Civ 582.

Note: Buyers/Beneficiaries agreed to purchase six vessels from Jinse Shipbuilding Co. Ltd. (Builders/Applicants). Each vessel cost US$33,300,000 and payment was to be made in five pre-delivery installments of US$6,660,000.

After the first installments were paid, Builders/Applicants entered a debt resolution procedure under Korean law. Claiming that they were entitled to a refund of the advance payments in the case of Builders/Applicants' insolvency under the "BUILDER'S DEFAULT" article of the contract, Buyers/Beneficiaries demanded refund of the paid installments from Builders/Applicants, when Buyers/ Beneficiaries drew on Kookmin Bank's (Guarantor) Bonds. Builders/Applicants disputed that the contract terms entitled Buyers/Beneficiaries to a refund. Guarantor denied demand, claiming that while the underlying contract entitled Buyers/Beneficiaries to refund in case of Builders/Applicants' insolvency, Guarantor's bond did not.

Buyers/Beneficiaries sued Guarantor for payment of the Bonds. The Commercial Court of the Queen's Bench Division, Simon J, awarded summary judgment to Buyers/Beneficiaries but the Court of Appeal, Thorpe and Patten LLJ in the majority, reversed, granting summary judgment to Guarantor. On appeal, the Supreme Court, Clarke, Kerr, Mance, Phillips, and Wilson LLJ, in an opinion by Clarke, LJ, reversed, reinstating judgment for Buyers/Beneficiaries.

The opinion focused on the terms of guarantees which promised to pay "all such sums due to you under the Contract." Guarantor contended that Buyers/Beneficiaries were entitled to refund of payments made prior to their "rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract or upon a Total Loss of the Vessel" but not in the case of Builders/Applicants' insolvency. Buyers/ Beneficiaries argued that Guarantor undertook to refund "all such sums due to you under the Contract", which entitled them to payment on the bond under the "BUILDER'S DEFAULT" article of the underlying contract for insolvency.

In seeking to interpret this provision, the Supreme Court looked to the terms of the underlying contract describing it as "plainly an important aid to the meaning of the Bonds". The Supreme Court stated that "the ultimate aim of interpreting a provision in a contract, especially a commercial contract, is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant". The opinion stated that the issue was the role to be played by "considerations of business common sense". The Supreme Court stated:

The language used by the parties will often have more than one potential meaning. I would accept the submission made on behalf of the appellants that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.

The Supreme Court concluded that reasonable parties would have expected that the bonds would be security for the Buyers/Beneficiaries' creditors in case of the Builders/Applicants' insolvency, whereas the Guarantor's interpretation would produce a "surprising and un-commercial" outcome under which Buyers/Beneficiaries' creditors are not protected.

Comment:

Rulings such as this one explain why lawyers insert clauses in LCs merging the terms of the undertaking with all related agreements, prior or contemporaneous. The interpretation of the terms of a letter of credit should be in light of how those terms would be understood under standard international letter of credit practices and not the underlying contract or transaction. When there is ambiguity, it should be construed against the issuer or guarantor.

Texts:

The text of the Bonds from the Opinion follows:

"[1] We refer to the ... Contract entered into between ... the Builder and yourselves for the construction and delivery of ... the 'Vessel' to be delivered before [31 July 2009]. Other terms and expressions used in this Bond shall have the same meaning as in the Contract, a copy of which has been provided to us.

[2] Pursuant to the terms of the Contract, you are entitled, upon your rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract or upon a Total Loss of the Vessel, to repayment of the pre-delivery instalments of the Contract Price paid by you prior to such termination or a Total Loss of the Vessel (as the case may be) and the value of the Buyer's Supplies delivered to the Shipyard (if any) together with interest thereon at the rate of ... (7%) per annum (or ... (10%) per annum in the case of a Total Loss of the Vessel) from the respective dates of payment by you of such instalments to the date of remittance by telegraphic transfer of such refund.

[3] In consideration of your agreement to make the pre-delivery instalments under the Contract and for other good and valuable consideration (the receipt and adequacy of which is hereby acknowledged), we hereby, as primary obligor, irrevocably and unconditionally undertake to pay to you, your successors and assigns, on your first written demand, all such sums due to you under the Contract (or such sums which would have been due to you but for any irregularity, illegality, invalidity or unenforceability in whole or in part of the Contract) PROVIDED THAT the total amount recoverable by you under this Bond shall not exceed US $[26,640,000] ... plus interest thereon at the rate of ... (7%) per annum (or ... (10%) per annum in the case of a Total Loss of the Vessel) from the respective dates of payment by you of such instalments to the date of remittance by telegraphic transfer of such refund.

[4] Payment by us under this Bond shall be made without any deduction or withholding, and promptly on receipt by us of a written demand (substantially in the form attached) signed by two of your directors stating that the Builder has failed to fulfil the terms and conditions of the Contract and as a result of such failure, the amount claimed is due to you and specifying in what respects the Builder has so failed and the amount claimed. Such claim and statement shall be accepted by us as evidence for the purposes of this Bond alone that this amount claimed is due to you under this Bond.

[5] Our liability under this Bond shall not be affected by ... (v) any insolvency, re-organisat ion or dissolution of the Builder, or (vi) any other matter or thing which may operate to discharge or reduce our liability hereunder.

..."

8 The Bonds further provided that they were assignable, that they were governed by English law and that all disputes arising out of them were to be determined by the Commercial Court.

The text of the Contract from the Opinion follows:

11 Article X of the Contracts provided, so far as material as follows:

"Article X: Payment

5. Refund By the Builder

...

The payments made by the Buyer to the Builder prior to delivery of the Vessel shall constitute advances to the Builder. If the Vessel is rejected by the Buyer in accordance with the terms of this Contract, or if the Buyer terminates, cancels or rescinds this Contract pursuant to any of the provisions of this Contract specifically permitting the Buyer to do so, the Builder shall forthwith refund to the Buyer in US dollars, the full amount of total sums paid by the Buyer to the Builder in advance of delivery together with interest thereon as herein provided within thirty (30) banking days of acceptance of rejection.

...The interest rate of the refund ... shall be seven per cent (7%) per annum ...

If the Builder is required to refund to the Buyer the installments paid by the Buyer to the Builder as provided in this Paragraph, the Builder shall return to the Buyer all of the Buyer's Supplies as stipulated in Article XIII which were not incorporated into the Vessel and pay to the Buyer an amount equal to the cost to the Buyer of those Buyer's Supplies incorporated into the Vessel.

Total Loss

If there is a total loss or a constructive total loss of t he Vessel prior to delivery thereof, the Builder shall proceed according to the mutual agreement of the parties hereto either:

(a) to build another vessel in place of the Vessel so lost ... provided that the parties hereto shall have agreed in writing to a reasonable cost and time for the construction ... or

(b) to refund to the Buyer the full amount of the total sums paid by the Buyer to the Builder under the provisions of Paragraph 2 of this Article and the value of Buyer's Supplies delivered to the Shipyard, if any, together with interest thereon at the rate of ten percent (10%) per annum ...

If the parties hereto fail to reach such agreement within two (2) months after the Vessel is determined to be a total loss or constructive total loss, the provisions of (b) hereinabove shall be applied."

Refund Guarantee

The Builder shall as a condition precedent to payment by the Buyer of the first installment deliver to the Buyer an assignable letter of guarantee issued by a first class Korean Bank ... to Buyer's Financiers for the refund of the first installment, and at the same time, together with the letter of guarantee relating to the first installment, Builder shall also deliver to the Buyer an assignable letter of guarantee issued by a first class Korean Bank ... for the refund of the respective installments following the way of the payment stipulated in this Article. The refund guarantees by the Builder to the Buyer shall be indicated pre-delivery installments plus interest as aforesaid to the Buyer under or pursuant to paragraph 5 above in the form annexed hereto as Exhibit 'A' which is yet to be agreed...

In the event that the Refund Guarantees, for all installments, have not been provided to the Buyer in a form acceptable to the Buyer's financiers and have not been issued by an entity acceptable to Buyer's financiers, by the 31st of August 2007 then the Buyer may cancel this Contract without penalty on either side."

It is common ground that no form of guarantee was in fact annexed to the Contracts.

12 Article XII provided, so far as relevant:

Article XII: Builder's Default

...

3. If the Builder shall apply for or consent to the appointment of a receiver, trustee or liquidator, shall be adjudicated insolvent, shall apply to the courts for protection from its creditors, file a voluntary petition in bankruptcy or take advantage of any insolvency law, or any action shall be taken by the Builder having an effect similar to any of the foregoing or the equivalent thereof in any jurisdiction, the Buyer may by notice in writing to the Builder require the Builder to refund immediately to the Buyer the full amount of all sums paid by the Buyer to the Builder on account of the Vessel and interest thereon at seven percent (7%) per annum on the amount to be refunded to the Buyer, computed from the respective date such sums were paid by the Buyer to the date of remittance of the refundable amount to the Buyer and immediately upon receipt of such notice the Builder shall refund such amount to the Buyer. Following such refund the Builder may, but shall not be obliged to, by notice in writing to the Buyer given within ten (10) business days terminate this contract. If the Builder does not so terminate the Contract the Buyer's obligation to pay further installments prior to delivery of the Vessel under Article X 2(a), (b), (c) and (d) shall be suspended and the full Contract price shall be paid to the Builder upon delivery of the Vessel in the manner contemplated by Article X paragraph 2(e)."

13. The Contracts contained a number of provisions which entitled the Buyer to cancel the contract, namely Articles III.1 and XII.1 (delay) and Article III.2(b), 3(c), 4(d) and 5(d) (insufficient speed, excessive fuel consumption, deficient deadweight or cargo capacity). Some of those provisions specifically entitled the Buyer to a refund of all advance payments following cancellation. Others did not, although in such cases Article X.5 would apply and have the same effect. The Contracts also contained in Article XIII further detailed provisions relating to Buyer's Supplies.

[JEB/dgs]

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