Article

Note: Spliethoff’s Bevrachtingskantoor BV (Buyer), a ship operating company in the Netherlands, contracted to purchase two ships from Rongcheng Xixiakou Shipyard Co Ltd. (Applicant) and China National Electronics Import and Export Shandong Company (Electronics) (Collectively “Sellers”). The contract between Buyer and Sellers provided that Buyer was entitled to cancel the contract if the ship was not delivered within 210 days.

Under each contract, Buyer was required to pay installments toward the purchase price of each ship, which were to be refunded with interest if the contracts were cancelled and Seller was required to provide Buyer with an advance payment guarantee to assure repayment of these advance payments. The Bank of China Limited (Guarantor) issued two refund guarantees for the account of Sellers to assure payment of their obligation to refund the installment payments.

Between 2996 and 2011, Buyer/Beneficiary paid USD 28.68 million in advance installments. When the ships were not delivered within the 210-day period, Buyer/Beneficiary instituted arbitration proceedings as provided in the contracts. Buyer/Beneficiary also communicated with Seller/Applicant invoking the extension provision in the guarantees. Apparently, the guarantees remained in effect.

Despite the contract clauses providing for dispute resolution by arbitration in London, Seller/Applicant sued Buyer/Beneficiary and a third-party engine manufacturer in the Qingdao Maritime Court (QMC) China claiming that they fraudulently supplied defective second-hand engines and concealed their second hand character. Buyer/Beneficiary unsuccessfully challenged the jurisdiction of the Chinese court in light of the arbitration clauses and award but then defended on the merits. The Chinese court entered an interim award of damages against Buyer/Beneficiary and ordered Guarantor not to pay on the Guarantees anywhere in the world. On appeal, the Shandong High Court upheld the trial court’s ruling. An application to appeal to the Chinese People’s Supreme Court had been made but not ruled on at the time that the English opinion was issued. The opinion stated that Guarantor was not a party to the Chinese actions but “has taken every step available to it in China to have the [Chinese court] orders against it set aside, to no avail.” [¶ 11]

When the arbitral tribunal determined that Buyer/Beneficiary was entitled to cancel the contract, it demanded that Seller/Applicant refund the installments. When Buyer/Beneficiary demanded payment on the Guarantees, Guarantor refused to honor on the ground that it was prohibited from doing so by the Chinese court orders. It stated:

"RE YOUR DEMAND UNDER OUR ADVANCE PAYMENT GUARANTEE…WE REGRET TO INFORM YOU THAT YOUR DEMAND FOR PAYMENT HAS NOT BEEN HONORED BY US, BECAUSE THERE ARE COURT INJUNCTION ORDERS …PROHIBITING US…AT HOME AND ABROAD FROM PAYING YOU UNDER THIS GUARANTEE. WE, AS THE GUARANTOR…, APPLIED TO THE DOMESTIC COMPETENT COURT [QMC] FOR LIFTING THE PAYMENT INJUNCTION, HOWEVER, THE APPLICATION WAS REJECTED BY THE COURT ON 120306, SO ALL PAYMENT UNDER THE A/M GUARANTEE SHALL NOT BE EFFECTED BY US WITHOUT LIFTING THE INJUNCTION." [¶ 165]

As stated in the Opinion, Guarantor “did not at this stage suggest that it had any other basis for declining to pay and did not, in particular, dispute [Buyer/Beneficiary]'s right to demand payment in the circumstances that had arisen. [Guarantor] wrote to the Sellers confirming that there were no material discrepancies in the claim documents and that it was obliged to pay” one of the Guarantees. [¶ 38]

Notwithstanding the Chinese court decision, Buyer/Beneficiary sued Guarantor in England for wrongful dishonor. Bank of China contended that “it could face criminal and/or civil sanction and would be at risk of double payment in the event of immediate judgment against it here and in the absence of a resolution in China.” [¶ 11] The Queen’s Bench Division, Commercial Court, Carr, J., ruled in favor of Buyer/Beneficiary and ordered the Guarantor to pay the guarantees notwithstanding the judgments in China.

The English decision addressed several issues, namely 1) the “true nature and proper construction of the Guarantees” [¶64]; 2) The effect of the Chinese decision on the jurisdiction of the English court; and 3) Whether a stay should be entered by the English court.

The Nature of the Guarantees

Guarantor argued the guarantees should have been construed as contracts of surety, thereby voided Guarantor’s liability because of the default of by Buyer/Beneficiary.

The Judge explained that “the various equitable defences available to a surety are not available to the issuer of a performance bond” [¶ 69]

The Judge identified “general principles of construction” regarding bank guarantees: “a) the question of whether a document such as each of the Guarantees is a true guarantee or a performance bond is a matter of construction to be determined on a case-by-case basis;

b) there are certain factors which may be indicative of the nature of the instrument, but these are not necessarily decisive;

c) the question that the Court will always be faced with is what, objectively, the parties to the contract intended;

d) in the modern commercial world, parties are capable of drafting agreements that are clear and that oblige the surety to pay regardless of the existence of any underlying liability if that is what they intend.” [¶70]

The Judge ruled that the guarantees were performance bonds because (1) they were issued by a bank; (2) used in the performance of international trade; and (3) included a covenant to pay on demand. Specifically the Judge stated “In my judgment, an objective consideration of the Guarantees as a whole points to them being demand guarantees in the nature of a performance bond, and not by way of surety, which irrevocably and unconditionally obliged [Guarantor], on demand, to make payment to [Buyer/Beneficiary] of advance instalment refunds due from the Sellers but not paid.”[¶72]

Guarantor argued that the clause in the Guarantees labeled in the opinion as “the Proviso” rendered the Guarantees a true guarantee. The Proviso provided:

"However, in the event of any dispute between you and the Seller in relation to:

1. Whether the Seller shall be liable to repay the instalment or instalments paid by you and

2. Consequently whether you shall have the right to demand payment from us,

And such dispute is submitted either by the Seller or by you [Buyer/Beneficiary] for arbitration or appeal in accordance with article XIII of the contract, we [Guarantor] shall be entitled to withhold and defer payment until the arbitration award or court order is published. We shall not be obligated to make any payment to you unless the arbitration award or court order orders the Seller to make repayment. If the Seller fails to honour the award or court order, then within thirty (30) days after the publication of award or court order we shall refund to you to the extent the arbitration award or court order orders but not exceeding the aggregate amount of this guarantee plus the interest described above. "

("the Proviso") [¶ 21]

The Judge rejected Guarantor’s argument, stating that:

“The obligation under the 2nd Paragraph of the Guarantees to pay within thirty days of receipt of authenticated demand is unequivocal. The Proviso, which itself engages only in limited circumstances, falls to be considered separately. The Guarantees make it clear that any disputes between SBV and the Sellers are irrelevant to [Guarantor]'s obligation to pay. The obligation is as "primary obligor not security" and irrevocable, unconditional and absolute. The fact that the obligation is engaged "should the Seller fail to make...repayment" does not point to the imposition of a secondary liability, but rather to the circumstances in which the obligation on [Guarantor] is triggered. Equally, the fact that the sums due under the Guarantees mirror the sums due from the Sellers does not point to a secondary liability only. It simply specifies the extent of [Guarantor]'s primary liability under the Guarantees.” (emphasis supplied) [¶ 75]

The Judge also pointed out that “in the event of a qualifying reference to arbitration or appeal, [Guarantor’s] liability is nevertheless still triggered by a document, namely an award or court order, not by reference to the merits of any underlying dispute between [Buyers] and the Sellers. [Guarantor] is not required to become concerned with the merits of any underlying dispute. The question is one of timing, not substance.” [¶ 78]

Relying on a prior English court decision, Guarantor argued that the repeated use of the word “guarantee” led to the conclusion that it was a true guarantee. The Judge stated that “[t]his is an area where the labelling used is generally accepted as being confusing (see for example the use of the phrase "demand guarantee" to describe a performance bond). I do not find the repeated use of the word "guarantee" in the Guarantees helpful to the process of construction, let alone determinative. … I prefer to look at the substance and international and commercial context of [Guarantor's] obligations under the Guarantees.” [¶84]

The Effect of the Orders of the Chinese Court on the Jurisdiction of the English Court

The Judge addressed the question of whether the Chinese court order remained in effect, concluding that the orders remained “live”. As a result, he addressed the argument of Guarantor that the English court should have deferred to the Chinese decision made and granted summary judgment in its favor, not permitting the Guarantees to be presented in England since the Chinese courts determined that there was fraud by Seller/Applicant.

On the question of whether the Buyer/Beneficiary submitted to the jurisdiction of the Chinese court, the Judge concluded that Buyer/Beneficiary did submit to the jurisdiction of the QMC. In the opinion of the Judge, it did so by defending on the merits after losing its jurisdictional challenge and that the English court had no jurisdictional authority to invalidate the orders of the QMC nor could it refuse to recognize them on the basis that they violated public policy in disregard of the contractual selection of arbitration subject to English law.

Propriety of Buyer/Beneficiary’s Demand

Guarantor claimed that the demand made on the Guarantees was inadequate, contending that Buyer/Beneficiary was required to prove that there had been termination and that Sellers were served with notice. Based on the testimony of a factual witness, the Judge concluded that the notice had been sent.

Guarantor also asserted that since the arbitral award was not a monetary award, no right to make a demand under the Guarantees had accrued under the so-called “Proviso” paragraph of the Guarantees which entitled the Guarantor to withhold payment pending an order to make repayment. The Judge concluded that the arbitral award resolved the dispute, making the “Proviso” irrelevant and ruled that “[n]o award was required in order for the demand … to be valid.” [¶ 149] The Judge concluded that this interpretation of the “Proviso” was neither “fair” nor “correct”: “Reference to arbitration suspends the timing for [Guarantor]'s obligation to pay during the currency of the dispute, but does not prevent an obligation to pay irrespective and independently of any award arising on the part of [Guarantor] subsequently.” [¶ 151]

The Judge also noted that Guarantor had written Seller/Applicant stating “there are no material discrepancies in the claim documents.” (emphasis supplied) [¶ 162]

The Effect of the Finding of Fraud by the Chinese Court

As an alternative, the Judge stated that even if the Guarantee was a “true guarantee” (that is, dependent), that their express terms “exclude discharge even for fraud such as that of which [Buyer] has been found culpable in the Chinese courts.” [¶ 174] The Judge observed that the delay in delivery was caused by the faulty character of the engines. The Judge also considered that the “no dispute” provision of the Guarantees, opining that “The clear intention of the no dispute provision, objectively construed, is that any dispute between buyer and seller, resolved or unresolved, should not affect [Guarantor's] obligations under the Guarantees.” [¶ 177]

Additionally, the Judge noted that “…the obligation on the part of [Guarantor] to pay on demand should not be affected by extraneous matters . . . (or judgments in fraud or otherwise against [Buyer/Beneficiary] in separate proceedings in China).” [¶224] The Judge concluded that the intentions established by the language of the Guarantees when properly constructed made any dispute between Buyer/Beneficiary and Sellers irrelevant to the obligations of Guarantor to honor the Guarantees and that Buyer/Beneficiary’s fraudulent conduct did not discharge Guarantor’s responsibility under its guarantee to refund Buyer/Beneficiary’s installment payments.

Stay of Execution

Guarantor requested a stay of execution of the judgement on the ground of its double exposure. The Judge declined to do so since the refund provisions were without reference to the Chinese legal system and were designed to protect Buyer’s cash flow and no payment has been received by Buyer from Seller.

The Judge also ruled that principles of comity had any application since the guarantee was subject to English law. The Judge noted that the experts summoned in the case had agreed that Guarantor “has done everything it can to avoid making payment under the Guarantees to [Buyer/Beneficiary].” [¶ 217] He also observed that the Chinese order prohibiting Guarantor from making payments did not prevent Guarantor from making payments in England as a result of separate proceedings under guarantees subject to English law.

Legal Analysis:

Comments:

  1. Characterization. Here is another instance of an abominably drafted undertaking. It is difficult to explain how this undertaking, filled as it is with non documentary conditions which appear to be central to the obligation that it represents, is independent. See the comment from James G. Barnes from Documentary Credit World (June 2015) that follows.

TEXT OF CONTRACT REGARDING REFUND GUARANTEES: [¶15 -17]

6. REFUND GUARANTEE

All payments made by the BUYER to the SELLER prior to delivery of the VESSEL shall be in the nature of advance to the SELLER, and in the event this Contract is cancelled by the BUYER, all in accordance with the specific terms of this Contract permitting such cancellation, the SELLER shall refund to the BUYER in United States Dollars the full amount of all sums already paid by the BUYER to the SELLER under this Contract, if applicable, together with interest (at the rate set out in the respective provisions hereof) from the respective payment date(s) to the date of remittance by telegraphic transfer of such refund to the account specified by the BUYER. All transfer and other bank charges shall be for the SELLER'S account. As security to the BUYER, the SELLER shall deliver to the BUYER a Refund Guarantee to be issued by Bank of China, Shandong branch or EXIM bank, and or other first class international bank acceptable to the BUYER's bank in it's absolute discretion substantially in the form as attached in Exhibit "A".

…

A. Law and jurisdiction of this CONTRACT

The terms and conditions of this CONTRACT and all other agreements relating thereto and any disputes arising out of or in connection therewith shall be subject to and governed by English law.

[…]

C. Arbitration

(1) Save as expressly provided elsewhere in this CONTRACT any dispute arising under or by virtue of this CONTRACT, may be referred to arbitration in England by either party. In any such arbitration, the laws and rules of England shall govern as to all matters of substantive law and procedure and the same shall be subject to the Arbitration Act 1996…

(5) The award of the two arbitrators nominated by the parties hereto shall be final and conclusive and shall have the same force and effect as if rendered unanimously by all three arbitrators…

TEXT OF REFUND GUARANTEES [¶21]:

“[…] in consideration of your agreeing to pay the Seller, the instalments before delivery of the vessel, under the shipbuilding contract […] dated June 3rd 06 (Hereinafter called the Contract) […] we, Bank of China, Shandong Branch, as the primary obligor, not as security, do hereby irrevocably, unconditionally and absolutely guarantee repayment to you by the Seller of an amount up to but not exceeding a total amount of USD16,392,000 […] plus interest thereon representing the 1st, 2nd, 3rd and 4th instalments of the contract price of the vessel, as you may have paid to the Seller under the Contract prior to the delivery of the Vessel, if and when the same or any part thereof becomes repayable to you from the Seller in accordance with the terms of the contract…”

(“1st Paragraph”)

““Should the Seller fail to make such repayment, we shall pay you the amount the Seller ought to pay with interest on that amount at the rate of […] 6 month LIBOR + 2 pct per annum if the cancellation of the contract is exercised by you for the delay caused by non-permissible delays […] in accordance with the provisions of article II 1 (C) […] within 30 days after our receipt of the relevant written demand from you for repayment. Such demand (‘an authenticated demand’) may be made by you in writing by any one or more of the following means:

1.  By you through your bank and duly authenticated by your bank, or

2.  By your bank on your behalf through authenticated SWIFT …”

(“2nd Paragraph”)

“Our obligations under this guarantee shall not be affected or prejudiced by any dispute between you as the Buyer and the Seller under the Shipbuilding Contract or by the Seller's delay in the construction and/or delivery of the Vessel due to whatever cause or by any variation or extension of their terms thereof or by any security or other indemnity now or hereafter held by you in respect therefore, or by any time or indulgence granted by you or any other person in connection therewith, or by any invalidity or unenforceability of the terms thereof, or by any act, omission, fact or circumstances whatsoever, which could or might, but for the foregoing, diminish in any way our obligations under this guarantee…”

(“the no dispute provision”)

“However, in the event of any dispute between you and the Seller in relation to:

1.  Whether the Seller shall be liable to repay the instalment or instalments paid by you and

2.  Consequently whether you shall have the right to demand payment from us,

And such dispute is submitted either by the Seller or by you for arbitration or appeal in accordance with article XIII of the contract, we shall be entitled to withhold and defer payment until the arbitration award or court order is published. We shall not be obligated to make any payment to you unless the arbitration award or court order orders the Seller to make repayment. If the Seller fails to honour the award or court order, then within thirty (30) days after the publication of award or court order we shall refund to you to the extent the arbitration award or court order orders but not exceeding the aggregate amount of this guarantee plus the interest described above. ”

(“the Proviso”)

“The said repayment shall be made by us by means of authenticated SWIFT transfer in United States Dollars… ”

(“5th Paragraph”)

“This letter of guarantee shall remain in force until the Vessel has been delivered to and accepted by you or full refund or refund to the extent the arbitration award or court order orders has been made by the Seller or ourselves, or until September 30 2009, whichever occurs earlier. […] However, in the event we have been informed, either by you or the Seller before above mentioned expiry date of this guarantee that there exists arbitration or appeal between you and Seller, then the validity of this guarantee shall be automatically extended until the date falling on the forty fifth (45th) calendar day after the arbitration award or court order is published …”

(“8th Paragraph”)

“Any payment by us under this guarantee shall be made without any set off or counterclaim and without deduction or withholding for or on account of any taxes, duties, or charges whatsoever unless we are compelled by law to deduct or withhold the same. In the later event we shall make the minimum deduction or withholding permitted and shall pay such additional amounts as may be necessary in order that the net amount received by you after such deductions or withholdings is equal to the amount which would have been received had no such deduction or withholding been required to be made….”

(“the no set-off provision”)

“This letter of guarantee shall be governed by, and construed in accordance with, the laws of England . . .”

(“11th Paragraph”)

[DW/MJK]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.