Guarantees: An update

As the global financial crisis extends into its fifth year, the use of guarantees to back contractual obligations is increasingly commonplace to secure the performance of long term obligations or asset poor counterparties.

Not all guarantees are created equally. It is crucially important to understand the type of guarantee being offered and the asset worthiness of the guaranteeing party before accepting it. Failure to do so may result in the acceptance of a guarantee that is no more than a piece of paper against which enforcement is hopeless.

We will consider how the English Courts have recently dealt with "on-demand" and "performance" guarantees.

On-demand?

An on-demand guarantee is perhaps the most straightforward of guarantees. Liability will usually be triggered by a written demand for payment, made in good faith. Once the demand is made, the guarantor is bound to pay.

In Meritz Fire & Marine Insurance Co Ltd v (1) Jan de Nul & (2) Codralux SA [2011] the defendants had entered into ship-building contracts with Huen Woo Steel Co and Meritz, the Korean insurer, issued advance payment guarantees to the defendants in respect of payments made by them to Huen Woo Steel. The Court of Appeal considered whether it was necessary to decide the merits of the underlying dispute before Meritz's obligations under advance payment guarantees were triggered. The answer was no. The Court held that the guarantee given was similar to a bond and liability to pay was triggered by a demand made in good faith.

Some on-demand guarantees will crystallise on the expiry of a time limit to commence arbitration or court proceedings. If no proceedings are commenced within time, then the ability to trigger the obligation to pay will be the same as in Meritz. Accordingly, a party giving an on-demand guarantee which contains wording concerning the commencement of proceedings must, if it wishes to dispute the payment, commence proceedings within time otherwise the ability to challenge the obligation to pay will be lost.

In Wuhan Guoyo Logistics Group Co Ltd & Others v Emporiki Bank of Greece SA [2012], the Court of Appeal considered the wording of a payment guarantee issued on behalf of the Buyers under a Shipbuilding contract.

The document was called a "payment guarantee", and contained elements of both on-demand and performance guarantees. The guarantee was given in respect of the buyers' obligation to pay punctually. Clause 1 stated that it guaranteed "the due and...