Clause And Effect: "See To It" And "On Demand" Guarantees

• Published date: 17 November 2021
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Corporate and Company Law, Contracts and Commercial Law, Arbitration & Dispute Resolution
• Law Firm: Shepherd and Wedderburn LLP
• Author: Mr Iain Drummond

In the recent case of Shanghai Shipyard Co. Ltd. V. Reignwood International Investment (Group) Company Limited [2021] EWCA Civ 1147 the Court of Appeal (COA) unanimously overturned the first instance decision and found a parent company guarantee to be a guarantee 'on demand'. Despite arbitration proceedings having commenced under the underlying contract, the COA found the guarantor liable to pay $170 million under the guarantee. The COA emphasised that the words used in the guarantee and the commercial context of the guarantee are critical factors.

'On demand' and 'see to it' guarantees

In construction projects, where a subsidiary company enters into a contract with a third party, it is common for the third party to request a parent company guarantee to ensure the performance of the contract. In that situation a parent company can give a guarantee to provide a level of security in respect of the obligations of its subsidiary under the contract. Typically, these guarantees are intended to protect employers against contractor insolvency. However, they are also sometimes called for in respect of employers whose financial covenant is uncertain.

Where an 'on demand' guarantee is entered into, the obligation to pay arises immediately in the event of a default and upon a demand being made under the guarantee.

A document is more likely to be an 'on demand' guarantee where it includes an undertaking to pay 'on demand' and it excludes or limits the defences available to a guarantor.

A 'see to it' guarantee is a secondary obligation, thus it is necessary to establish liability before the beneficiary is entitled to benefit from the guarantee.

Background

Shanghai Shipyard (the builder) entered into a bespoke contract with a special purpose company (the buyer) dated 21 September 2011 for the construction of an offshore drillship for $200 million. Investment company Reignwood (the parent company) acquired an indirect shareholding in the buyer. Reignwood funded payment of the first $30 million instalment due by the buyer under the contract, and entered into a payment guarantee in respect of the remaining $170 million final instalment.

The buyer refused to take delivery of the drillship, stating that it was defective, and defaulted on payment, so Reignwood was called upon to pay under the guarantee but failed to pay. Meantime, the buyer commenced arbitration proceedings against Shanghai Shipyard under the contract to determine whether the ship was in a deliverable...