Stage payment financings often involve bank guarantees, especially where the customer and the supplier are in different countries, says Alan Cunningham.
A supplier will typically require its customer to make advance payments against the purchase price on signing of the contract and at key stages prior to delivery.
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The customer will be concerned to ensure that if the supplier does not deliver in accordance with the contract, it will be reimbursed for the stage payments already made. Customers will often insist that the supplier provides a bank guarantee under which the supplier’s bank promises to repay the stage payments in the event the supplier fails to deliver.
Where the customer makes limited stage payments prior to delivery or only following the supplier completing a key stage of the manufacture, the supplier will be concerned to ensure that the customer can and will pay. The supplier may require the customer to provide a bank guarantee to cover its stage payment obligations.
Whether it is the supplier or the customer providing the bank guarantee, the other party will want a simple, straight forward relationship with the bank issuing the guarantee so that the issuing bank pays out "on-demand" with no investigation as to whether the buyer or the supplier is contractually obliged to pay. These bank guarantees are known as on-demand or performance bonds.
In the recent case of Wuhan Guoyu Logistics Group and Yangzhou Guoyu Shipbuilding v Emporiki Bank of Greece, the Court determined that the true construction of a "guarantee" issued by the customer’s bank to the supplier (a Chinese shipyard) was a guarantee in the sense of a surety or accessory guarantee rather than an on-demand bond.
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By GlobalDataThe Facts
A Chinese shipyard contracted to build two bulk carriers, the first of which was priced at US$41.25m, payable in five instalments.
The second instalment (of just over US$10m) was payable by the buyer on satisfaction of certain conditions, one of which was evidence of the cutting of the first steel plate for the vessel.
The buyer procured that its bank, Emporiki Bank of Greece, issued a "Payment Guarantee" with respect to the second instalment. Emporiki Bank was providing stage payment financing.
The Payment Guarantee provided:
"In the event that the Buyer fails to punctually pay the second Instalment guaranteed hereunder or the BUYER fails to pay any interest thereon, and any such default continues for a period of twenty (20) days, then upon receipt by us of your first written demand stating that the Buyer has been in default of the payment obligation for twenty (20) days, we shall immediately pay to you or your assignee the unpaid 2nd Instalment together with Interest".
The document also contained guarantee wording that would be found in a standard guarantee and which specifically provided that the second instalment would become due and payable by the buyer upon the satisfaction of certain conditions, one of which was the buyer countersigning the certificate acknowledging that the first steel plate had in fact been cut.
The shipyard provided an invoice for the second instalment and a certificate confirming the first steel plate had been cut. The buyer disputed that the steel had been cut at all, refused to pay the second instalment as invoiced and the shipyard made demand on the bank guarantee provided by Emporiki Bank.
Emporiki Bank refused to pay as it claimed it would be liable only once the buyer’s liability to pay the second instalment had been established, i.e. once it was established whether the steel plates had been cut and whether the second instalment was due under the contract.
The Decision
The Court determined:
- The Payment Guarantee was not an on-demand bond. The Payment Guarantee consistently referred to itself as a guarantee and clause 1 of the Payment Guarantee was set out in the classic language of a guarantee, guaranteeing the due and punctual payment of the second instalment.
- The Payment Guarantee contained a guarantee of interest after the buyer was in default. That guarantee obligation was inconsistent with a free standing obligation to pay interest from the date of demand by the shipyard which would be found in an on-demand bond.
- The Payment Guarantee included terms commonly found in a standard guarantee intended to ensure that it would not be rendered unenforceable due to, for example, variation without the guarantor’s consent or time given to the buyer to pay. This language was inconsistent with an on-demand bond.
- The fact that the second instalment was payable by Emporiki Bank only upon the buyer countersigning the certificate in relation to the cutting of the steel clinched the issue. The parties effectively had to agree that the second instalment was due and payable (or a court had to determine that issue) before demand could be made on Emporiki.
Conclusion
Suppliers, buyers and financiers of equipment on stage payment terms who require on-demand bonds should opt for short-form forms of document which make clear that the only conditions to be satisfied to obtain payment under the guarantee are the beneficiary making demand for payment and the beneficiary’s assertion that the money is due.
Additional wording that the issuing bank guarantee certain payment obligations may look innocuous and even comforting but the effect may be to reduce an on-demand bond to a standard guarantee where the guarantor’s obligation to pay is dependent upon the beneficiary first proving in court that it is entitled to payment under the underlying contract.
? Alan Cunningham is partner with DLA Piper and head of its transactional asset finance team
