English courts take a robust approach to on-demand bonds which routinely finance international trade, including large leasing agreements. The court has held in a recent judgment that sums paid under such a bond are not held on trust by the recipient even if demand is made under an incorrect premise.
In Wuhan Guoyu Logistics Group Co Ltd v Emporiki Bank of Greece SA, the bank guaranteed the payment obligations of its customer, the buyer, to the claimant, the seller, under a shipbuilding contract. A dispute arose between the claimant and the buyer as to whether a payment instalment was due under the contract. The claimant called for payment under the guarantee from the bank which the bank refused to make. The bank argued the guarantee was a traditional guarantee of the buyer’s obligations, not an on-demand bond.
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Proceedings commenced and, in December 2012, the Court of Appeal determined that the payment guarantee was an
on-demand bond and payment was to be made under it, whether or not there was an underlying dispute as to payment between the parties to the contract.
Following that decision, the bank made payment, but by the time it did so, it had been conclusively determined by an arbitration award that the disputed instalment had not in fact fallen due. The bank argued that as a result, the claimant held the money on trust for the bank, or the buyer, and sought a declaration to that effect.
The matter again came before the Court of Appeal in December 2013. The court refused to grant the declaration holding that such a guarantee or bond is an autonomous contract independent of any disputes between the parties to the underlying contract.
However, the underlying contract would be subject to an implied term that the beneficiary of the bond would compensate the buyer to the extent it had been overcompensated by the guarantor.
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By GlobalDataThese principles were the basis upon which international trade was routinely financed. As between the beneficiary and the bank, the position crystallised at the time of presentation of a conforming demand.
The bank could only resist payment if there was a fraudulent demand by the beneficiary.
In this case, when the claimant made its demand it had acquired a complete and immediately enforceable cause of action against the bank. The bank was obliged to make payment immediately.
Once payment was due, it remained due. It was irrelevant that it was subsequently determined that the demand, although made in good faith, had been made upon an incorrect premise (that payment was due).
It was due to the bank’s delay in paying that, by the time of actual payment, it had been determined that the instalment was not actually due.
If payment had been made when demanded, that position would not have arisen.
Things to consider
Sellers and lessors must have confidence they will get paid (and so can conduct their businesses) if a compliant on-demand bond is in place and demand is properly made.
This decision helps reinforce that certainty. Whether the particular guarantee is deemed to be an on-demand bond will of course be a matter of interpretation.
Greg Standing, partner in Wragge & Co’s finance litigation team
