Can I have my money back please? How to make sure your refund guarantee works
Several recent cases in the English courts have highlighted the issues that can invalidate a refund guarantee. We discuss three of these cases below, each of which highlights the importance of reviewing this kind of document carefully.
Until a shipyard hands over the completed ship to the buyer, the buyer's deposit and stage payments made during construction are at risk. If the shipyard defaults or becomes insolvent, the buyer is likely only to have an unsecured claim against the shipyard, which may not be a great comfort.
A refund guarantee from a creditworthy bank is usually used to cover this risk. If the shipyard defaults, the buyer can simply claim its money back from the bank. The bank (which will have charged a fee for the guarantee) will have to recover its losses from the shipyard. The buyer has simply supplemented the credit risk of the shipyard with what they hope is a better one – that of the issuing bank.
The recent economic downturn has affected the shipping industry particularly severely. This in turn has tested the effectiveness of refund guarantees and we discuss some of the lessons learnt in this article.
Key points to watch out for
Watch out for the following points if you are taking a refund guarantee, or you may find it is worthless:
- Make sure it is a demand guarantee or stand-by letter of credit, not a conventional guarantee. There is less room for the guarantor to avoid liability. The difference between the two is in the substance of the obligations, not the title given.
- Take special care when the refund guarantor is not a bank or other financial institution; normally, no other type of body will issue a demand guarantee.
- Make sure there are no practical hurdles to making a demand, such as obtaining a certificate from a third party.
- Ship deliveries can often be delayed. The expiry date of the refund guarantee must extend automatically to match and cover any alterations to the shipbuilding contract.
- Does the guarantee actually cover all the events that you may want to claim for? It should at the least cover a default under the shipbuilding contract and insolvency events.
- Can you assign the refund guarantee to your bank if you are looking for finance? Has your bank approved the terms of the guarantee?
- Who holds the original guarantee? You may need it to make a demand.
- Check the governing law and jurisdiction provisions. Can you enforce it easily? Is it validly executed?
- Remember: the refund guarantee is only as good as the credit of the issuing bank.
Main legal issues
There are a number of pitfalls for the unwary when dealing with guarantees.
If the guarantor promises to compensate the beneficiary (in this case, the buyer) or to perform the obligations of another (in this case, the shipyard), if the other defaults, the guarantor's obligations are secondary. The contract is one of surety and the guarantor is legally entitled to certain protections which can limit or extinguish its liability. For example, a variation to the underlying contract or the conduct of the beneficiary could let the guarantor off the hook – particularly if that variation or conduct could increase the guarantor's liability. A well-drafted suretyship guarantee will normally exclude these protections.
It is important to bear in mind that there is a spectrum of guarantees rather than discrete types. Where on the spectrum a guarantee falls is very much dependent on a number of important drafting distinctions, not simply the title of the document. A demand guarantee (or a performance bond) is at the other end of the spectrum from a suretyship guarantee. In a demand guarantee, the guarantor (usually a financial institution) undertakes to pay a specified amount of money to a third party on the occurrence of a specified event, usually in return for a fee from its customer. The specified event may only be the service of a demand by the beneficiary, although sometimes other requirements are also imposed. Where the guarantor is not a financial institution, there is a very strong presumption that any guarantee is a suretyship guarantee and not a true demand guarantee.
Not all refund guarantees fit neatly into one category or the other, and "primary obligor" wording may not be conclusive.
In Vossloh Aktiengesellschaft v Alpha Trains (UK) Ltd  EWHC 2443 (Ch), a case in which the defendant alleged that the guarantee provided by the parent company of a train manufacturer was a demand guarantee, the court specifically stated that the two types of guarantee, suretyship and demand guarantees, were on a spectrum. Where any particular guarantee fell would depend on its wording and the commercial context of the transaction. However, if the guarantor was not a bank, there was a strong presumption that the document would not be a demand guarantee. This could be overcome by clear and conclusive drafting. People could agree to the terms they chose, however, the judge said: "Where on the spectrum a particular case falls may call for a nice judgment on the part of the court".
Ultimately, the court decided the guarantee was only a suretyship guarantee: the guarantor was not a bank or a similar financial institution, but the parent of the manufacturer. The terms of the guarantee were not sufficient to rebut the presumption that it was a suretyship guarantee. The drafting was typical of suretyship guarantees. It guaranteed that the manufacturer would perform its obligations and stated that payment was only due on a default, even though Alpha could serve a demand without having first to take action.
In Meritz Fire & Marine Insurance Co Ltd v Jan de Nul NV and Codralux SA  EWHC 3362 (Comm), Meritz, which acted as guarantor and was an insurance company, attempted to avoid liability for a refund guarantee. It argued that the guarantee (in this case called an advance payment guarantee) was a suretyship guarantee rather than a performance bond. The underlying contracts had been varied and the shipbuilder had changed identity because of a restructuring. Meritz claimed that this was sufficient to release it from its obligations as surety. There were no provisions in the document excluding the usual suretyship protections.
- the guarantor's undertaking is to pay on demand;
- the guarantee does not contain the typical guarantee provisions excluding or limiting the defences normally available to a surety;
- the underlying transactions are cross-border; and
- the guarantor is a bank (Meritz was an insurer, which Meritiz tried to make much of).
The judge was satisfied that in this case the guarantee was a demand guarantee as:
- it incorporated the ICC's Uniform Rules for Demand Guarantees (the URDG) and was consistent with the definition of a demand guarantee in the URDG;
- it was immaterial that Meritz was an insurance company and not a bank as the URDG envisaged insurance companies as being capable of issuing demand guarantees;
- the guarantee was irrevocable, unconditional and payable on demand from the beneficiary without proof of any event relating to the underlying contracts; and
- the evidence that the guarantor's liabilities might be secondary (ie dependent on the underlying contracts) was not sufficiently convincing.
Consequently, Meritz was obliged to pay. While the outcome for the buyer was positive, the case was hard fought and shows the sorts of issues which guarantors can raise when faced with a demand for payment.
In Kookmin Bank v Rainy Sky SA and others  EWCA Civ 582, a case from earlier in 2010, the outcome was far less favourable for the ship buyer. The refund guarantee clearly was a demand guarantee. The shipyard had entered into insolvency proceedings and the buyer had claimed under the refund guarantee. Kookmin, the guarantor, asserted that the buyer could not call on the guarantee in these circumstances. The refund guarantee obliged Kookmin to repay "all such sums due to [the buyer] under the [shipbuilding] contract". The dispute was whether the "such sums" referred to the shipyard's obligations to repay all the pre-delivery instalments or just the sums referred to in the previous paragraph of the refund guarantee. The previous paragraph referred only to repayments arising from rejection, cancellation, termination, rescission or total loss, but crucially not insolvency.
The Court of Appeal rejected the buyer's argument that it made no sense to have a guarantee that it could not call on in the very circumstances when it might want to, preferring to interpret the contract more narrowly.
The poorly worded guarantee did not clearly express the circumstances in which the buyer could call on the guarantee. The judgment indicated that the buyer should have made sure that the guarantee covered all the risks it wanted protection against and there was no reason to assume that the parties had not agreed to the terms they had written down. The result is an appeal to the Supreme Court.
All three cases indicate the importance of reviewing this type of document carefully. If you want a demand guarantee, it is not enough for these words to appear in the title. The document needs to express the parties' obligations clearly.