Chapter 1
Introduction
1.1
It is a common feature of shipbuilding projects and contracts that the purchase price will be paid by the buyer to the builder in instalments against certain milestone events. Typically a shipbuilding contract may require payments to be made upon (1) signing the contract or lifting board approvals; (2) steel cutting; (3) keel-laying; (4) launching; and (5) delivery, although the amount and number of instalments will vary from contract to contract.1
1.2
Commonly also, the instalments are paid as advances against the purchase price (and not as deposits), and title in the newbuilding does not pass to the buyer until delivery.2
1.3
The buyer will almost always be entitled under the shipbuilding contract to a refund of the pre-delivery instalments together with interest if he terminates the contract for causes such as (1) insolvency of the builder;3 (2) excessive delay in delivery;4 (3) total loss of the vessel;5 or (4) material breach of the builderās obligations under the contract. The precise terms governing termination of the shipbuilding contract and the refund of the pre-delivery instalments will vary from contract to contract.
1.4
It can be readily appreciated that the buyer is exposed to risk in respect of the pre-delivery instalments in the event that the builder fails for any reason to refund them when due. Although the buyer would, of course, have a cause of action against the builder under the shipbuilding contract if the builder wrongfully refuses to refund the advance payments made by the buyer, this will give the buyer (and its financiers) no protection in the event of the insolvency of the builder.
1.5
Further, even if the buyer could be confident that the builder would remain solvent, the buyer will not usually be willing to rely solely upon its rights to bring court or arbitration proceedings against the builder as security for the advance payments, since any such action will involve delay, cost, inconvenience and at least some element of risk. This is particularly so where the terms of the buyerās finance require the immediate repayment of any pre-delivery instalments upon termination of the shipbuilding contract.
1.6
It is for these reasons that the buyer will usually insist upon security for the builderās obligation to repay one or more of the pre-delivery instalments in the form of a refund guarantee from an acceptable bank or similar financial institution, committing the bank/financial institution to refund the advance payment(s) upon demand.
1.7
Because of the importance attached to the provision of a refund guarantee, the builderās obligation to furnish refund guarantees is often expressed as a condition precedent to the shipbuilding contract as a whole, or to the buyerās obligation to pay instalments as and when the payment milestones fall due.
1.8
The guarantorās liability under the refund guarantee will usually be limited to the amount of the pre-delivery instalments plus interest at the rate agreed in the shipbuilding contract.
1.9
There is no standard practice as to either the form or the wording of refund guarantees.6 They may either take the form of a contract of guarantee or a contract of indemnity, and the wording of refund guarantees, even when in the same form of instrument, often differs markedly from case to case. As a result of this, the sharp downturn in the shipping markets following the global recession in 2008, and the large sums of money usually at stake, there has in recent years been a plethora of disputes concerning refund guarantees in London arbitration and English court proceedings.
1.10
In order to avoid similar disputes in future, it is necessary for those engaged in the sale, purchase and finance of newbuildings to have an understanding of the relevant terminology, definitions, and characteristics of the different types of guarantee instruments. These are considered in Chapter 2.
Notes
Chapter 2
Definitions and characteristics
Introduction
2.1
There are essential differences under English law between different types of guarantee instruments. There are two different types of guarantee contracts, which are relevant in the context of refund guarantees, both of which come within the general heading of ācontracts of suretyshipā. The first is a contract of guarantee; the second is a contract of indemnity. The nature of the instrument in question is a matter of construction of the instrument as a whole,1 and the description of an instrument as a āguaranteeā is never of itself determinative.2
2.2
As Sir William Blackburne noted in Vossloh AG v Alpha Trains (UK) Ltd,3 contracts of suretyship are an area of law ābedevilled by imprecise terminologyā and āit is important not to confuse the label given by the parties to the suretyās obligation (although the label may be indicative of what the parties intend) with the substance of that obligationā.
2.3
It is, therefore, necessary to have an understanding of the relevant English law concepts and terminology in order to understand the nature of the obligations assumed by the guarantor in any given case.
2.4
This chapter will introduce the key features and characteristics of (1) contracts of suretyship; (2) contracts of guarantee; and (3) contracts of indemnity, insofar as they are relevant to refund guarantees.4
Contracts of suretyship
2.5
Suretyship is a generic term for contracts by which the surety agrees in favour of the creditor to be answerable for the debt or obligations of the principal debtor. In most English common law jurisdictions the terms āsuretyā and āguarantorā are used interchangeably, and will be used in this way in this book.
2.6
In the context of a refund guarantee, the principal debtor is the builder under the shipbuilding contract and the creditor, to whom the promise is made, is the buyer under the shipbuilding contract. The surety is the issuer of the refund guarantee.
2.7
The relevant obligation, for which the surety agrees to be answerable, is that of the builder to refund one or more pre-delivery instalments to the buyer. Such obligation typically arises under the shipbuilding contract in the event that the buyer exercises its contractual right to terminate the contract for cause such as insolvency of the builder, excessive delay in delivery, total loss of the vessel, and/or material breach of the builderās obligations under the contract.
2.8
Contracts of suretyship fall into two main categories, namely contracts of guarantee and contracts of indemnity. Refund guarantees are routinely issued in either form. Although the word āguaranteeā is often used to describe both contracts of guarantee and contracts of indemnity, there are important differences between the two. Whether a contract falls into one class or another (or contains a combination of the two) is a question of construction in each case,5 which as the case law demonstrates, is not always easy to resolve.6
Contracts of guarantee
Definition and characteristics
2.9
Contracts of guarantee are commonly referred to as ācontracts of guarantee, properly so-calledā ātraditional guaranteesā ātrue guaranteesā āsee to it guaranteesā or āsecondary obligation/liability instrumentsā.
2.10
In Vossloh AG v Alpha Trains (UK) Ltd,7 Sir William Blackburne gave the following definition of a contract of guarantee:
āA contract of guarantee, in the true sense, is a contract whereby the surety (the guarantor) promises the creditor to be responsible for the due performance by the principal of his existing or future obligations to the creditor if the principal fails to perform them or any of them.ā
2.11
A contract of guarantee is predicated upon the existence of a valid obligation owed by the principal debtor to the creditor. In Lakeman v Mountstephen,8 Lord Selborne affirmed the principle that there can be no suretyship unless there is a principal debtor and no-one can guarantee anybody elseās debt unless there is a debt of some other person to be guaranteed.9
2.12
The secondary nature of the suretyās obligations means that the surety will generally only be liable to the same extent as the principal debtor is liable to the creditor and will also usually be discharged from liability under the guarantee if the underlying obligation is void or unenforceable,...