Guarantee arrangements – the English law landscape Daniel Finch, Associate Director, Banking Types of guarantees under English law

• The “true” guarantee (suretyship) vs. the independent guarantee • True guarantee – a secondary obligation - entirely dependent on the primary obligation. In order to enforce the guarantee, beneficiary must first prove its claim for breach of contract against the primary obligor. • Independent guarantee – no need to establish underlying liability of the primary obligor. Beneficiary just needs to satisfy the documentary conditions specified in the guarantee in order to enforce it. This is the same as the “autonomy” principle that underpins letters of credit. Helpful statement of this principle can be found in case law: “A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions. The only exception is where there is a clear case of fraud of which the bank has notice.” Edward Own Engineering Ltd v Barclays Bank International Ltd [1978] QB 159 at 171

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TRUE GUARANTEE Guarantor

Supported by Counterindemnity Beneficiary (usually unwritten since it arises automatically and is implied by law) Primary obligation

Obligor Beneficiary INDEPENDENT Primary obligation GUARANTEE

Obligor Guarantor Guarantor

Counterindemnity (generally in an express agreement as unclear if Obligor automatically implied by law) www.blplaw.com Page 3 © Berwin Leighton Paisner Types of guarantees under English law

• How do you tell the difference between a true guarantee and an independent guarantee? Ø Under English law, it comes down to how the court construes the contractual terms. The terminology used is not necessarily conclusive and the court will analyse the document in light of the substance of the transaction as a whole. Ø If, for example, the guarantee is issued by a bank as part of an international transaction and is expressed to be on demand, the tendency would be for the courts to view this as an independent guarantee. Ø However, in a well-drafted document, it should be made clear whether the document is intended to be either a true guarantee or an independent guarantee (or both).

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• Usually issued by banks, financial institutions or insurance companies in order to provide credit support for a party’s obligations under a wider commercial arrangement – for example: • issued to a buyer under a sale or services contract to support a seller’s obligation to provide the goods or services in accordance with the contract • issued to a seller under a sale or services contract to support a buyer’s obligation to pay the purchase price upon seller’s performance of its obligations to provide the goods or services in accordance with the contract • It could take, for example, the form of: • a demand guarantee (also called a performance bond) – often drafted so as to be subject to the ICC’s Uniform Rules for Demand Guarantees • standby letter of credit - often drafted so as to be subject to the ICC’s International Standby Practices 1998

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• How does the Guarantor recover if it pays out under the demand guarantee?

• Fraud exception – what if the Beneficiary claims fraudulently under a demand guarantee?

• What if a Beneficiary recovers under the demand guarantee more than what its losses are?

• In making a demand under the demand guarantee, does a principle of strict compliance apply in the same way as with letters of credit?

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• True guarantees are most often found in the context of loan transactions

• The Loan Market Association’s standard loan agreement contains a very typical “Guarantee and indemnity” clause, which maximises protection for the lender by containing a triple cocktail of (a) a true guarantee (b) a principal debtor obligation and (c) an indemnity. This wording creates a true guarantee under para (a), but also seeks to bolster the lender’s position by creating primary, independent obligations under paras (b) and (c).

“Each Guarantor irrevocably and unconditionally jointly and severally: (a) guarantees to each Finance Party punctual performance by each other Obligor of all that Obligor's obligations under the Finance Documents; (b) undertakes with each Finance Party that whenever another Obligor does not pay any amount when due under or in connection with any Finance Document, that Guarantor shall immediately on demand pay that amount as if it was the principal obligor; and (c) agrees with each Finance Party that if any obligation guaranteed by it is or becomes unenforceable, invalid or illegal, it will, as an independent and primary obligation, indemnify that Finance Party immediately on demand against any cost, loss or liability it incurs as a result of an Obligor not paying any amount which would, but for such unenforceability, invalidity or illegality, have been payable by it under any Finance Document on the date when it would have been due. The amount payable by a Guarantor under this indemnity will not exceed the amount it would have had to pay under this Clause if the amount claimed had been recoverable on the basis of a guarantee.”

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• Form, flexibility and scope. An English law guarantee: v can be limited to a specified amount (i.e. a monetary cap); v can either guarantee liabilities arising under specified documents or guarantee all liabilities owed from time to time by the Obligor to the Beneficiary (known as an “all monies” guarantee); and v can cover both present and future liabilities. Under a very old piece of law - the Statute of Frauds 1677 - there is still a requirement that a “true” guarantee must be in writing and signed by the guarantor (case law has confirmed that an electronic signature will satisfy this).

• Corporate guarantee - is there sufficient corporate benefit to the guarantor? When taking a guarantee from an English company, the risk of the guarantee being void for lack of corporate benefit can be mitigated by obtaining a shareholder resolution. However, other jurisdictions may have their own corporate benefit restrictions that could prevent or limit the ability of companies in that jurisdiction from giving guarantees – always need to take local legal advice if dealing with an overseas jurisdiction.

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• Guarantees from natural persons. Under English law, additional formalities should be followed when taking a personal guarantee. Lender must obtain confirmation from an independent solicitor that he/she has explained to the guarantor the content of the guarantee and the nature and implications of the guarantee.

• Protected position of the guarantor under a true guarantee • In the event of ambiguity, court will interpret the guarantee in favour of the guarantor – “contra proferentem” principle. • If the guarantee is a guarantee of liabilities under specific documents, an amendment to those documents without Guarantor consent may discharge the guarantor’s liabilities under the guarantee (unless the guarantee expressly covers amendments and the proposed amendment is a genuine amendment and not, in substance, a new transaction). In order to mitigate this risk, it’s therefore generally advisable to obtain guarantor’s consent to any amendments.

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From a bank’s perspective:

• ENSURE DRAFTING IS CRYSTAL CLEAR AND CONSISTENT AS TO THE NATURE OF THE GUARANTEE (I.E. WHETHER SECONDARY OR INDEPENDENT) - THE LABEL OR TITLE OF THE DOCUMENT IS NOT NECESSARILY INDICATIVE

• IF YOU ARE ISSUING OR TAKING THE BENEFIT OF A DEMAND/INDEPENDENT GUARANTEE, ENSURE ABSOLUTE CLARITY ABOUT HOW A VALID DEMAND GETS MADE AND WHAT DOCUMENTS NEED TO ACCOMPANY IT

• IF YOU ARE TAKING THE BENEFIT OF A GUARANTEE AS PART OF A LENDING TRANSACTION, ENSURE THE “TRUE” GUARANTEE IS REINFORCED BY HAVING AN INDEMNITY (I.E. AN INDEPENDENT OBLIGATION) AS WELL

www.blplaw.com Page 10 © Berwin Leighton Paisner This document provides a general summary only and is not intended to be comprehensive. Specific legal advice should always be sought in relation to the particular facts of a given situation.