15 Jan 2018

Are you sure?

Linkedin

A recent decision of the High Court has served as a useful reminder and warning to parties of the need to carefully draft contracts of suretyship, and the distinction between indemnities (primary obligations) and guarantees (secondary obligations).

In Ultrabulk A/S v Jagatramka [2017] EWHC 2792 (Comm), Mr Justice Teare held that the language used in the contract was indicative of a primary liability and that it provided for an on demand bond which required the defendant to pay a sum to the claimant equal to that which his company was indebted.

The difference between suretyships of guarantee, and suretyships of indemnity

  • A guarantee is a promise to ensure that a third party fulfils its obligations and/or a promise to fulfil those obligations if that third party fails to do so. It is a contractual agreement that creates a secondary obligation to support a primary obligation of one party to another. The guarantor promises that the borrower will perform its obligations and, if he does not do so for any reason, the guarantor will perform them on its behalf. The guarantor's obligation is contingent on the borrower's primary obligation. It will therefore never be greater than that of the borrower under the primary agreement.
  • An indemnity is a promise to be responsible for another's loss. However, unlike a guarantee, it is a primary obligation given by the indemnifier to the person to be indemnified. It is independent to, and not contingent upon, the obligations of the borrower.  This means that if the underlying transaction is set aside for any reason the indemnity will remain valid.
  • Most documents that are usually described as guarantees are actually combined guarantees and indemnities. However, it is important for the contracting parties to make it absolutely clear in the documents whether a guarantee or indemnity or both are being given.

Ultrabulk case

The claimant company operated and traded ships.  It entered into two agreements with a coke-producing company, Gujarat. Mr Jagatramka was the chairman and managing director of Gujarat. Gujarat was indebted to Ultrabulk in the sum of c.US$4.25 million. Gujarat and Ultrabulk agreed to pay the indebtedness to Ultrabulk by way of instalments. This agreement was fortified the same day by a personal guarantee from Mr Jagatramka.  The personal guarantee stated that "[Mr Jagatramka was] aware of the Joint Venture Agreement between [Ultrabulk] and [Gujarat] dated 6 June 2007 and 5 July 2007 ('the Agreements')….[and he was] also aware of the liability due on date, i.e. USD4,259,395/- to [Ultrabulk] by Gujarat under the Agreement (the 'Gujarat Liabilities')…..hereby unconditionally and irrevocably guarantee that, if for any reason Gujarat do not repay the Gujarat Liabilities latest by 31 December 2013 then [he would] on [Ultrabulk's] first written demand from [Ultrabulk], pay a sum equivalent to the Gujarat Liabilities plus the interest….[he] irrevocably confirmed that [he would] not contest and/or defend any application and/or proceedings to enforce this Personal Guarantee…"

There was no dispute that Gujarat had not paid the Gujarat Liabilities. The question before the Court was whether or not, on the true construction of the personal guarantee, Mr Jagatramka was obliged to pay a sum equivalent to US$4,259,395, or a lesser amount taking into account the sums Gujarat had actually paid towards the Gujarat Liabilities (being c.US$1.95 million).  This turned upon whether or not the guarantee provided for a primary liability arising on demand, or whether the guarantee was in fact a true guarantee which provided for a secondary liability in the sense that the guarantor's liability only mirrors the liability of the principal debtor.

Mr Justice Teare said he had no doubt that the instrument provided for an on demand bond, and that, if demanded by Ultrabulk, Mr Jagatramka was bound to pay a sum equal to US$4,259,395 and not such sum as Gujarat was in fact liable to pay at that time. The language used (such as "unconditionally and irrevocably") was indicative of a primary liability, and inconsistent with his liability being coextensive with that of Gujarat. Mr Justice Teare commented that while there was authority for a presumption against construing an instrument as an on demand bond where it was not given by a bank or other financial institution, there was no doubt that with regard to its language the instrument signed by Mr Jagatramka provided for an on demand bond and following a valid demand he was bound to pay a sum equal to the full liability.


Conclusions

  1. Recent case law confirm that guarantors should ensure that the drafting of their primary and secondary obligations reflect exactly what obligations they are agreeing to be liable for. They will not be able to rely on the contra proferentum rule to support their interpretation of their obligations, or the presumption against on demand bonds being given by individuals. The court will look at the true construction of the surety.  

  2. The fact that the parties have called the contract a guarantee does not make it so, and likewise the use of the term indemnity is not determinative. Even if the parties refer to a surety acting as a primary obligor, this will not alone be sufficient to make the obligation a contract of indemnity. What matters is the substance of the obligation undertaken.  

  3. Not seeking legal advice at the time of entering into the surety will not excuse guarantors from their obligations.  

  4. When drafting a contract, if the parties wish the surety to take primary liability and avoid the principle of co-extensiveness, clear wording should be used to create an independent obligation to pay an ascertained or ascertainable sum. This can be achieved with an obligation to pay immediately on, for example, the insolvency of the debtor as opposed to on default of payment by the debtor. Making payment conditional on default rather than some other event such as insolvency is likely to be construed as a guarantee.

  5. Finally, recent cases highlight the importance placed by the court, not just on the words used by the parties but also on the commercial purpose of the contract in deciding what the parties intended.  By including express wording in a recital to the contract, the draftsman can provide valuable assistance in establishing the true commercial purpose.
Linkedin

KEY CONTACT

Sue Millar

Sue Millar
Partner

T:  + 44 20 7809 2329 M:  + 44 7825 625 898 Email Sue | Vcard Office:  London

Alina Neal

Alina Neal
Senior associate

T:  +44 20 7809 2266 M:  Email Alina | Vcard Office:  London