Parent company guarantees: Unreasonable demands?

Security for non-performance or insolvency may be attracting a little more attention than the norm by those potentially exposed in the event that, say, a contractor or a developer seeking development finance finds themselves with cash flow difficulties. One of the most popular methods of providing security to those potentially exposed contracting with, for example, a contractor or developer is the requirement for a parent (or holding) company guarantee (PCG).

Depending upon its wording, a PCG can take various forms: it can be what are referred to as “pure” or ” true” guarantees; an indemnity (or on-demand) guarantee; or, as is more common in the industry, a combination of the two.

PCGs are certainly useful tools for securing the interests of a proposed beneficiary, but to realise their full potential and to obtain the expected result without ending up in court, Rubicon provides a timely warning that each step in the process of negotiation and making a demand must be given careful consideration

Under a true guarantee, the parent company’s obligations are secondary and inextricably linked to its subsidiary company’s performance under the building contract. With a true guarantee, the parent may take advantage of defences available to the subsidiary (which is usually the building contractor), and the beneficiary of the PCG (usually the employer) must pursue the contractor for breach of its building contract or prove that it is insolvent (if that has been expressly specified as an event of default) before it is allowed to require the parent company to pay out under the guarantee.

An indemnity guarantee is an entirely different beast. The parent company’s liability under an indemnity guarantee is a primary one; it is independent of the contractor’s performance and is payable on demand from the employer to the extent that the parent cannot rely on any defences or set-offs to which the contractor is entitled under the building contract. The employer does not have to pursue the contractor before it makes a demand under the indemnity guarantee and if the building contract becomes invalid, the liability of the parent company under the guarantee is unaffected. Hybrid wording, which incorporates elements of true guarantees and indemnity guarantees, is also used, for example, so that performance is guaranteed as a secondary obligation, but circumstances in which the guarantee might fail (such as termination or insolvency) are covered by an indemnity.

Given the differences between guarantees and indemnities in PCGs, it is not surprising that parties can find themselves in dispute as to the extent of their liabilities, particularly if the drafting is unclear.

The idea that, courtesy of the Court of Appeal decision back in 2012 (in Wuhan Guoyu Logistics Group Co Ltd & Anor vs Emporiki Bank of Greece SA), the commercial context and relationship between the guarantor and, say, the contractor could be a deciding factor on the meaning of a PCG (the Court of Appeal when deciding upon the nature of a guarantee, saying that the commercial context and the relationship between the guarantor and the contractor should be taken into account, listing several matters to consider, one of these being that guarantees given by banks or other independent financial institutions more often than not fell into the indemnity category) was effectively scotched by the Commercial Court in a case in late July this year, Rubicon Vantage International Pte Limited vs Krisenergy Ltd.

The Rubicon case concerned the validity of demands made in connection with a PCG covering life extension works under a charter of a floating storage and offloading facility. The judge in the case was at pains to state that the simple fact that the guarantor was a parent company (and not a bank) did not help with understanding whether or not the parent company had to pay on demand. Although parent companies traditionally avoid giving indemnity guarantees, this point on its own did not mean that it could be presumed that the guarantee was not intended to be an indemnity payable on demand. The wording of the PCG (and not the identity of the guarantor) was paramount.

The facts in Rubicon were illustrative of the difficulties that can arise from unclear drafting in relation to understanding exactly what a PCG means. With a view to heading off a possible trip to the court, what lessons can be learned from this case?

First, a PCG should be drafted with absolute clarity, checking that it accurately reflects the parties’ intentions on how and in what situations it is intended to pay out. Second, if circumstances arise that mean a demand will be made under a PCG, the demand should be made strictly in accordance with the procedure set out in it.

PCGs are certainly useful tools for securing the interests of a proposed beneficiary, but to realise their full potential and to obtain the expected result without ending up in court, Rubicon provides a timely warning that each step in the process of negotiation and making a demand must be given careful consideration.

Stephanie Canham is is national head of projects and construction at Trowers & Hamlins