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In this post Aleksandra Gajewska, an Associate, and David McKie, a Partner at CMS, preview the decision awaited from the UK Supreme Court in the matter of Shanghai Shipyard Co. Ltd v Reignwood International Investment (Group) Company Ltd.

On 8 December 2022, the Supreme Court will hear the appeal in Shanghai Shipyard Co. Ltd v Reignwood International Investment (Group) Company Ltd. This will be a significant decision for those involved in construction projects and their financing and should clarify the legal principles applicable to the interpretation and effect of guarantees of payments or refunds due under shipbuilding, onshore and offshore construction contracts.

Factual background

Shanghai Shipyard Co. Ltd (the “Shanghai Shipyard”) is a company operating a shipyard in Shanghai, providing shipbuilding and repairing services. Reignwood International Investment (Group) Company Ltd (“Reignwood”) is an international multi-industrial company offering investment services and investing in a number of industries.

By a shipbuilding contract (the “Contract”) Shanghai Shipyard agreed to build an offshore drillship, “Tiger 1” (the “Vessel”) for Reignwood for US$200 million.

In due course, Reignwood was replaced as the buyer by a single purpose vehicle, Opus Tiger 1 Pte. Ltd (“OT1”). The price was to be paid in three instalments, with the final instalment of US$170 million due upon delivery (the “Final Instalment”). Reignwood entered into an “Irrevocable Payment Guarantee” to support OT1’s obligation to pay the Final Instalment in favour of Shanghai Shipyard (the “Guarantee”).

The key provisions of the Guarantee were as follows:

  1. Clause 1 of the Guarantee provided that:

“In consideration of your entering into the Shipbuilding Contract…[Reignwood] hereby IRREVOCABLY, ABSOLUTELY and UNCONDITIONALLY guarantee in accordance with the terms hereof, as the primary obligor and not merely as the surety, the due and punctual payment by the OWNER of the Final Instalment of the Contract Price amounting to a total sum of United States Dollar US$170,000,000 as specified in (2) below…”. (Emphasis added.)

  1. Clause 4 of the Guarantee provided that in the event that OT1 fails to punctually pay the Final Instalment and:

“any such default continues for a period of fifteen (15) days, then, upon receipt by us of your first written demand, we shall immediately pay to you or your assignee all unpaid Final instalment, together with the interest as specified in paragraph. (3) hereof, without requesting you to take any or further action, procedure or step against the Owner or with respect to any other security which you may hold”.

  1. Clause 4 provided that in the event of any dispute between OT1 and Shanghai Shipyard and if such dispute is submitted to arbitration (in accordance with Clause 17 of the Contract), Reignwood:

 “shall be entitled to withhold and defer payment until the arbitration award is published”

and

“shall not be obligated to make any payment to [Shanghai Shipyard] unless the arbitration award orders [OT1] to pay the Final Instalment”.

  1. Clause 7 further provided that:

Reignwood’s “obligations under this guarantee shall not be affected or prejudiced by: (a) any dispute between [Shanghai Shipyard and OT1] under the Contract…”.

On 12 December 2016, Shanghai Shipyard gave notice of completion of the Vessel to OT1, and on 11 January 2017, Shanghai Shipyard made a demand to OT1 for the Final Instalment and other sums allegedly due under the Contract. Given that the sums due had not been paid, on 23 May 2017 Shanghai Shipyard made a demand of Reignwood under the Guarantee for payment of the Final Instalment.

At some stage OT1 contended that the Vessel contained a number of major and critical defects and a dispute arose between Shanghai Shipyard and OT1 as to whether the Vessel was in a deliverable condition. On 10 December 2018, Reignwood commenced proceedings in the Singapore court, seeking leave to commence an arbitration against Shanghai Shipyard, in the name of OT1. The arbitration proceedings were eventually commenced on 3 June 2019.

Meanwhile, Shanghai Shipyard commenced the proceedings in the Commercial Court against Reignwood under the Guarantee.

Decision of the Commercial Court

The Commercial Court had to decide the following issues (as preliminary issues).

Firstly, was the Guarantee:

  • a demand guarantee, such that, subject to issue 2 below, Reignwood’s liability arose upon (and by reason of) a demand, regardless of OT1’s liability under the terms of the Contract; or
  • a “see to it” guarantee such that Reignwood’s liability arose only if OT1 was liable to pay the Final Instalment under the terms of the Contract?

Secondly, whether Reignwood, as a guarantor, could refuse payment under Clause 4 of the Guarantee pending the outcome of an arbitration between Shanghai Shipyard and OT1 concerning OT1’s liability to pay, and Shanghai Shipyard’s entitlement to claim, the Final Instalment under the terms of the Contract.

The Commercial Court (Knowles J) determined both issues in favour of Reignwood. It was held that: (1) the Guarantee was a “see to it” guarantee; and (2) in any event, Clause 4 was engaged by the commencement of the arbitration, notwithstanding that it had commenced after the date of demand, such that Reignwood was entitled to refuse payment pending the outcome of the arbitration.

Shanghai Shipyard appealed the Commercial Court decision.

Decision of the Court of Appeal

The Court of Appeal considered the same two issues and found for Shanghai Shipyard.

The Court of Appeal disagreed with the Commercial Court on the construction of the Guarantee and found that: (1) the Guarantee was a demand guarantee; and (2) Shanghai Shipyard was entitled to payment under the Guarantee, given that it made a demand prior to the arbitration being commenced.

With regard to the first issue, in reaching its decision, the Court of Appeal commented extensively on the differences between a demand guarantee and a “see to it” guarantee (or a surety guarantee). In particular:

  • The Court of Appeal restated that a “see to it” guarantee creates an independent, primary liability of the guarantor upon the obligor’s default. A demand guarantee, in turn, is contingent upon and arises by reason of the demand (without the beneficiary having to establish a liability of the obligor). In case of any dispute as to the obligee’s entitlement, a demand guarantee provides that the guarantor must “pay now and argue later”.
  • The Court of Appeal further emphasized that guarantees should be interpreted in accordance with normal principles of construction and no particular regard should be given to the identity of the guarantor, such that similarly worded guarantees shall be interpreted in the same manner, regardless of whether they are issued by a bank, or a parent company. The court highlighted the risk in over-reliance on preconceptions or presumptions. In particular, the court considered that “Paget’s Presumption” (derived from Paget’s Law of Banking (15th edition)), approved by the Court of Appeal in Wuhan Guoyo Logistics Group Co Ltd v. Emporiki Bank of Greece SA [2012] EWCA Civ 1629, was not of any real assistance. The authors of Paget were attempting to provide a succinct statement of guidance based on previous case law, and wrote that an instrument will almost always be construed as a demand guarantee if it: (a) relates to an underlying transaction between the parties in different jurisdictions; (b) is issued by a bank; (c) contains an undertaking to pay “on demand”; and (d) does not contain clauses excluding or limiting the defences available to a guarantor.
  • The court also cautioned against overreliance on previously decided cases regarding instruments that appear to be similarly worded. The court noted that such precedents may only be applied if both (a) the words used therein “taken as a whole”; and (b) the contractual context, are materially identical.
  • The court considered that a combination of the following language was critical in making this a demand guarantee:
  1. The capitalised words “ABSOLUTELY and UNCONDITIONALLY” which in the court’s view would convey to a businessman that the obligations were not conditional on the liability of OT1.
  2. The words “as the primary obligor and not merely as the surety”, which expressly state that the instrument is not merely a surety guarantee.
  3. The language contained in Clause 4, including that “upon receipt by us of your first written demand, we shall immediately pay to you”, which indicates that: (a) a payment is to be made against a demand (which is a characteristic of a demand guarantee); and (b) it is to be made immediately without a need for a prior assessment of entitlement.

Taking into account the factors set out above, based on the construction of the Guarantee as a whole, the Court of Appeal decided in favour of the Shanghai Shipyard that this was a demand guarantee.

With regard to the second issue, the Court of Appeal noted that Clause 4 of the Guarantee defined the circumstances in which the demand guarantee ceases to be payable on demand, and instead, becomes payable against an arbitration award. Based on the natural meaning of the words in Clause 4, the guarantor is “entitled to withhold or defer payment” when a dispute is submitted to arbitration. However, this was only the case if the arbitration was commenced prior to a valid demand being made. This implied by Clause 4 (which provides that if a “default continues for a period of fifteen (15) days, then, upon receipt…of…first written demand”) that a right to payment under the Guarantee is “immediately” triggered. The court concluded that to divest a party of an accrued right would require clear language and such language was not contained in the proviso in Clause 4.

The 15-day timeframe to commence an arbitration was not uncommercially short and was intended to protect cash flow.

Reignwood appealed to the Supreme Court.

Comment

The Supreme Court’s judgment is eagerly anticipated. In simple terms, the Supreme Court has to decide whether on its language the Guarantee was a “demand” guarantee or a “see to it” (or surety) guarantee and if it is a demand guarantee, whether the obligation is a pay now, sue later one. These two issues of law often arise in practice and are fundamental to the efficacy of performance and refund guarantees which are used in many construction projects, not just shipbuilding. There is now some difference of opinion at the Court of Appeal level between the judgments in Shanghai Shipyard Co. Ltd v Reignwood International Investment (Group) Company Ltd and Wuhan Guoyo Logistics Group Co Ltd v. Emporiki Bank of Greece SA so it is hoped that the Supreme Court’s decision will provide further guidance as to the principles to be applied with regard to the construction of guarantees and the appropriate use (if any) of presumptions in this process.