Publications & Events
Client Alert
Alert

Advance payment guarantees: three unsuccessful attempts to prevent encashment

Advance payment guarantees are commonly used in the construction industry. However, successful challenges to a demand made under an advance payment guarantee appear to be less common. This article looks at three recent cases where demands were made under advance payment guarantees, and considers why the attempts to prevent encashment failed.

 

Advance Payment Guarantees

In construction and engineering projects an employer will often make advance payments to a contractor to enable it to meet significant start up or procurement costs. As a condition of advance payment, the employer will typically require a guarantee (also referred to as a bond), provided by a bank or other financial institution, to secure the payment against any default by the contractor. The value of the guarantee will usually be expressed to amortise as the contractor performs work and earns money under the contract, because the amount of the advance payment to be secured is reduced.

Advance payment guarantees are often provided on an ‘unconditional’ or ‘on demand’ basis. This means the guarantor has an autonomous obligation to pay out in the event that a compliant demand is made. In this article, we consider how the guarantors challenged the ‘on demand’ nature of the guarantees by claiming the demands were not compliant with the terms of the guarantee.

Case 1: Técnicas Reunidas Saudia v Korea Development Bank [2020] EWHC 968 (TCC)

In the first case, Técnicas Reunidas Saudia (“TRS”) was engaged as the main contractor for a major construction project in Saudi Arabia. Korea Development Bank (“KDB”) provided a demand guarantee in respect of advance payments made by TRS to a subcontractor. The guarantee was expressed to be payable on TRS’ ‘first simple written demand’.

TRS made a demand for payment from KDB under the guarantee after the subcontractor defaulted under the subcontract. KDB rejected the demand, stating that a condition of the guarantee had not been met. The guarantee required that the advance payment be made to a bank account of a specific account number ‘held with HSBC’ (the “HSBC Condition”). TRS had made the advance payment into a bank account with the correct account number, but the account was held at a different bank. KDB argued the HSBC Condition was not met.

The English Technology and Construction Court reviewed the relationship between the other bank and HSBC and held there was an association between them, and therefore the conditions of the guarantee had been met. In reaching this decision, the judge examined the corporate relationship between the banks and even considered the fact that they used the same logo to be significant. The judge also gave weight to the evidence that there was no other bank account with the correct account number held at HSBC.

The case shows the court’s willingness to apply the written details of an advance payment guarantee without taking a literalist approach if to do so would produce an uncommercial outcome. Here, the court noted that if KDB’s argument were accepted, it would render the entire document worthless from the beginning.

Case 2: Leonardo S.p.A v Doha Bank Assurance Company LLC [2020] QIC (A) 1

Advance payment guarantees were also considered in the second case, where Leonardo was the main contractor for the provision of a radar system in Qatar. Doha Bank Assurance Company (“DBAC”) provided two demand guarantees in respect of an advance payment made by Leonardo to a subcontractor and the performance of the subcontractor. Leonardo subsequently terminated the subcontract and demanded payment from DBAC under the guarantees.

The guarantees were expressed to be ‘unconditionally payable’ to Leonardo ‘upon first written demand’. However, DBAC rejected the demands and argued the guarantees required Leonardo to make a claim in writing against the subcontractor before making a demand, and to attach evidence of such claim to its demand. DBAC relied on the wording in the guarantees, which stated that with regards to DBAC guaranteed sums, ‘[Leonardo] might have to claim [back] in writing from [the subcontractor]’.

Similarly to the case of TRS v KDB, the Appellate Division of the Civil and Commercial Court of the Qatar Financial Centre carefully analysed this wording. The judgment of the court, which was given by Lord Thomas of Cwmgiedd (a former Lord Chief Justice of England and Wales), made it clear that the guarantees did not require documentary evidence to be provided to support a demand under the guarantees. The court stated that including a documentary requirement would have been simple, if one had been intended. As a result, the court concluded that the words referring to a claim in writing should be disregarded, and the demands were valid.

Secondly, in relation to the advance payment guarantee, DBAC claimed the limit of the guarantee had been amortised as work was performed, and therefore Leonardo’s demand for payment was excessive. Using the same approach as above, the court reviewed the precise wording of the guarantee to assess the condition for a reduction. The condition required the subcontractor to present to DBAC an invoice which had been approved, signed and certified by Leonardo. However, the subcontractor had not provided any such invoice to DBAC, even though it was clear that substantial work had been performed by the subcontractor. The court emphasised that the obligations under the advance payment guarantee operate independently of the subcontract, and stated it was not sufficient for DBAC to show agreement under the subcontract of amounts due for work performed. The court found that without the required invoice, the condition had not been met and DBAC’s argument that the limit of the guarantee had been reduced was therefore not accepted.

Case 3: Obayashi Qatar LLC v Qatar First Bank LLC (Public) [2020] QIC (F) 5

In the third and most recent case, Obayashi Qatar and HBK Contracting Co., acting through a joint venture (the “Claimants”), were the main contractors for a construction project in Doha, Qatar. Qatar First Bank (“QFB”) provided an advance payment guarantee in respect of a payment made by the Claimants to a subcontractor. The subcontractor failed to perform under the subcontract, and the Claimants demanded payment from QFB under the guarantee.

QFB rejected the demand, claiming that the Claimants had: (i) already recovered the advance payment in full by way of monthly deductions from monies payable to the subcontractor, and (ii) as a result, acted fraudulently in making such claim. 

The Claimants argued that the subcontractor’s performance had been inadequate, and the Claimants had incurred significant expenses in rectifying the work. It was agreed with the subcontractor to recover these expenses through reductions in the amounts otherwise payable to the subcontractor. The Claimants and subcontractor also agreed this debt would (in part) be secured by the advance payment guarantee, and agreed to reduce the monthly repayments of the advance payment by the subcontractor.

The Civil and Commercial Court of the Qatar Financial Centre held that there was nothing to prevent the Claimants from agreeing with the subcontractor to reduce the recovery of the advance payment. The court noted that the advance payment guarantee was a separate contractual instrument, and the terms of the subcontract were not incorporated into the guarantee. However, the court added that the Claimants were not permitted to reverse or reallocate any part of the advance payment which had already been recovered. The court allowed the demand for the unamortised portion of the advance payment guarantee to proceed.

 

Commercial Implications

All three cases display a common feature of advance payment guarantees. When expressed in ‘on demand’ language, the courts will treat guarantees as autonomous instruments, with the starting position being that a demand which appears to be valid is to be honoured by the guarantor. This is consistent with the usual purpose of advance payment guarantees, namely, to function as a liquid financial instrument that may be called upon in the event of an advance payment not being repaid.

Each case also demonstrates some of the subtle nuances of the courts’ approach to ‘on demand’ advance payment guarantees.

First, although the terms of an advance payment guarantee will be closely applied when assessing the compliance of a demand under the guarantee, the courts will seek to avoid an overly literal application of those terms if doing so renders the advance payment guarantee commercially worthless (TRS v KDB).

Secondly, it is important to understand the role of the guarantor (or bondsman), which will often be a bank or other financial institution. When a demand is made on an advance payment guarantee, the guarantor is not concerned with the contractual position as between the procurer of the guarantee (e.g. a subcontractor) and the beneficiary of it (e.g. a main contractor). The guarantor’s function is essentially to verify whether the demand is in accordance with the terms of the guarantee. If so – payment must be made. Thus, the fact that the amount of the advance payment has amortised as between a main contractor and its subcontractor does not mean it has amortised for the purposes of the guarantee if the guarantee lays down a procedure for recognising that amortisation, and that procedure has not been followed (Leonardo v DBAC).

Thirdly, if an advance payment guarantee has amortised pursuant to its terms, the beneficiary is only entitled to demand up to the amortised value of the guarantee. If, however, a beneficiary in good faith demands more than this amortised amount, the demand may still be valid – and needs to be met – but only to the extent of the amortised value of the guarantee (Obayashi v QFB).

 

Rosa Hurdidge (White & Case, Trainee Solicitor, London) contributed to the development of this publication.

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2020 White & Case LLP