Demand Bonds: In The UK, Less Is More

A recent case has opened a debate as to the drafting required to create a demand bond as opposed to a guarantee. If you are involved with issuing demand bonds or are a beneficiary under a document that purports to constitute a demand bond, you will need to look closely at the language used in such document to ensure a court will interpret it as such.

Summary

It is often a requirement of commercial arrangements that a third party agrees to stand behind a party to the main contract. This support can take many forms—an agreement to ensure that the party to the main contract duly performs or an entirely separate obligation to make good the failure to perform. The former is an example of a guarantee and the latter an example of a demand bond.

Demand bonds provide comfort to the beneficiary that if its counterparty under a contract breaches that agreement, it need only inform the provider of the demand bond (usually a bank) in writing of the default, and the provider will pay out a specified sum. The beneficiary is entitled to payment simply on submitting a statement (or certificate) that the counterparty is in default of the contract.

Under English law, demand bonds create a primary liability that is wholly independent of the main contact, whereas guarantees create a secondary liability that is contingent upon the obligation under the main contract being enforceable. The distinction can therefore be crucial if there is dispute as to the validity of the terms of the main contract.

In a recent case (Wuhan Guoyu Logistics Group Co Ltd and others v Emporiki Bank of Greece SA [2012] EWHC 1715 (Comm) (22 June 2012)), the High Court in England found that even though a bank had agreed to "irrevocably, absolutely and unconditionally guarantee, as primary obligor and not merely as surety, the due and punctual payment by the buyer" and that "upon receipt by us of your first written demand stating that the [Buyer] has been in default of the payment obligation for twenty (20) days, we shall immediately pay to you...," this was nevertheless a guarantee, not a demand bond. Such wording (particularly if given by a bank) had previously been viewed as a strong indicator of a demand bond, but the court held that the primary obligation assumed by the bank was the obligation to pay the sum actually due under the underlying contract.

Facts

The seller entered into shipbuilding contracts with the buyer. The contract price was to be paid in installments, and the bank...