Shipbuilding Contract – Advance Payment Bond – Court’s position where there are two possible constructions

Shipbuilder agreed to build and sell one vessel to each of the Buyers. It was a condition precedent to payment by the Buyers of the first instalment that the Shipbuilder would deliver to the Buyers refund guarantees relating to the first and subsequent instalments in a form acceptable to the Buyers’ financiers. Shipbuilder’s bank issued refund guarantees in respect of six shipbuilding contracts.

Relevant text of the Bond:

[2] Pursuant to the terms of the Contract, you are entitled, upon your rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract or upon a Total Loss of the Vessel, to repayment of the pre-delivery instalments of the Contract Price paid by you prior to such termination or a Total Loss of the Vessel (as the case may be) and the value of the Buyer's Supplies delivered to the Shipyard (if any) together with interest thereon at the rate of ... (7%) per annum (or ... (10%) per annum in the case of a Total Loss of the Vessel) from the respective dates of payment by you of such instalments to the date of remittance by telegraphic transfer of such refund.

[3] In consideration of your agreement to make the pre-delivery instalments under the Contract and for other good and valuable consideration (the receipt and adequacy of which is hereby acknowledged), we hereby, as primary obligor, irrevocably and unconditionally undertake to pay to you, your successors and assigns, on your first written demand, all such sums due to you under the Contract (or such sums which would have been due to you but for any irregularity, illegality, invalidity or unenforceability in whole or in part of the Contract) PROVIDED THAT the total amount recoverable by you under this Bond shall not exceed US $[26,640,000] ... plus interest thereon at the rate of ... (7%) per annum (or ... (10%) per annum in the case of a Total Loss of the Vessel) from the respective dates of payment by you of such instalments to the date of remittance by telegraphic transfer of such refund.

Article XII 3 of the Contract provides that:

3. If the Builder shall apply for or consent to the appointment of a receiver, trustee or liquidator, shall be adjudicated insolvent, shall apply to the courts for protection from its creditors, file a voluntary petition in bankruptcy or take advantage of any insolvency law, or any action shall be taken by the Builder having an effect similar to any of the foregoing or the equivalent thereof in any jurisdiction, the Buyer may by notice in writing to the Builder require the Builder to refund immediately to the Buyer the full amount of all sums paid by the Buyer to the Builder on account of the Vessel and interest thereon at seven percent (7%) per annum on the amount to be refunded to the Buyer, computed from the respective date such sums were paid by the Buyer to the date of remittance of the refundable amount to the Buyer and immediately upon receipt of such notice the Builder shall refund such amount to the Buyer. Following such refund the Builder may, but shall not be obliged to, by notice in writing to the Buyer given within ten (10) business days terminate this contract.

If the Builder does not so terminate the Contract the Buyer's obligation to pay further installments prior to delivery of the Vessel under Article X 2(a),(b),(c) and (d) shall be suspended and the full Contract price shall be paid to the Builder upon delivery of the Vessel in the manner contemplated by Article X paragraph 2(e).”

Due to financial difficulties Shipbuilder entered into and/or became subject to a debt workout procedure under the Korean Corporate Restructuring Promotion Law 2007. Buyers notified Shipbuilder that such action triggered Article XII.3 of the Contracts and demanded immediate refund of all the instalments paid, together with interest at 7% per annum. Shipbuilder disputed Buyers contention and refused to effect any refund.

Buyers then demanded repayment of the instalments paid under the Contracts from the Bank under the Bonds. The Bank refused to pay on the ground that it was not obliged to pay pending resolution of the dispute between the Buyers and the Shipbuilder (this argument was rejected by the Judge and not pursued at the Court of Appeal). The Bank subsequently contended that the Bonds did not cover refunds to which the Buyers were entitled pursuant to Article XII.3 of the Contracts.

Buyers’ contented that the Bonds guaranteed repayment of pre-delivery instalments under Article XII.3 in the case of any insolvency event. However, the Bank argued that the Bonds did not cover refunds to which the Buyers were entitled pursuant to Article XII.3 of the Contracts. This argument was rejected by the Judge but accepted by the majority in the Court of Appeal [2010] EWCA Civ 582.

Recently, the Supreme Court has unanimously overruled the Court of Appeal. In doing so, Lord Clarke referred to various authorities on the subject and stated inter alia that

“…I would accept the submission made on behalf of the appellants that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.”

He preferred the Buyers’ position as it was consistent with the commercial purpose of the Bonds.

Reference: Rainy Sky S. A. and others (Appellants) v Kookmin Bank (Respondent) [2011] UKSC 50