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

Facts

The builder agreed to build one vessel for each of the buyers. Under the terms of the shipbuilding contracts, the builder was required provided the buyers with advance payment bonds relating to the first and subsequent instalments. Accordingly, the builder’s bank issued advance payment bonds in respect of six shipbuilding contracts. 

Under Article XII.3 of each shipbuilding contract, the buyer may require the builder to refund the full amount of all sums paid by the buyer to the builder in the event of the builder’s insolvency. 

Paragraph 2 of the advance payment bonds (bonds) states that in the event of “termination, cancellation, or rescission of the contract or a total loss of the vessel”, the bank was on the buyers’ first demand, obligated to pay the pre-delivery instalments to the buyers. 

Paragraph 3 of the bonds provided that in consideration of buyers’ agreement to make the “…pre-delivery instalments under the Contract…”, the bank as primary obligor, irrevocably and unconditionally undertook to pay on the buyer first written demand, “all such sums” due to the buyer under the contract. 

Due to financial difficulties shipbuilder entered and/or became subject to a debt workout procedure under the Korean Corporate Restructuring Promotion Law 2007. The buyers notified the builder that such action triggered Article XII.3 of the contracts (insolvency event) and demanded immediate refund of all the instalments paid, together with interest. The builder refused to refund the instalments. 

The buyers then demanded repayment of the instalments from the bank under the bonds, asserting that the bonds guaranteed pre-delivery instalments repayable under Article XII.3 in any insolvency event. The buyers asserted that the expression “pre-delivery instalments” in in the first line of Paragraph 3 meant all pre-delivery instalments paid by the buyers. Also, the bank agreed to pay the buyers “all such sums due to you.”  

However, the bank argued that (a) they were not obligated to make any payment to the buyers as the expression “such sums” was limited to the sums referred to in Paragraph 2 of the bonds, (b) Paragraph 2 did not include any reference to the buyers’ rights under Article XII.3 of the contracts to repayment upon the builders’ insolvency. Thus, the bonds cover the repayment of the instalments only in the circumstances described in paragraph (2) of the bond. 

The first instance judge rejected the bank’s argument. He stated that the bank’s construction would have “the surprising and uncommercial result that the Buyers would not be able to call on the Bond on the happening of the event which would be most likely to require the first-class security." 

However, at the CoA Lord Justice Thorpe, Lord Justice Patten (and Sir Simon Tuckey dissenting) reversed the decision of the judge and gave summary judgment in favour of the bank. According to the CoA, the word "such" in paragraph 3 of the bonds were significant and should not be disregarded. While acknowledging it could potentially refer only to the "pre-delivery installments" mentioned in paragraph 2, the CoA found it grammatically more likely that "such sums" referred to the entirety of the sums defined in paragraph 2. These sums were specifically those due upon rejection, termination, cancellation, rescission, or total loss of the vessel. Lord Justice Patten reasoned that interpreting "such sums" as only referring to pre-delivery installments would render paragraph 2 meaningless. If the bond was to guarantee for the repayment of the pre-delivery instalments regardless of the circumstances in which they came to be repayable, paragraph (2) could have been omitted in its entirety. He added that effect should be given to the natural meaning of the words, unless this produced a result that was so extreme that it could not have been intended. In the present case, the construction of the bond in the banks’ favour would not produce an absurd or irrational result. The matter went before the Supreme Court. 

Held

The Supreme Court unanimously reversed the Court of Appeal decision. 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 [the buyer] 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.” In the end, the Supreme Court preferred the buyers’ submission 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