Interpretation – bank guarantee – linked to shipbuilding contract – ambiguous term resolved by recourse to commercial common sense
Six one-ship shipbuilding contracts were entered into between the shipbuilder and 6 buyers. The total price for each vessel was payable in 5 equal installments with the final installment payable on delivery.
It was a condition precedent to advance payment by the buyers that the shipbuilder would provide refund guarantees.
The guarantees were duly issued by the builders’ bank and payment of the first installment was made by each buyer. Thereafter the builders became subject to a debt work-out procedure under the Korean Corporate Restructuring Promotion Law which lead to the buyers’ first calling upon the builders to return the first instalment and then, when they failed to do so, upon the bank to honour the guarantees.
The relevant clauses in the shipbuilding contract and the Advance Payment Bonds read as follows:
“ARTICLE XII: BUILDER’S DEFAULT
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).”
 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.
 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. (emphasis added)
The buyers contended the phrase “all such sums due to you under the contract” in clause 3 of the Bonds included the builders’ obligation to refund the installments pursuant to Article XII of the shipbuilding contracts. The bank contended that the phrase referred back to the pre-delivery installments described in clause 2 of the Bonds which made cancellation of the shipbuilding contracts a pre-requisite for the honouring of the Bonds.
Simon J in the Commercial Court held in favour of the buyers. The Court of Appeal (Patten and Thorpe LJJ, Sir Simon Tuckey dissenting) found for the bank.
The UK Supreme Court (Lords Clarke, Phillips, Mance, Kerr and Wilson concurring) restored the decision of the Commercial Court.
The difference between the majority of the Court of Appeal and the prevailing view was the primary assessment of the language used in the two related contracts.
The Court of the Appeal thought that clause 3 of the Bonds had a fairly obvious meaning and this precluded the further exercise of subjecting the competing meanings to the test of commercial common sense. Simon J, Sir Simon Tuckey and Lord Clarke saw the clause as ambiguous and settled the matter by the further test.
Lord Clarke expressed the current position as follows:
[T]he 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.
The Courts have moved away from Lord Wensleydale’s view that the language can and must be looked at in isolation in the first instance (Grey v Pearson 1857). Patten LJ went on to consider what would happen if the language was clear but the result was unsatisfactory. Commenting on Patten LJ’s approach, Lord Clarke said:
It is not in my judgment necessary to conclude that, unless the most natural meaning of the words produces a result so extreme as to suggest that it was unintended, the court must give effect to that meaning.
This case is a further example of how astute judges differ on the assessment of meaning.
Lord Diplock’s statement in the Antaios, “If detailed and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense it must yield to business common sense” is often used by protagonists on opposite sides.
Lord Clarke’s (and most modern judges’) approach is not to take a rigid view, easily finding that the words have only one meaning. In this vein he quoted Lord Hoffman as follows:
“This robust declaration [ie Diplock’s] does not, however, mean that one can rewrite the language which the parties have used in order to make the contract conform to business common sense. But language is a very flexible instrument and, if it is capable of more than one construction, one chooses that which seems most likely to give effect to the commercial purpose of the agreement.”
Although the interpretation of a contract is regarded as a question of law, the primary assessment of the language used is more properly a question of fact.
When we say that a question is one of law we mean that the question must be decided by the application of principles. Questions of fact, on the other hand, are decided by assessing the sensory perceptions of others. The intellectual understanding of language is akin the physical sense of sight.
If this approach was taken, greater deference would be given to the court of 1st instance with less scope for further division of opinion.
This content is restricted to site members. If you are an existing user, please login. New users may register below.