Repudiatory breach sinks ships

The High Court judgment in Havila Kystruten AS v Abarca Companhia De Seguros, SA [2022] EWHC 3196 (Havila) provides a clear example as to how contracts are interpreted in practice. One of the main issues of contention in this case was regarding the bond wording and whether the bonds were ‘on demand’. Havila offers clarity into how the wording of a bond may be interpreted by the courts and demonstrates the importance of clear and concise drafting.

Specifically, did it make any difference that the bond wording did not state payable ‘on demand’ but instead referred to a ‘claim’?

Background

This case concerns the termination of two shipping contracts for the design and build of two vessels to be carried out by Hijos. When the dispute arose, Havila, the Norwegian ship owner and buyer, had already paid Hijos three instalments which amounted to a sum of €36.8m for both vessels.

On 24 November 2019, Hijos sought to terminate the contracts on the basis that Havila had failed to provide a written committed statement of its financing for the vessels. Havila argued that Hijos was not lawfully entitled to terminate the contract and that instead they, Havila, were terminating the contract. Havila sought to recover the three instalments that they had already paid from Abarca Companhia Seguros (Abarca) who had provided six bonds to Havila as a security mechanism in case of termination of the shipping contracts.

Issues

The main issues regarding surety law concerned whether the bonds provided to Havila were in the nature of ‘on demand’ bonds or whether in order to claim on the bonds Havila had to establish that its termination was valid and that Hijos was obliged to refund the instalments Havila had paid. Also in dispute was whether the bonds responded to termination at common law or only to the express contractual terms relating to breach.

Havila’s commitment letter was held to be sufficient to meet the contract requirement, so Hijos’ attempted termination became a repudiatory breach, allowing Havila’s claim, and hence the call on the bonds.

On demand?

Both parties cited the principles in Shanghai Shipyard Co Ltd v Reignwood International Investment (Group) Co Ltd [2021] EWCA Civ 1147.

A key aspect of a surety guarantee is that whether the guarantor is liable depends upon whether the principal is liable themselves. A surety guarantee may also still require for there to be a demand made for the sum.

On the other hand, a demand guarantee is a form of security that is payable upon there being a demand made for the sum and is based on production and examination of documents. Payment must be made irrespective of any underlying disputes as to the liability of the principal.

Havila contended that where a bond was issued by an insurance company in the ordinary course of its business, as here, that fact made it more likely to be a demand bond. To the contrary Abarca submitted that the absence of certain language such as ‘absolutely and unconditionally’, ‘first written demand’ and ‘immediate payment’ led to the presumption that the bonds were not on demand.

The bonds were found to be demand bonds because Abarca were obliged to make payment once particular documents were produced and Havila was not required to prove that Hijos was liable. It was held that the focus should not be on an individual word but instead, “what is important is to construe the bonds as a whole and identify their essential nature,” (para 388). Mr Justice Henshaw outlined that it makes no difference that the words ‘on demand’ and ‘demand’ were not used and rather the word ‘claim’ was, as this is a functionally similar word.

Whether the bonds respond to termination at common law

Abarca submitted that if Havila was entitled to terminate the shipbuilding contracts due only to Hijos’s repudiatory breach, then Havila was not allowed to recover the sums under the bond. The court rejected this view.

What does this mean?

This case offers further clarity on how the wording of a bond may be construed in practice. It makes clear that it is the true essence of the bond as a whole that is key to determining whether a bond is on demand or not, and that individual words are not determinative of this.

This insight was co-authored by trainee solicitor, Emily Pitts.