16 May 2017
Parent Company Guarantees - why a seemingly 'simple' document can be so lengthy and why attention to detail is crucial to avoid any problems further down the line.
David Lowe: Kirsty you're a Partner in our Banking and Finance team. I'm really keen to hear from you about Parent Company Guarantees. But there seems to be all sorts of guarantees and bonds out there, can you just give me a feeling for what they all are?
Kirsty Barnes: If you want a short succinct answer – no, not in one sentence. There are so many out there, they are used in all sorts of different sectors, what's really interesting though is that the overarching term, Parent Company Guarantee, captures so many different types.
David: But there seems to be particular bonds and guarantees and a vaguely remember from law college that there is some fundamental legal differences between those terms can you run me through that?
Kirsty: They are very very different animals. A Bond is a separate independent obligation, it's issued by one party, it doesn't depend on the underlying contract. The trigger point for payment is very simply a trigger. A guarantee, very very different animal as I've said. It is on the underlying contract, it is entirely based on that and it's entirely linked to that contract. It is a secondary obligation, it's a promise to do something if the main contracting parties fail to do so.
David: With a Bond if the underlying contract falls apart for some reason the Bond still survives and you can still use it?
Kirsty: Yes you can.
David: While with a Guarantee because it is secondary, if the underlying contract falls apart for some reason – it was ultra vires or something like that then the Guarantee falls over as well.
Kirsty: That's exactly right the Guarantee depends on the underlying contract if the underlying contract falls away, the Guarantee falls away. That's why you often see Guarantees and Indemnities used together. The Guarantee if it falls away could be backed up by the separate Indemnity which is on itself an independent obligation contained within the same document…
David: …ah right thanks. So that's why in a Parent Company Guarantee it might start off saying Guarantee but then you get further down in indemnities it's to try and strengthen the Guarantee?
Kirsty: Exactly. So just in case there's a problem with the Guarantee and the Guarantee fails for any reason the Indemnity, which is that separate independent obligation, could still survive the termination or the invalidity of the underlying contract or if the Guarantee falls away the Indemnity itself could continue.
David: Right so although there's this big difference between Bonds and Guarantees, I'm guessing then in the real world they all…well Guarantees merge a bit because you end up putting into a Guarantee all this primary stuff.
Kirsty: That's what we see a lot. The language is used interchangeably, documents are often called Parent Company Guarantees when they are actually a Bond or they are called a Bond when they are actually a Guarantee and that's why it's so important to look at the language. It's so important to make sure that what you're drafting is actually what you want.
David: Right so all the case law then presumably says…don't really care what is called, what does it actually say. Does it…is it primary or secondary?
Kirsty: There is a huge amount of case law and you can imagine if somebody thinks they've got a Bond and just make a claim for a payment of money actually the language that has been used in the underlying document creates a Guarantee, you've then got to take step back and look at what can you claim for. There's been a huge amount of case law on the subject over the last 20, 30, 40 years, all of it on the same notion, all of it on the same basis. What does the language actually say, what do the parties actually intend?
David: So if you're the beneficiary of a Parent Company Guarantee it would be really important then that you not just have Guarantee wording that you've got this Indemnity and you've got primary obligor and that kind of stuff that would be really helpful then.
Kirsty: It could be but again you've really got to stop and think about what kind of Guarantee are you looking for. Are you looking for a Performance Guarantee for example? In which case the Indemnity could be helpful but the Indemnity will be for a payment of a sum of money. Whereas if you're looking for a Performance Guarantee then actually what you want is somebody to step in and perform the contract if your primary party falls away for any reason, becomes insolvent for example.
David: Right so actually good point, because with a Parent Company Guarantee often you want the Parent to step in and finish off so you want often a Parent Company Guarantee to be a Performance Guarantee.
Kirsty: But again you've got to remember in certain sectors the specialist person that you are contracting with might be the only person in the UK or across the globe that can deliver that particular service or produce that particular widget. If you're looking for another company to step in is it the Parent Company, have they got the access to the kit to be able to do that. In that instance the Parent Company Guarantee, it might actually be better having a Payment Guarantee so that the Parent will pay a sum of money so that you can go and source it elsewhere or you could purchase the manufacturing organisation if it looks as if it is going insolvent.
David: And of course motivates the Parent to make sure that the subsidiary carries on anyway.
Kirsty: It is a huge motivating factor but again these are all things just to remember and just to consider what do you want in terms of the back-up? What do you want in terms of that level of comfort? Is it a Guarantee? Is it performance? Is it payment? All of it depends on the organisation that you are working with, the beneficiary can demand quite a lot but you've then got to think about the person who is actually entering into the contract, who is giving the Guarantee? What is their financial strength? Or what's the position they could be in to step-in and actually carry out that contract.
David: Now I also remember from law college, you know it's some time ago but I do vaguely remember that with Guarantees there's loads of special rules about it needs to be in writing. Isn't there some 17th century law, isn't there something about that?
Kirsty: That Statute of Frauds is what you're referring to. Guarantees do need to be in writing, they need to be signed, they need to be entered into between the Beneficiary and the personal actually giving the Guarantee. The other party doesn't need to be a member of that agreement but it's really key that the Beneficiary and the Guarantor sign. Some recent case law, very exciting, has just ruled that you can create a Guarantee by an email chain.
David: If it's not written there on paper and wet ink signature and it's just an email exchange that might work?
Kirsty: That might be enough. Again it's always best to make sure that you have a document which is signed by both parties and it's a nice separate piece of paper, but you can actually create a Guarantee by an exchange of emails. You can actually, if you've got sufficient evidence to show that the contracting parties knew what they were doing, the intention was to create a relationship on that legal level, then actually that exchange of emails is enough.
David: Wow so that's good news and that is easy to form, it could be bad news because they are easy to form and you might accidentally give a guarantee.
Kirsty: Exactly…or more importantly you could get partway through a negotiation have a whole string of emails which purports to be agreeing an Guarantee on its terms. You've got two parties negotiating in good faith on behalf of each party and yet the negotiations could fall away or the contract could change but you still might have that Guarantee, that Guarantee might be in place because of the emails.
David: So do Guarantees need to be deeds?
Kirsty: Not necessarily. It's always better if it is because it does away with the need to show the intention to create legal relations but as long as you've got something in writing it could be enough.
David: Obviously a Parent Company Guarantee is traditionally from the Parent of the supplier to a more senior company in the organisation but sometimes it's not, sometimes it's a sister company or some other distant subsidiary and I've heard of the downstream and upstream guarantees, could you tell me about what that means?
Kirsty: Parent Company Guarantees are the generic term and obviously we've talked about they can be used in any and many different situations. It is usually the Parent that issues the Guarantee because it is the TopCo of a group. In that case there's no need for the parent to show corporate benefit because it's the overarching Parent of the group. If you have a sister company or another subsidiary of that group that's absolutely fine and there's nothing to stop that and there's certainly no legal reason why it can't be that other entity but then you need to show that there's a corporate benefit in the relationship between the beneficiary and the company entering into that Guarantee. It needs to show that actually it's doing it for the good of the whole group for example. That needs to be documented, it needs to be documented in the board resolutions of that particular company.
David: I'm a beneficiary, the Parent Company Guarantee suggests I am going to get it from a Parent, but sometimes it's not from the TopCo sometimes it's from the sister company, what issues does that present?
Kirsty: A number of issues, first is obviously to make sure that you know the party that is giving the Guarantee and you check out their financial strength. Do they have the wherewithal to pay if it's a Payment Guarantee or do they have the ability to actually perform the Guarantee if it's Performance Guarantee. The other thing to consider as well is if it is a sister company what's their opportunity to show corporate benefit how can you generate the idea of the corporate benefit that it needs to show can actually be evidenced by way of Board resolutions.
David: So if you're the beneficiary and it is not from a Parent Company the guarantee it's from a sister company do you need to ask to see those Board minutes to satisfy yourself?
Kirsty: It's always best to, but again you might be aware of the organisation, you might be aware of the way that the group structure for the Parent works and you might be comfortable that the entity actually it's supporting the rest of the group it's entering into the Guarantee because it is in the wider benefit of the rest of the group that it's a party to. But as a beneficiary you do need to stop and think about the corporate entity that you are dealing with. Is it financially strong? Can it perform the obligations you are asking it to and what's its relationship with the contracting parties.
David: Ok, so we've talked about how Guarantee is a secondary obligation and it sort of lives off that underlying contract. What about if the underlying contract is varied?
Kirsty: That's the biggest difference between Bonds and Guarantees. A Bond is that separate obligation, so if the underlying contract is varied it does not change the Bond. With a Guarantee the overarching presumption is if you vary the underlying contract the Guarantee itself is void.
David: You could accidentally find yourself with a void Guarantee by doing some small variations to the contract.
Kirsty: Not necessarily a small variation, there's a case back from the 1800s called Holme v Brunskill and it's still good law today and basically it sets out the presumption that if you vary the underlying contract unless that variation is patently insubstantial or it doesn't affect the obligations of the Guarantor then the Guarantee can be void and unenforceable. So it depends what the variation is, it depends what the amendment to the contract is.
David: Sometimes you see in a Guarantee that wording that says this Guarantee is going to survive even if the underlying contract is varied. Does that not work?
Kirsty: Not anymore. It was a great piece of drafting and it was included in a lot of Guarantees and you still see it in Guarantees today. It was designed to protect, it was designed to give the pre-approval of the Guarantor so if there were any amendments it didn't matter unfortunately there was a case not so very long ago and the Courts decided that any amendment if it was substantial, if it was changing the underlying contract to a material degree it could and it would cause the Guarantee to fall away.
David: Ok so I'm a beneficiary of the Guarantee, I'm a customer of the contract, we are varying the terms of the contract materially, the pricing is all going to change, or the terms are going to be increased or whatever. What do I do, do I need a new Guarantee?
Kirsty: No you don't, all you need is the Guarantor's consent, preferably in writing to evidence that they have actually agreed but you need to do so before you amend the underlying contract.
David: So if you're an in-house lawyer looking at Guarantees what are the key things then in summary that you should be looking at?
Kirsty: The top tips, really simple, understand what you're looking for, what type of Guarantee are you really going to benefit from. Is it going to be a Performance Guarantee? Is it going to be a Bond or Payment Guarantee? Really understand who you're contracting with and what's their ability to actually stand behind the obligation that you want them to. Then think about the language that you are going to use and think about the ability to call on the guarantee, will there be any restrictions in terms of time or amount? Is there going to be a longstop date on that Guarantee? Really work it through with the underlying contract and make sure that the two sit together and the Guarantee backs up what's in the underlying contract.
David: Thank you Kirsty.
Kirsty: A pleasure.
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