Refund Guarantee for Shipbuilding Contracts

Overview

Refund guarantees are an integral part of a shipbuilding project. Whilst they are not part of the shipbuilding contract as such, it is unlikely that any ship building contract would be signed if there was no such guarantee for the buyer. The refund guarantee is often regarded as the “financial cornerstone” of a shipbuilding project.

Copyright in the BIMCO Refund Guarantee for Shipbuilding Contracts is held by BIMCO.

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Background

Refund guarantees are an integral part of a shipbuilding project. Whilst they are not part of the shipbuilding contract as such, it is unlikely that any ship building contract would be signed if there was no such guarantee for the buyer. The refund guarantee is often regarded as the “financial cornerstone” of a shipbuilding project.

The construction of the ship is paid in advance in instalments between the date of contract and the delivery of the ship. The purpose of the refund guarantee is to provide the buyer with a safe option to recover the instalments already paid in case the shipbuilding contract is terminated due to the builder’s default and the ship is not delivered.

The BIMCO Refund Guarantee for Shipbuilding Contracts is intended to be a balanced instrument designed to protect the interests of all parties involved in the project - the builder, the buyer and the issuing bank.

It can be used with all typical shipbuilding contracts, including   NEWBUILDCON, SAJ and Chinese forms. It provides legal certainty for the parties in an area which can involve some legal complexity. It is important to note that the Refund Guarantee should be read and operated in conjunction with the shipbuilding contract pursuant to which it is issued, and be consistent with it.

It is important that anyone contemplating using the guarantee should carefully read these explanatory notes prior to using it.

The latest edition of this contract is the BIMCO Refund Guarantee for Shipbuilding Contracts, issued in 2021.

Copyright in the BIMCO Refund Guarantee for Shipbuilding Contracts is held by BIMCO.

Drafting team

The BIMCO Refund Guarantee for Shipbuilding Contracts has been developed by a team comprised of shipyards, banks, owners and legal experts. BIMCO is grateful to the following individuals for assisting us with this important project:

  • Ian Gaunt (Chairperson)
  • David Lan, ICBC
  • Insu Chung, Hyundai Heavy Industries (HHI)
  • Min Han, Ewha Womans University
  • Klaus Vilstrup, Dampskibsselskabet NORDEN A/S
  • Yu Yang, Innomarine 
  • Richard Lord, QC
  • Chris Kidd, Ince Gordon Dadds LLP
  • Sean Gibbons, Stephenson Harwood LLP

BIMCO secretariat support was provided by Nina Stuhrmann, Manager, Contracts & Clauses and Mads Wacher Kjærgaard, Manager, Contracts & Clauses.

Explanatory Notes

BIMCO is aware that contracts are a result of negotiations and therefore compromises are made to reach an agreement. Whilst the majority of BIMCO contracts are standard forms and changes and amendments are made to reflect individual projects, this is not what we recommend for the Refund Guarantee. This is because English law is complex when it comes to guarantees and there are many legal principles and judgments to be taken into account. In case the wording of the guarantee is not crystal clear when it comes to the nature of the guarantee, this has to be decided by arbitration tribunals or the courts.

Due to the complexity of the subject, it is recommended that parties act cautiously and obtain legal advice before amending the guarantee to ensure that they fully understand the consequences of amendments.

Why is it of utmost importance for a buyer to understand the nature of the guarantee?

It is important to understand the nature of the guarantee and the different types of guarantees which can be issued. This has a significant impact on whether and when the guarantor has to pay. There are two principal types of guarantees often described as “demand/performance bonds” and “primary obligation guarantees” on the one hand and, on the other, “secondary liability guarantees” and “secondary obligation guarantees” sometimes described as “see-to-it guarantees”. The names are sometimes used interchangeably and the mere name of the guarantee does not always determine its legal characterisation. The material and decisive difference is in the wording of the guarantee, sometimes construed in the context of the “factual matrix” which forms the background to the issue of the guarantee.

The difference between these two types of guarantee instruments might seem to be legalistic at first sight but it can have a significant practical impact when it comes to a dispute under a shipbuilding contract. Under a guarantee which is a secondary liability guarantee, the payment obligation and the primary liability rests with the builder under the shipbuilding contract. This means that the bank will only have to pay under the guarantee when it has been ascertained that the builder is liable to repay under the shipbuilding contract.

The position is different under a demand guarantee/performance bond. A demand bond or guarantee may in principle be called on immediately and the guarantor is obliged to make payment, even if there is a dispute under the shipbuilding contract as to whether the events giving rise to payment have occurred. The guarantor cannot use any defences under the shipbuilding contract and would have to make the payment. Consequently, it would be preferable for a buyer to receive a demand guarantee/performance bond. This mechanism, however, could expose the guarantor to fraudulent or improper demands when the conditions to draw down under the guarantee are not met and there is a dispute between the buyer and the seller on whether the instalments should be refunded. To address this and to protect the guarantor and the parties to the shipbuilding contract, Clause 5 of the guarantee contains a right to delay payment pending the outcome of the arbitration or court proceedings relating to the correctness of the termination of the buyer’s termination of the shipbuilding contract.

The term “guarantee” has been retained in the title of the document but the intention of the instrument is clearly to provide for an on demand instrument with a possible postponement of payment pending the outcome of arbitration or court proceedings relating to the buyer’s right to terminate the underlying shipbuilding contract.

The parties should be aware when making changes to the BIMCO Refund Guarantee which could result in the guarantee becoming a secondary liability guarantee. What is often overlooked in practice is that any changes to the shipbuilding contract which have a material impact on the guarantor might, in the case of a secondary liability guarantee, discharge the guarantor’s liability. In practice this means that if a guarantee is a secondary liability and the parties, for example, move the delivery date, which commonly happens, the guarantor potentially could validly reject the payment unless it has agreed to the changes.

Things to keep in mind

Disclosing the shipbuilding contract to the guarantor to avoid any potential arguments on whether the guarantor can escape liability for alleged unusual provisions.

  • Avoiding any backdating of the shipbuilding contract.
  • Checking the enforceability of the guarantee in the place of registration of the guarantor.
  • Checking for local requirements to ensure that the guarantee can be validly enforced.

Clause 1 – Definitions

Definition of “Contract” – Material amendments and changes to the shipbuilding contract such as changes to the delivery or termination date and the price of the instalments should be made very cautiously and we recommend obtaining legal advice before such changes are made to ensure they do not result in the guarantor becoming entitled to reject payment under the guarantee.

Material amendments and changes to the shipbuilding contract such as changes to the delivery or termination date and the amount/number of the instalments should be made very cautiously and we recommend obtaining legal advice before such changes are made to ensure they do not result in the guarantor becoming entitled to reject payment under the guarantee.

Definition of “Demand” – The demand should be accompanied by a statement of one of the buyer’s officers. This is a formal requirement intended to provide the bank with certainty that a valid demand has been made. It should prevent fraudulent or otherwise improper demands. There is no legal definition of “officers” but we intend it to mean a person who has the appropriate authority in an organization to issue such a statement. Alternatively, the wording might be amended to substitute “authorised signatory” for “officer”.

This definition is limited to the first demand under the guarantee. In cases where a dispute as to the builder’s liability to repay the paid instalments under the shipbuilding contract has been referred to the courts or arbitration, a so called “further demand” needs to be made. This demand has to be accompanied by a copy of the award or judgment and is further described in Clause 5.

Definition of “Maximum Liability” – The parties are required to agree and state a maximum liability amount. Legal costs are not covered under the maximum liability. The parties should amend the guarantee if they want legal costs to be included.

Clause 2

Effectiveness of the guarantee and payment obligation - The guarantee becomes effective once the builder has received the first instalment. The end of the validity period is dealt with in Clause 4 which determines that the guarantee will remain in force until one of the listed events occurs (for more, see Clause 4 below).

Clause 3

Nature of the guarantee - This clause determines the nature of the guarantee. It has been included to make it clear that the guarantee is an demand guarantee.

Clause 4

Duration of the guarantee  - The guarantee will come into force once the first instalment has been paid (see Clause 2) and will remain so until one of the three listed events occur.

The first event is when the ship is delivered under the contract and the second event is when the instalments have been refunded to the buyer by the builder or the guarantor.

The third event is a date the parties have to insert. It has to be calculated in accordance with the terms of the shipbuilding contract which will need to be carefully reviewed to take account of the potential duration of the contract, the extent to which the delivery date may be extended for permissible delay under the contract and the agreed rights for the buyer to cancel, rescind or terminate the contract. Consideration should also be given to allowing additional time for the buyer to make a decision as to how to proceed in relation to a possible termination of the shipbuilding contract and then make a valid demand under the contract and the guarantee as it may need to obtain board approval and consult with any financing bank. We recommend obtaining legal advice before agreeing the expiry date.

We recommend inserting a fixed date and not a reference to a number of days after the contractual delivery date to avoid any uncertainties as to when the demand has to be made.

 It is very important to make the demand before the end of the validity period. Any demand after the validity period has lapsed will be invalid and the guarantee will not be able to be drawn on. Consequently, the guarantor is not obliged to refund the instalments.

This clause also gives the guarantor the right to delay payment. The guarantor can do so in situations where either the buyer or the builder have started legal proceedings. To give the guarantor the right to delay the payment, the dispute must relate to the right to repayment of the sums guaranteed and as stated in the demand.

Clause 5 - Postponement of payment in the event of a dispute

This clause deals with the consequences when a “Notice of Dispute” under Clause 4 has been sent. It is important to note that after a final and unappealable award has been handed down, a further demand with the amount finally awarded should be sent to the guarantor.

The guarantee does not cover settlement agreements and the parties need to amend it if they want to include such agreements.

Clause 6

Grossing up provision - This clause is self-explanatory.

Clause 7

Currency - This clause is self-explanatory.

Clause 8

Assignment - This provision is intended to reflect the industry practice on the assignment of refund guarantees. We recommend that you review the assignment provision under the shipbuilding contract to ensure that it is aligned with the guarantee.

This provision needs to be read in conjunction with Clause 2. Clause 8 does not deal with how payment has to be made to an assignee (usually following an event of default under an underlying finance contract between buyer and its bank). This will be dealt with in a separate assignment agreement and notice of assignment.

The guarantee does not address a novation of the guarantee in case of a novation of the shipbuilding contract. In practice, a new guarantee would need to be issued in such circumstances since the novation operates as a discharge and replacement of the parties and their respective contractual obligations.

Clause 9

Law and Arbitration -  The clause provides for two options as to the forum in which disputes under the guarantee are to be referred. Both have in common that the governing law is English law. This reflects the fact that most international shipbuilding contracts are governed by English law.

The first jurisdiction option is based on the English law option in the BIMCO Law and Arbitration Clause 2020. This clause does not include the LMAA Small and Intermediate Claims procedures. The reason is that the amount under this guarantee will invariably be higher than the default limits set out in these procedures. The clause also does not provide options for arbitration venues other than London, but parties can adapt if they wish to refer to another venue. The explanatory notes for the BIMCO Law and Arbitration Clause 2020.

The second jurisdiction option is the High Court of England and Wales. In case neither of the options are deleted, the clause will default to option (a) which is arbitration.

In choosing between arbitration or court proceedings for resolution of disputes it is important to consider the enforceability of an arbitration award or court judgement in the country where the guarantor has its principal place of business or assets. Arbitration awards are generally enforceable in over 160 countries which are parties to the 1958 New York Convention whereas the recognition of foreign court judgements is likely to be based on more restricted multilateral international conventions (such as the Lugano convention) or bilateral treaties or on principles of reciprocity. It may also be considered that the underlying shipbuilding contract will almost invariably subject disputes to arbitration and it may be convenient for proceedings involving a dispute under the refund guarantee to be dealt with in arbitration simultaneously with an arbitration under the relevant shipbuilding contract by consolidation or through an order of the tribunals for concurrent conduct of the arbitrations.

Clause 10

Notices - This clause determines how notices, claims, demands and the Notice of Dispute can validly be given. If the parties wish to use another method to deliver any notices under the guarantee, this method needs to be added to the clause. It should be noted that notice of arbitration is covered under Clause 9.

We strongly recommend stating a generic email address (such as contracts@bimco.org) and not personal email addresses.

Attention should be paid to the delivery of the Demand under the guarantee as it has to be received by the guarantor within a certain time. The definition of “Demand” states that it has to be accompanied by a statement from one of the buyer’s officers. Since the SWIFT system has been updated, attachments can be sent via the system as well. Sending the demand by SWIFT is the safest way to ensure that it will be received by the guarantor. In practice however, due to time pressure and a potential refusal of the buyer’s bank to send such documents, the demand might in practice need to be sent by email. Despite the fact that receipt of an email can be established, it is recommended practice to send the demand by courier as well.

Clause 11

Warranties of the guarantor - This clause reflects that the guarantee is part of an international transaction and potentially local legal requirements or formalities need to be met for it to be valid. In case of any doubt, we recommend obtaining legal advice locally from where the guarantor is registered to clarify whether there are special requirements which need to be met.

Clause 12

Approvals and authorisations - At the time of drafting this guarantee, it is understood that no exchange control registration in China is required for a guarantee issued by a registered bank. However, it is recommended that parties check the current position before the guarantee is provided.

If the guarantor is in breach of this warranty, and has not obtained the necessary approvals and authorisations, and does not have to or is not allowed under local law to make payment under the guarantee, it may be liable in damages under English law for breach of the warranty. In practice, however, it might be difficult to enforce such a claim and get recovery from the bank.

Conditions of Use

BIMCO is the author of and has copyright in the BIMCO Refund Guarantee for Shipbuilding Contracts and has sole worldwide distribution rights. Use of the BIMCO Refund Guarantee for Shipbuilding Contracts is free of charge but is subject to acceptance of and compliance with the following conditions:

You are permitted to use Microsoft Word™ copies of the BIMCO Refund Guarantee for Shipbuilding Contracts for your own business to business purposes but may not otherwise distribute copies by sale, donation or lending. A Microsoft Word™ copy of the BIMCO Refund Guarantee for Shipbuilding Contracts may be obtained by contacting contracts@bimco.org.

The master copy of the BIMCO Refund Guarantee for Shipbuilding Contracts form you use must be obtained from and authenticated by BIMCO.
You may delete and/or amend the original wording of the BIMCO Refund Guarantee for Shipbuilding Contracts and/or add new wording provided that such changes are clearly marked to distinguish them from the original printed text.

You are not permitted to produce any new term sheet derived from the Refund Guarantee.

You may add your own corporate branding to the BIMCO Refund Guarantee for Shipbuilding Contracts but you may not remove or amend the BIMCO logo.

We reserve the right, at our sole discretion, to modify or replace these Conditions of Use at any time. We will try to provide at least 30 days' notice prior to any new or modified Conditions of Use taking effect. Notice will be posted on BIMCO’s website at www.bimco.org.

By using the Refund Guarantee you agree to be bound by these Conditions of Use. If you disagree with any part of the Conditions of Use you may not use the BIMCO Refund Guarantee for Shipbuilding Contracts.

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