Expert Opinion (#01-02 January-February 2013)

English Law Guarantee vs Ukrainian Suretyship — a Tale of Two Systems

Igor V. Krasovskiy, Tatiana M. Golubko

Ukrainian companies are often required to provide an English law guarantee in cross-border financing. Traditionally, overseas lenders seek to eliminate exposure to a less-established legal system and prefer to have English law governed loan documentation.

In this article we will look into some major differences between a guarantee (suretyship) under English law and Ukrainian law, and will, on that basis, discuss the enforceability of an English law guarantee against Ukrainian obligors.

What is a guarantee under English law

Suretyship exists in English law as a general term to describe a contract “by which one person (the surety) agrees to answer for existing or future liability of another (the principal) to a third person (the creditor), and by which the surety’s liability is in addition to, and not in substitution for, that of the principal”1. Contracts of suretyship fall in the categories of either guarantee contracts or indemnity contracts2.

More specifically, a guarantee is “a promise to ensure that a third party fulfils its obligations and/or a promise to fulfil those obligations if that third party fails to do so”3. An English law guarantee is a secondary obligation given to a third party to support another (primary) payment or performance of an obligation owing to that third party. A guarantor is only liable to the same extent as the principal is liable under its primary obligation.

An English law guarantee provided by a trade company in relation to the obligations of a third party corresponds to a suretyship under Ukrainian law, which is an accessory undertaking to, and entirely contingent upon, the guaranteed obligation.

Under English law a guarantee can be provided by a trade company, a financial institution, an individual and others. To the same extent, Ukrainian law imposes no limitations on the entity or the person granting the suretyship. Even though there is no legal distinction between English law suretyships granted by banks and trade companies, different forms and instruments have been developed to cater for the specific requirements of each.

For instance, English law distinguishes between a pure guarantee and a conditional payment guarantee. A pure guarantee is a contractual undertaking where a guarantor guarantees due performance by the principal obligor of its obligations under the primary agreement. Breach by the primary obligor results in the automatic breach by the guarantor and gives the beneficiary a claim for damages against the guarantor for the loss suffered as a result of the breach under the primary agreement. A conditional guarantee is created when the guarantor promises to make a payment if the principal obligor is in breach. A breach by the principal obligor under the primary contract does not amount to a breach by the guarantor but gives the beneficiary a contractual right to demand payment from the guarantor.

By comparison, it is implied under Ukrainian law that in the case of a default in relation to the underlying obligation the surety and the primary obligor are liable towards the creditor as joint and several obligors unless otherwise stated in the suretyship. Even though the surety is not liable unless the primary obligor has defaulted, it is generally accepted that the surety has the right to discharge the obligation guaranteed instead of the primary obligor prior to the occurrence of a default.

It is, however, worth noting that accessory guarantees are rarely used by the lenders and it is preferable to draft a guarantee and an indemnity which creates a “stand-alone” obligation of the guarantor.

What an indemnity is under English law

An indemnity is a primary obligation to make good any loss of the indemnified person. It is an independent obligation and is not contingent upon the underlying obligation of a third party in favor of the person to be indemnified4. If the underlying transaction is set aside the indemnity will continue to be effective.

If the underlying obligation ceases to exist for any reason the guarantee will be unenforceable as it is a secondary obligation. This also applies if the agreement is amended (except where the guarantor consented to such amendment or the amendments are not substantial and not capable of adversely affecting the guarantor). The indemnity, however, will remain in force once the underlying obligation ceases to exist, is void, unenforceable or is amended.

The concept of an “indemnity” is not supported by Ukrainian law. Thus, the inclusion of indemnity provisions approximates an English law guarantee to a first demand stand-alone guarantee under Ukrainian law.

In particular, Ukrainian law distinguishes between a stand-alone guarantee, which is independent of the guaranteed debt, and a suretyship, which is a “secondary” contract contingent upon the principal obligation. The distinction is marked by the fact that only regulated entities such as banks and financial institutions have legal capacity to provide stand-alone guarantees.

An English law guarantee and indemnity cannot be considered as equivalent to a Ukrainian law stand-alone guarantee. Instead, a Ukrainian law guarantee is more akin to an English law first demand bank guarantee or performance bond which are often payable by banks upon breach of a contractual obligation by a principal obligor in favor of a beneficiary. The duty to pay usually arises upon demand by the beneficiary. Strictly speaking performance bonds are not guarantees, and have been accepted by courts as letters of credit.

General terms

An English law guarantee needs to be in writing and signed by the guarantor whereas indemnities do not. Both, however, must feature an offer, acceptance, consideration and intention to create legal relations in accordance with English contract law. Additionally, a subsidiary must derive some corporate benefit in the event that it gives a guarantee in relation to the obligations of its parent company. To overcome potential difficulties with consideration guarantees are often executed in the form of a deed.

In contrast, both the guarantee and suretyship under Ukrainian law are regarded as security for a third person’s obligations and require neither consideration nor corporate benefit in order for the suretyship or guarantee to be valid and enforceable. Of course, care should still be taken to obtain necessary corporate authorisations/approval by shareholders or the supervisory board where required.

Guaranteed sums

The wording of an English guarantee can be relatively broad and seek to include the present and future liabilities of an obligor. Under Ukrainian law the guaranteed obligations including any future debt must be specified as precisely as possible to ensure enforceability.

In particular, when the amount of future debt is unknown the suretyship must refer to the specific description of the debt so that it can be easily ascertained once the default has occurred.

It is worth noting that the liability of the surety under Ukrainian law is not confined to payment obligations of the primary obligor and the parties are allowed to foresee in the contract an undertaking of the surety to reimburse losses and/or pay penalties for undue performance.

Irrevocable and unconditional obligation

The obligations of an English law guarantor are discharged only after the full payment under the underlying contract (which is not subsequently set aside).

An unconditional obligation indicates an indemnity nature of the contract. In the context of Ukrainian suretyship, “irrevocable” and “unconditional” have no distinct legal meaning. Instead, Ukrainian law releases the surety from the liability to the extent the claims of the creditor under the underlying obligation are paid. In the context of a stand-alone guarantee, irrevocable would mean that the guarantor may not unilaterally withdraw from the guarantee, and unconditional would mean that the guarantee could be enforced immediately without recourse to the primary obligor.

Demand for payment

Under English law, it may be stipulated that an obligation of the guarantor to pay arises only upon a demand made by the beneficiary (or notice of default) once any available recourse against the primary obligor has been exhausted. Standard practice, however, is to ensure that no steps need to be taken by the beneficiary prior to enforcement of the guarantee5. Under Ukrainian law the beneficiary is not normally required to enforce any remedies against the primary obligor before seeking redress from the surety;

a written demand for payment stating that the primary obligor defaulted will suffice.

The surety, however, gains the benefit of all defences available to the primary obligor under the underlying contract.

Subrogation

Once the payment has been made under the guarantee, the English law guarantor can assume the role of the original beneficiary. This allows it to exercise any right of set-off and security to which the beneficiary was originally entitled. The right of subrogation can be excluded from the guarantee or can be implied to be excluded where there is no evidence that the parties intended it to apply6. The right of subrogation (as well as other rights the guarantor acquires against the principal obligor) may conflict with the rights of the beneficiary under the guarantee and are typically contractually deferred until the primary contract is fully discharged. The right of the surety, who has paid under the suretyship, to seek reimbursement from the primary obligor is implied by Ukrainian law and it is often difficult to exclude this result by express language in the suretyship. Moreover, a clause excluding the right of subrogation until the guaranteed debt is paid in full has yet to be tested in Ukrainian courts.

Duration of guarantee

A guarantee would normally have a limited duration, although under English law it is possible for the parties to enter into a guarantee for an indefinite period (for example, in relation to an overdraft facility granted by a bank to a trade company)7. Ukrainian courts, however, have recently taken the view that if the suretyship is expressed to be terminated on the discharge of the guaranteed obligations then it is deemed to be executed for an indefinite term. Where there is no explicit termination date in the suretyship, it expires if no demand for payment has been served on the surety within 6 months from the due date under the principal obligation or, if no due date was fixed, within a year from the date of its execution. There is also a 3-year limitation period for claims arising out of the suretyship which commences on the date the demand for payment is delivered.

Waiver of guarantor right

As any variation of the primary obligation may cause unenforceability of the guarantee under English law, a beneficiary would want to include a waiver in the guarantee whereby the guarantor agrees to all variations of the underlying contract to be made without his/her consent8. The Ukrainian surety is deemed to be discharged if his liability has been materially increased or a new primary obligor has stepped into the underlying obligation without his consent.

The existing court practice shows that the consent can be given in the text of the suretyship. Notwithstanding such waivers, it is prudent to obtain a written consent of the guarantor or surety for any amendments to be made to the underlying contract, in order to further limit any possibility for the guarantor to seek invalidation of the guarantee based on changes to the underlying obligation.

Enforcement against Ukrainian guarantor

The enforceability of an English law guarantee in Ukraine is unlikely to be questioned except for some specific “saving provisions” such as the waiver of subrogation or legal remedies, suspense account clause, etc.

The position is different with guarantees and indemnities issued by non-regulated companies which appear to be susceptible to challenge. There is no certainty as to whether a court would give effect to indemnity provisions purporting to create a primary rather than secondary obligation of the guarantor. Given that only regulated entities are allowed to issue stand-alone guarantees there is a risk that the guarantor may contest the guarantee and indemnity on the grounds that it lacked capacity under Ukrainian law to issue such an instrument.

In theory, a court may apply Ukrainian law to the guarantee irrespective of the parties’ choice of English law on the grounds that the parties may not derogate from “imperative rules” of Ukrainian law. The notion of imperative rules has not been expressly defined by law or developed by court practice. As a result, a court may take a formal approach and interpret the imperative rules not only as the provisions of law related to public policy matters but also as those which cannot be derogated from by the parties to a purely domestic contract.

In this regard, we consider two possible scenarios. One possibility would be for the guarantee and indemnity to be set aside by Ukrainian court on the grounds that a non-regulated company had no legal capacity to enter into an independent guarantee. We are, however, not aware of any such court decisions.

In our view, the most likely outcome would be a reclassification of the guarantee into a simple suretyship. As a result, indemnity provisions to the effect that the guarantee survives any termination and invalidity of the principal obligation or liquidation of the primary obligor would not be given effect while other provisions would remain in force.

As a preventive measure against any possible invalidation of the deed of guarantee and indemnity, the parties may separate out the guarantee wording (accessory obligation) and indemnity wording (primary obligation) into two different documents. Contrary to suggestions by some legal practitioners, a mere change of the name of the document (i.e. from guarantee to suretyship) cannot be considered a sound solution to the problem. Undoubtedly, the name given to the document may be some evidence of its nature but is not conclusive. A court will have regard to the terms and wording rather than the name of the document or the descriptions of any parties therein.


1 G. Andrews and R. Millett Law of Guarantees (5th edn, Sweet & Maxwell 2008), 1, 1-001.

2 G. Andrews and R. Millett Law of Guarantees (5th edn, Sweet & Maxwell 2008), 2, 1-003.

3 PLC UK Finance Practice Note: overview Guarantees and Indemnities.

4 PLC UK Finance Practice Note: overview Guarantees and Indemnities.

5 G. Andrews and R. Millett Law of Guarantees (5th edn, Sweet & Maxwell 2008), 10, 1-011.

6 See Andrew Conquest v Patrick McGinnis and Brian McGinnis [2007] EWHC 2943 (Ch).

7 G. Andrews and R. Millett Law of Guarantees (5th edn, Sweet & Maxwell 2008), 9, 1-010.

8 See PLC UK Finance Practice Note: overview Guarantees and Indemnities.

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