Do Parent Company Guarantees create a pay now, argue later obligation?
June 1, 2019
The recent decision of the Supreme Court of Western Australia in JKC Australia LNG Pty Ltd v CH 2M Hill Companies  WASC 177 considered whether a clause of a Parent Company Guarantee created a `pay now, argue later` obligation.
JKC Australia was engaged to engineer, procure, construct and commission the Ichthys Project, an LNG development in Darwin. JKC Australia entered into a subcontract with the CH2M Hill Companies (and others) (the Consortium), by which the Consortium promised to perform certain works related to a combined cycle power plant. Relevantly, the Consortium procured three separate Parent Company Guarantees (PCGs) which were provided to JKC Australia to guarantee the due performance of the obligations under the subcontract. A dispute arose between the parties, and the subcontract was subsequently terminated in 2017. The termination is currently the subject of an arbitration.
In the interim, JKC Australia gave written notices to the guarantors asserting they were liable under the PCGs to discharge certain liabilities of the subcontractor (the Notices of Demands). In broad terms, JKC Australia sought to rely on a provision of the subcontract which provided that any additional costs and expenses in completing the Works in the event of termination or takeover of the subcontract by JKC Australia, are a debt due to JKC Australia by the subcontractor. The Consortium resisted the Notices of Demands arguing that any obligations under the PCGs were expressly subject to any defence, set-off or counterclaim available to the subcontractor in relation to its `primary liability`. JKC Australia commenced these proceedings in the Supreme Court of Western Australia seeking declarations as to the proper construction of the PCGs.
One issue before the Court was whether the terms of the PCGs imposed separate and independent obligations on the guarantors. Relevantly, Clause 2 of the PCGs provided for an `unconditional and irrevocable guarantee` for the performance of the obligations under the subcontract. Further, Clause 3 of the PCG required the guarantors to `step-in` and perform the subcontractor`s obligations on written notice from JKC Australia.
JKC Australia argued that Clause 3 of the PCGs was not a guarantee, but rather ?it is or is analogous to a performance bond?, such that JKC Australia was entitled to seek payment from the guarantors under the PCGs before `primary liability` was determined in the arbitration. The Consortium contended that any obligation under the PCGs required JKC Australia to first establish actual liability under the subcontract, which could not be done until the arbitration had run its course.
In rejecting JKC Australia`s arguments, Quinlan CJ found that:
- The PCGs were not analogous to unconditional performance bonds and, as such, it was necessary for JKC Australia to establish actual liability as against the Consortium prior to any further steps being taken.
- The PCGs did not contain any drafting which suggested they were intended to act as a cash equivalent or unconditional performance bond.
- The two main purposes of a guarantee are to provide security, and to allocate risk. In the present case, the words of the PCGs did not support a finding that its purpose was risk allocation.
- The notion that there is a `presumption` relating to the interpretation of performance bonds goes against a long line of Australian authority concerning how courts should approach the construction of commercial contracts. This authority demonstrates that each case depends upon the particular language of the instrument in question, having regard to its context and purpose.
For these reasons, Quinlan CJ held that the PCGs in question did not, on their proper construction, create a `pay now, argue later` obligation.
This decision highlights the importance when drafting a security instrument to ensure that its intended effect and purpose is clear and unambiguous. If a `pay now, argue later` obligation is desired, then the words in both the underlying contract and the guarantee should reflect such purpose.
The full decision can be found here.