View source for Kookmin Bank v Rainy SA

DMC/SandT/11/09

'''English Court of Appeal'''

'''Kookmin Bank v Rainy SA and others'''

'''English Court of Appeal: Thorpe and Patten LJJ and Sir Simon Tuckey: [2010] EWCA Civ 582, [2010] 1 CLC 829: 27 May 2010'''

Guy Philipps QC and James Cutress, instructed by Linklaters LLP, for the Defendant/Appellant Bank

Andrew Baker QC and Socrates Papadopoulos, instructed by Ince & Co, for the Claimants/Respondents Ship Buyers

'''SHIPBUILDING: LETTER OF GUARANTEE: CONTRACTUAL INTERPRETATION: EXTREME CONSEQUENCES REQUIRED TO DEPART FROM MEANING OF WORDS AS CONVEYED TO REASONABLE PERSON: NO DEPARTURE SIMPLY BECAUSE COURT WOULD REACH DIFFERENT BALANCE OF PARTIES’ INTERESTS AND OBLIGATIONS UNDER CONTRACT'''

'''Summary'''

A Shipbuilder entered into various contracts whereby they would repay Buyers of its vessels any pre-payments made by the latter should those contracts be terminated. It was also obliged to repay upon demand, should it go into insolvency protection. It provided to the Buyers a letter of guarantee from Kookmin Bank (the Bond) which stated that “[i]n consideration of [the Buyer’s] agreement to make pre-delivery instalments… [Kookmin Bank]… undertake[s] to pay to you… all such sums due to you under the Contract [with the Shipbuilder]…” Subsequently, the Shipbuilder went into insolvency protection, and the Buyers demanded repayment of their pre-delivery instalments from Kookmin Bank under the Bond. The majority of the Court of Appeal overturned the decision of Simon J at trial, and held that on a proper construction, the Bond did not cover the situation where the Shipbuilder had to repay due to its own insolvency. There was nothing uncommercial about this interpretation of the Bond and it was not permissible for the Court to speculate as to why the Bond did not cover repayment on insolvency. 

This note has been contributed by Ken To-ching Lee, LLB(Hons), PCLL (University of Hong Kong), BCL(Oxon) and pupil barrister in Hong Kong.

'''Background'''

Jinse Shipbuilding Co Ltd (“the Shipbuilder”) entered into 6 materially identical shipbuilding contracts (“the Shipbuilding Contracts”) with the First to Sixth Claimants as buyers (collectively called “the Buyers”).

Under the Shipbuilding Contracts, the Buyers had to make various pre-delivery instalment payments. Article X.5 required the Shipbuilder to refund the pre-payments made by the Buyers and the value of their supplies if the Buyers terminated, cancelled or rescinded the Contracts in accordance with the terms of the Contracts. Similar refund provision was made under Article X.6 in case of total or constructive total loss of the vessels prior to delivery.

Article X.8 required the Shipbuilder to provide to the Buyers an assignable letter of guarantee for the refund of pre-delivery instalments. A letter of guarantee (“the Bond”) from Kookmin Bank (“the Bank”) was so duly provided, and was subsequently assigned to the Seventh Claimant.

Article XII of the Shipbuilding Contracts provided that, in case the Shipbuilder entered into insolvency protection, it was obliged to refund any pre-payment made by the Buyer upon written notice. Following the refund, the Shipbuilder “may, but shall not be obliged to” terminate the Shipbuilding Contracts; if the Contracts were terminated, the Buyers’ obligation to pay instalments under the Contract would be suspended.

Instalments were paid by the Buyers. However, due to financial difficulties, in 2009, the Shipbuilder entered into a “debt work out procedure” under the Korean Corporate Restructuring Programme Law. Article XII of the Shipbuilding Contracts was thus triggered. The Shipbuilder was required, but failed, to refund the full amount of the instalments; so the Buyers demanded repayment from the Bank under the Bond.

The Bank refused payment. It argued that the Bond did not cover the case of the Shipbuilder’s insolvency, and thus it was not obliged to repay the pre-delivery instalments under the Bond.

The Bond was in the following terms, with paragraph numbers added by the trial judge for easy reference:

“ADVANCE PAYMENT BOND

(2) Pursuant to the terms of the [Shipbuilding] Contract, you are entitled, upon your rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract… to repayment of the pre-delivery instalments of the Contract Price paid by you prior to such termination… and the value of the Buyer’s Supplies delivered to the Shipyard (if any), together with interest…

(3) In consideration of your agreement to make the pre-delivery instalments under the Contract…, we hereby, as primary obligor, irrevocably and unconditionally undertake to pay to you, your successors and assigns, on your first written demand, all such sums due to you under the Contract… PROVIDED THAT the total amount recoverable by you under this Bond shall not exceed US$[26,640,000]…” 

'''High Court Judgment [2009] EWHC 2624 (Comm), [2010] 1 All ER (Comm) 823'''

Simon J rejected the Bank’s argument that the present case of the Shipbuilder’s insolvency was not covered under the Bond. Paragraph (2) of the Bond was a preamble in the sense that it set out some, but not all, of the Shipbuilder’s obligations to pay sums due to the Buyers under the Shipbuilding Contracts. Paragraph (3) set out the Defendant’s obligation to pay the Buyers, the exact mechanism of which was further described in the Bond.

The phrase “all such sums due under the Contract” in Paragraph (3) was not defined; but it made better grammatical sense if it referred to the “pre-delivery instalments” in the same sentence, rather than the Shipbuilder’s repayment obligations recited as a preamble in Paragraph (2). Further, Simon J thought that the Bank’s construction would lead to a surprising and uncommercial result, as the Buyer would not be able to call on the Bond in case of insolvency when first class security would most likely be required.

Thus, the phrase “all such sums due under the Contract” under Paragraph (3) would require the Defendant to pay in case of the Shipbuilder’s insolvency, and the claim was allowed.

The Defendant Bank appealed. The issue before the Court of Appeal was whether on a proper construction of the phrase “all such sums due under the Contract” in Paragraph (3) of the Bond, the Bank was obliged to pay the Buyers in case of the Shipbuilder’s insolvency.

'''Court of Appeal Judgment'''

The majority of the Court of Appeal (Patten and Thorpe LJJ; Sir Simon Tuckey dissenting) allowed the Bank’s appeal.

The majority judgment was given by Patten LJ, with whom Thorpe LJ agreed. He disagreed with the trial judge’s interpretation of “all such sums due under the Contract” as referring to the “pre-delivery instalments” in the same Paragraph (3). Such interpretation would rob Paragraph (2) of any purpose or effect, that is, to provide the reader with a clear statement of the Shipbuilder’s obligation which would be covered under the Bond, and which would be consistent with the Shipbuilder’s obligation to provide a guarantee under Article X.8 of the Shipbuilding Contracts. The wordings of Paragraph (2) only covered repayment in case of termination of the Shipbuilding Contracts, and not repayment in case of insolvency under Article XII.

Further, Simon J was wrong in holding that the Bank’s construction of the Bond would lead to uncommercial consequences. The proper starting point in construing a contract was that commercial parties could look after themselves and were sufficiently organised and well advised in ensuring that contractual documents accurately reflected their intentions. Thus, in modern times, contracts should be construed according to the meaning which they would convey to a reasonable person knowing all the background knowledge available to the parties at the time of contracting: see ICS Ltd v West Bromwich Society [1998] 1 WLR 896. Authorities showed that courts would only depart from this meaning where there was some detectable error in the drafting of the document, or where that construction would lead to consequences so extreme, arbitrary or irrational that the parties would be unlikely to have intended them: see Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101. Courts should not reformulate contractual provisions which were relatively clear in meaning simply because they balanced the parties’ interests and obligations in a way which the judge considered to be one-sided or inappropriate.

In the present case, while it was, objectively speaking, desirable for the Bond to cover the situation of the Shipbuilder’s insolvency, this was not sufficient by itself to justify departure from what would otherwise be the natural and obvious construction of the Bond. It was impermissible to speculate on the reasons for omitting repayment obligations in the event of insolvency, or why the Buyers were prepared to take such risk. Thus, the Bank’s construction was the proper one, and the Bond did not cover the present case of the Shipbuilder’s insolvency.

The dissentient, Sir Simon Tuckey, was of the view that both constructions offered by the Bank and the Buyers were arguable. However, he agreed with Simon J that the Bank’s construction would lead to uncommercial consequences. Insolvency of the Shipbuilder was a situation for which the security of an advance payment bond was most likely to be needed. No credible commercial reason had been advanced as to why this situation was not covered under the Bond. Thus, giving considerable weight to the conclusion reached by an experienced commercial judge, the Bond should be construed to cover the present situation of the Shipbuilder’s insolvency, and the Bank held liable to pay.