Rainy Sky v Kookmin Bank
Rainy Sky SA v Kookmin Bank
UK Supreme Court: Lord Phillips, Lord Mance, Lord Kerr, Lord Clarke and Lord Wilson:  UKSC 50: 2 November 2011
Mark Howard QC and Michael Ashcroft QC, instructed by Ince & Co LLP, for the Appellants, Rainy Sky
Guy Philipps QC and James Cutress, instructed by Linklaters LLP, for the Respondent Bank
SHIPBUILDING: LETTER OF GUARANTEE: CONTRACTUAL INTERPRETATION BEING A UNITARY PROCESS: ROLE OF COMMERCIAL CONSIDERATIONS: WEIGHT TO BE GIVEN TO VIEW OF COMMERCIAL JUDGE
The UK Supreme Court reversed the Court of Appeal and held that, on a proper interpretation of the Advance Payment bonds in question, Kookmin Bank was liable to pay the claimants the pre-delivery instalments as the shipbuilders in question had been placed under insolvency protection. The Supreme Court was of the view that contractual interpretation was a unitary process. The Court would look at all the relevant surrounding circumstances and ascertain what a reasonable person would understand the contract to mean. Commercial considerations were relevant in the process of interpretation, and there was no need for the literal meaning of the contract to lead to absurd results before such considerations could be taken into account.
This note has been contributed by Ken To-ching Lee, LLB(Hons), PCLL (University of Hong Kong), BCL(Oxon) and barrister-at-law in Hong Kong.
Jinse Shipbuilding Co Ltd (“the Shipbuilder”) entered into 6 shipbuilding contracts (“the Contracts”) under which it would build and sell one vessel to each of the First to Sixth Claimants (collectively called “the Buyers”) in return for US$33.3m payable in various instalments before delivery.
Article X.5 of the Contracts required the Shipbuilder to refund the pre-delivery instalments made by the Buyers plus interest if the Buyers terminated, cancelled or rescinded the Contracts in accordance with the terms therein. The Shipbuilder was also required to refund under Article X.6 in case of total or constructive total loss of the vessels prior to delivery.
Article X.8 of the Contracts provided that, as a condition precedent to the Buyers’ payment of the various instalments, the Shipbuilder would deliver to them letters of guarantee. Such refund guarantees would cover the obligation to refund under other paragraphs of Article X and be “in the form annexed hereto as Exhibit ‘A’ which is yet to be agreed.” It was common ground between the parties that no form of guarantee was in fact annexed to the Contracts.
Article XII.3 of the Contracts provided: If the Builder… shall apply to the courts for protection from its creditors, file a voluntary petition in bankruptcy or take advantage of any insolvency law… the Buyer may by notice in writing to the Builder require the Builder to refund immediately to the Buyer the full amount of all sums paid by the Buyer to the Builder on account of the Vessel and interest thereon at seven percent (7%) per annum on the amount to be refunded to the Buyer... and immediately upon receipt of such notice the Builder shall refund such amount to the Buyer. Following such refund the Builder may, but shall not be obliged to, by notice in writing to the Buyer given within ten (10) business days terminate this contract.”
On 22 August 2007, in compliance with Article X.8 of the Contracts, the Shipbuilder supplied to each of the Buyers 6 materially identical “Advance Payment Bonds” (“the Bonds”) issued by Kookmin Bank (“the Bank”). Each of the Buyers then paid the first instalment on 29 August 2007.
The Seventh Claimant was the assignee of the benefit of the Bonds.
The Bonds were in the following terms, with paragraph numbers added by the trial judge, Simon J, 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… 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]…”
(5) Our liability under this Bond shall not be affected by …
(v) any insolvency, re-organisation or dissolution of the Builder, or
(vi) any other matter or thing which may operate to discharge or reduce our liability hereunder.
The Shipbuilder suffered financial difficulties, and in January 2009, entered into a “debt workout procedure” under the Korean Corporate Restructuring Promotion Law 2007. On 25 February 2009 the Buyers wrote to the Builder notifying it that this development triggered Article XII.3 of the Contracts and demanding an immediate refund of all the instalments paid, together with interest at 7% per annum. The Builder refused to make any refund on the ground that Article XII.3 of the Contracts had not been triggered as alleged. The dispute between the Buyers and the Builder has been submitted to arbitration pursuant to Article XIV.3 of the Contracts.
In April 2009, the Buyers demanded repayment of the instalments from the Bank under the Bonds. The Bank refused. It argued that that the phrase “all such sums due to you under the Contract” in Paragraph (3) of the Bonds referred back only to the refunds in the cases of termination of the Contract set out in Paragraph (2). Thus, it was not obliged to pay in the present case as it involved the Shipbuilder’s insolvency. On the other hand, the Buyers argued that as the purpose of the Bonds was to guarantee the refund of pre-delivery instalments, the phrase should be interpreted as referring back to the words “pre-delivery instalments” in the opening line of Paragraph (3).
Simon J, sitting in the Commercial Court  EWHC 2624 (Comm),  1 All ER (Comm) 823, held that the Bank was liable. The Bank’s interpretation should be rejected, for it would lead to an uncommercial result that the Buyer would not be able to call on the Bonds in case of insolvency when first class security would most likely be required.
The Court of Appeal, by a majority of 2:1, allowed the Bank’s appeal:  EWCA Civ 582,  1 All ER (Comm) 18. The majority, Patten and Thorpe LJJ, held that the Judge’s interpretation would rob Paragraph (2) of its purpose, which was to outline the extent of the Shipbuilder’s obligation under the Bonds. Thus, the phrase “all such sums due to you under the Contract” in Paragraph (3) did not cover the present case where repayment was due to the Shipbuilder’s insolvency. No room was to be given to the so-called uncommercial effect of such an interpretation as the result was not so extreme as to suggest that it was not intended.
Sir Simon Tuckey, dissenting, was of the view that, although both constructions offered by the Bank and the Buyers were arguable, the Bank’s construction would lead to uncommercial consequences. Thus, giving considerable weight to the conclusion reached by the experienced commercial judge, the Bonds should be construed to cover the present situation of the Shipbuilder’s insolvency, and the Bank should be liable to pay.
The leading judgment of the Supreme Court was given by Lord Clarke, with whom the other Justices agreed.
Cases like Investors Compensation Scheme Ltd v West Bromwich Building Society  1 WLR 896 and Chartbrook Ltd v Persimmon Homes Ltd  1 AC 1101 showed that the ultimate aim of interpreting a provision in a contract, especially a commercial contract, was to determine what the parties meant by the language used. Where the parties have used unambiguous language, the Court must apply it.
However, the language used by parties would often have more than one potential meaning. In such case, the Court would have regard to all the relevant surrounding circumstances and ascertain what a reasonable person would have understood the contract to mean when equipped with all the background knowledge reasonably available to the parties at the time of the contract. Each of the rival meanings should be checked against other provisions of the document and its commercial consequences investigated; and the court was entitled to prefer a construction which was consistent with business common sense. This was essentially one unitary exercise and an iterative process. It was not necessary to conclude that a particular construction would produce an absurd or irrational result before departing from the literal meaning of the words in the contract and having regard to its commercial purpose. In cases where an appellant court was asked to consider a question of construction, it was entitled to take account of the conclusion reached by an experienced judge of the Commercial Court as to the commercial consequences of competing interpretations.
Turning to Paragraph 3 of the Bonds, as it was capable of bearing the two meanings as advanced by the Bank and the Buyers, Lord Clarke considered it appropriate to have regard to considerations of commercial common sense in resolving its meaning.
If one looked at Paragraph (3) alone, the phrase “all such sums due” clearly referred to the “pre-delivery instalments” mentioned earlier in the same paragraph. Lord Clarke agreed with Simon J that this construction made perfect sense because one would naturally expect the parties to agree that the Buyers should have security for the repayment of pre-instalments in case of the Shipbuilder’s insolvency, and that any other construction would lead to uncommercial consequences. His Lordship took the view, contrary to that taken by the majority in the Court of Appeal, that the existence of Paragraph (2) did not affect this analysis because it did not actually identify the scope of the Bank’s obligation under Paragraph (3). Paragraph (2) did reproduce the terms of Articles X.5 and X.6 of the Contracts, but the clause requiring the provision of guarantee, Article X.8, did not purport to dictate the scope of the guarantee. Article X.8 did not require the guarantee to cover only refund obligations arising under Articles X.5 and X.6. Indeed, no form of guarantee was attached to the Contracts as contemplated under Article X.8. The parties were simply left to agree on the final form of the Bonds.
Thus, the Buyers’ arguments were to be preferred. On a proper interpretation of the Bonds, the Bank was obliged to pay the pre-delivery instalments. The appeal was accordingly allowed.
The short and unanimous judgment of the Supreme Court is clearly to be welcomed. It affirmed a more common sense approach to contractual interpretation under which the Court would consider all the circumstances of the case. It also clarified that commercial considerations always play a role in the process, whether or not a literal construction would give rise to absurd results. In the memorable words of Sir Thomas Bingham MR in Arbuthnott v Fagan  CLC 1396, 1400, interpretation was “a composite exercise, neither uncompromisingly literal nor unswervingly purposive.” But of course, at the end of the day, there is no substitute to careful drafting by commercial parties if disputes are to be avoided altogether.