Advance Contractual Payments and the Benefits of Bank Guarantees

Contracts often require payments for services to be made in advance in order to get the ball rolling and provide liquidity, but this gives rise to obvious risks. An instructive High Court ruling, however, showed how effective bank guarantees are in ensuring that such payments are recovered in the event of non-performance.

A Spanish company which was the main contractor on a major construction project in Saudi Arabia made an advance payment of about £8 million to a South Korean subcontractor. It was a condition of the subcontract that the subcontractor would secure the contractor's position by entering into a bank guarantee.

A bank guaranteed that, in the event of default by the subcontractor, it would repay such part of the sum advanced which had not been used in paying for work that had actually been done. On the basis that the subcontractor had defaulted on its obligations by effectively walking off the site, the contractor made demand upon the bank in respect of the whole of the sum guaranteed. The guarantee conferred on the courts in London jurisdiction to resolve any disputes arising and, when the bank declined to meet the demand, the contractor launched proceedings.

The guarantee required as a condition precedent that the advance payment be made into a numbered account held by the subcontractor with HSBC. There was nothing to suggest that the subcontractor had not received the money. However, whilst the payment had been made by the contractor into an account bearing the correct number, it was not held with HSBC. On that basis, the bank argued that the condition had not been met and the guarantee was unenforceable.

Ruling on the matter, the Court noted that, if the bank's restrictive interpretation of the guarantee were correct, it would have had the result of rendering the guarantee entirely worthless at the moment the advance payment was made. In striving to avoid such an absurd result, it was permissible for the Court to take into account extraneous evidence as to the parties' intentions.

The bank into which the payment was made was 40 per cent owned by HSBC, which had no retail branches in Saudi Arabia. The bank's logo bore the distinctive HSBC symbol and there was no other qualifying bank account bearing the required number into which the money could have been paid. On that basis, the Court found that it was a classic case of misnomer. The bank had been misidentified in the guarantee and the money had been paid into the account intended.

The bank having no real prospect of defending the matter, and there being no other compelling reason for a trial of the action, the contractor was awarded summary judgment on its claim.