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assignments basic law

Assignments: The Basic Law

The assignment of a right or obligation is a common contractual event under the law and the right to assign (or prohibition against assignments) is found in the majority of agreements, leases and business structural documents created in the United States.

As with many terms commonly used, people are familiar with the term but often are not aware or fully aware of what the terms entail. The concept of assignment of rights and obligations is one of those simple concepts with wide ranging ramifications in the contractual and business context and the law imposes severe restrictions on the validity and effect of assignment in many instances. Clear contractual provisions concerning assignments and rights should be in every document and structure created and this article will outline why such drafting is essential for the creation of appropriate and effective contracts and structures.

The reader should first read the article on Limited Liability Entities in the United States and Contracts since the information in those articles will be assumed in this article.

Basic Definitions and Concepts:

An assignment is the transfer of rights held by one party called the “assignor” to another party called the “assignee.” The legal nature of the assignment and the contractual terms of the agreement between the parties determines some additional rights and liabilities that accompany the assignment. The assignment of rights under a contract usually completely transfers the rights to the assignee to receive the benefits accruing under the contract. Ordinarily, the term assignment is limited to the transfer of rights that are intangible, like contractual rights and rights connected with property. Merchants Service Co. v. Small Claims Court , 35 Cal. 2d 109, 113-114 (Cal. 1950).

An assignment will generally be permitted under the law unless there is an express prohibition against assignment in the underlying contract or lease. Where assignments are permitted, the assignor need not consult the other party to the contract but may merely assign the rights at that time. However, an assignment cannot have any adverse effect on the duties of the other party to the contract, nor can it diminish the chance of the other party receiving complete performance. The assignor normally remains liable unless there is an agreement to the contrary by the other party to the contract.

The effect of a valid assignment is to remove privity between the assignor and the obligor and create privity between the obligor and the assignee. Privity is usually defined as a direct and immediate contractual relationship. See Merchants case above.

Further, for the assignment to be effective in most jurisdictions, it must occur in the present. One does not normally assign a future right; the assignment vests immediate rights and obligations.

No specific language is required to create an assignment so long as the assignor makes clear his/her intent to assign identified contractual rights to the assignee. Since expensive litigation can erupt from ambiguous or vague language, obtaining the correct verbiage is vital. An agreement must manifest the intent to transfer rights and can either be oral or in writing and the rights assigned must be certain.

Note that an assignment of an interest is the transfer of some identifiable property, claim, or right from the assignor to the assignee. The assignment operates to transfer to the assignee all of the rights, title, or interest of the assignor in the thing assigned. A transfer of all rights, title, and interests conveys everything that the assignor owned in the thing assigned and the assignee stands in the shoes of the assignor. Knott v. McDonald’s Corp ., 985 F. Supp. 1222 (N.D. Cal. 1997)

The parties must intend to effectuate an assignment at the time of the transfer, although no particular language or procedure is necessary. As long ago as the case of National Reserve Co. v. Metropolitan Trust Co ., 17 Cal. 2d 827 (Cal. 1941), the court held that in determining what rights or interests pass under an assignment, the intention of the parties as manifested in the instrument is controlling.

The intent of the parties to an assignment is a question of fact to be derived not only from the instrument executed by the parties but also from the surrounding circumstances. When there is no writing to evidence the intention to transfer some identifiable property, claim, or right, it is necessary to scrutinize the surrounding circumstances and parties’ acts to ascertain their intentions. Strosberg v. Brauvin Realty Servs., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998)

The general rule applicable to assignments of choses in action is that an assignment, unless there is a contract to the contrary, carries with it all securities held by the assignor as collateral to the claim and all rights incidental thereto and vests in the assignee the equitable title to such collateral securities and incidental rights. An unqualified assignment of a contract or chose in action, however, with no indication of the intent of the parties, vests in the assignee the assigned contract or chose and all rights and remedies incidental thereto.

More examples: In Strosberg v. Brauvin Realty Servs ., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998), the court held that the assignee of a party to a subordination agreement is entitled to the benefits and is subject to the burdens of the agreement. In Florida E. C. R. Co. v. Eno , 99 Fla. 887 (Fla. 1930), the court held that the mere assignment of all sums due in and of itself creates no different or other liability of the owner to the assignee than that which existed from the owner to the assignor.

And note that even though an assignment vests in the assignee all rights, remedies, and contingent benefits which are incidental to the thing assigned, those which are personal to the assignor and for his sole benefit are not assigned. Rasp v. Hidden Valley Lake, Inc ., 519 N.E.2d 153, 158 (Ind. Ct. App. 1988). Thus, if the underlying agreement provides that a service can only be provided to X, X cannot assign that right to Y.

Novation Compared to Assignment:

Although the difference between a novation and an assignment may appear narrow, it is an essential one. “Novation is a act whereby one party transfers all its obligations and benefits under a contract to a third party.” In a novation, a third party successfully substitutes the original party as a party to the contract. “When a contract is novated, the other contracting party must be left in the same position he was in prior to the novation being made.”

A sublease is the transfer when a tenant retains some right of reentry onto the leased premises. However, if the tenant transfers the entire leasehold estate, retaining no right of reentry or other reversionary interest, then the transfer is an assignment. The assignor is normally also removed from liability to the landlord only if the landlord consents or allowed that right in the lease. In a sublease, the original tenant is not released from the obligations of the original lease.

Equitable Assignments:

An equitable assignment is one in which one has a future interest and is not valid at law but valid in a court of equity. In National Bank of Republic v. United Sec. Life Ins. & Trust Co. , 17 App. D.C. 112 (D.C. Cir. 1900), the court held that to constitute an equitable assignment of a chose in action, the following has to occur generally: anything said written or done, in pursuance of an agreement and for valuable consideration, or in consideration of an antecedent debt, to place a chose in action or fund out of the control of the owner, and appropriate it to or in favor of another person, amounts to an equitable assignment. Thus, an agreement, between a debtor and a creditor, that the debt shall be paid out of a specific fund going to the debtor may operate as an equitable assignment.

In Egyptian Navigation Co. v. Baker Invs. Corp. , 2008 U.S. Dist. LEXIS 30804 (S.D.N.Y. Apr. 14, 2008), the court stated that an equitable assignment occurs under English law when an assignor, with an intent to transfer his/her right to a chose in action, informs the assignee about the right so transferred.

An executory agreement or a declaration of trust are also equitable assignments if unenforceable as assignments by a court of law but enforceable by a court of equity exercising sound discretion according to the circumstances of the case. Since California combines courts of equity and courts of law, the same court would hear arguments as to whether an equitable assignment had occurred. Quite often, such relief is granted to avoid fraud or unjust enrichment.

Note that obtaining an assignment through fraudulent means invalidates the assignment. Fraud destroys the validity of everything into which it enters. It vitiates the most solemn contracts, documents, and even judgments. Walker v. Rich , 79 Cal. App. 139 (Cal. App. 1926). If an assignment is made with the fraudulent intent to delay, hinder, and defraud creditors, then it is void as fraudulent in fact. See our article on Transfers to Defraud Creditors .

But note that the motives that prompted an assignor to make the transfer will be considered as immaterial and will constitute no defense to an action by the assignee, if an assignment is considered as valid in all other respects.

Enforceability of Assignments:

Whether a right under a contract is capable of being transferred is determined by the law of the place where the contract was entered into. The validity and effect of an assignment is determined by the law of the place of assignment. The validity of an assignment of a contractual right is governed by the law of the state with the most significant relationship to the assignment and the parties.

In some jurisdictions, the traditional conflict of laws rules governing assignments has been rejected and the law of the place having the most significant contacts with the assignment applies. In Downs v. American Mut. Liability Ins. Co ., 14 N.Y.2d 266 (N.Y. 1964), a wife and her husband separated and the wife obtained a judgment of separation from the husband in New York. The judgment required the husband to pay a certain yearly sum to the wife. The husband assigned 50 percent of his future salary, wages, and earnings to the wife. The agreement authorized the employer to make such payments to the wife.

After the husband moved from New York, the wife learned that he was employed by an employer in Massachusetts. She sent the proper notice and demanded payment under the agreement. The employer refused and the wife brought an action for enforcement. The court observed that Massachusetts did not prohibit assignment of the husband’s wages. Moreover, Massachusetts law was not controlling because New York had the most significant relationship with the assignment. Therefore, the court ruled in favor of the wife.

Therefore, the validity of an assignment is determined by looking to the law of the forum with the most significant relationship to the assignment itself. To determine the applicable law of assignments, the court must look to the law of the state which is most significantly related to the principal issue before it.

Assignment of Contractual Rights:

Generally, the law allows the assignment of a contractual right unless the substitution of rights would materially change the duty of the obligor, materially increase the burden or risk imposed on the obligor by the contract, materially impair the chance of obtaining return performance, or materially reduce the value of the performance to the obligor. Restat 2d of Contracts, § 317(2)(a). This presumes that the underlying agreement is silent on the right to assign.

If the contract specifically precludes assignment, the contractual right is not assignable. Whether a contract is assignable is a matter of contractual intent and one must look to the language used by the parties to discern that intent.

In the absence of an express provision to the contrary, the rights and duties under a bilateral executory contract that does not involve personal skill, trust, or confidence may be assigned without the consent of the other party. But note that an assignment is invalid if it would materially alter the other party’s duties and responsibilities. Once an assignment is effective, the assignee stands in the shoes of the assignor and assumes all of assignor’s rights. Hence, after a valid assignment, the assignor’s right to performance is extinguished, transferred to assignee, and the assignee possesses the same rights, benefits, and remedies assignor once possessed. Robert Lamb Hart Planners & Architects v. Evergreen, Ltd. , 787 F. Supp. 753 (S.D. Ohio 1992).

On the other hand, an assignee’s right against the obligor is subject to “all of the limitations of the assignor’s right, all defenses thereto, and all set-offs and counterclaims which would have been available against the assignor had there been no assignment, provided that these defenses and set-offs are based on facts existing at the time of the assignment.” See Robert Lamb , case, above.

The power of the contract to restrict assignment is broad. Usually, contractual provisions that restrict assignment of the contract without the consent of the obligor are valid and enforceable, even when there is statutory authorization for the assignment. The restriction of the power to assign is often ineffective unless the restriction is expressly and precisely stated. Anti-assignment clauses are effective only if they contain clear, unambiguous language of prohibition. Anti-assignment clauses protect only the obligor and do not affect the transaction between the assignee and assignor.

Usually, a prohibition against the assignment of a contract does not prevent an assignment of the right to receive payments due, unless circumstances indicate the contrary. Moreover, the contracting parties cannot, by a mere non-assignment provision, prevent the effectual alienation of the right to money which becomes due under the contract.

A contract provision prohibiting or restricting an assignment may be waived, or a party may so act as to be estopped from objecting to the assignment, such as by effectively ratifying the assignment. The power to void an assignment made in violation of an anti-assignment clause may be waived either before or after the assignment. See our article on Contracts.

Noncompete Clauses and Assignments:

Of critical import to most buyers of businesses is the ability to ensure that key employees of the business being purchased cannot start a competing company. Some states strictly limit such clauses, some do allow them. California does restrict noncompete clauses, only allowing them under certain circumstances. A common question in those states that do allow them is whether such rights can be assigned to a new party, such as the buyer of the buyer.

A covenant not to compete, also called a non-competitive clause, is a formal agreement prohibiting one party from performing similar work or business within a designated area for a specified amount of time. This type of clause is generally included in contracts between employer and employee and contracts between buyer and seller of a business.

Many workers sign a covenant not to compete as part of the paperwork required for employment. It may be a separate document similar to a non-disclosure agreement, or buried within a number of other clauses in a contract. A covenant not to compete is generally legal and enforceable, although there are some exceptions and restrictions.

Whenever a company recruits skilled employees, it invests a significant amount of time and training. For example, it often takes years before a research chemist or a design engineer develops a workable knowledge of a company’s product line, including trade secrets and highly sensitive information. Once an employee gains this knowledge and experience, however, all sorts of things can happen. The employee could work for the company until retirement, accept a better offer from a competing company or start up his or her own business.

A covenant not to compete may cover a number of potential issues between employers and former employees. Many companies spend years developing a local base of customers or clients. It is important that this customer base not fall into the hands of local competitors. When an employee signs a covenant not to compete, he or she usually agrees not to use insider knowledge of the company’s customer base to disadvantage the company. The covenant not to compete often defines a broad geographical area considered off-limits to former employees, possibly tens or hundreds of miles.

Another area of concern covered by a covenant not to compete is a potential ‘brain drain’. Some high-level former employees may seek to recruit others from the same company to create new competition. Retention of employees, especially those with unique skills or proprietary knowledge, is vital for most companies, so a covenant not to compete may spell out definite restrictions on the hiring or recruiting of employees.

A covenant not to compete may also define a specific amount of time before a former employee can seek employment in a similar field. Many companies offer a substantial severance package to make sure former employees are financially solvent until the terms of the covenant not to compete have been met.

Because the use of a covenant not to compete can be controversial, a handful of states, including California, have largely banned this type of contractual language. The legal enforcement of these agreements falls on individual states, and many have sided with the employee during arbitration or litigation. A covenant not to compete must be reasonable and specific, with defined time periods and coverage areas. If the agreement gives the company too much power over former employees or is ambiguous, state courts may declare it to be overbroad and therefore unenforceable. In such case, the employee would be free to pursue any employment opportunity, including working for a direct competitor or starting up a new company of his or her own.

It has been held that an employee’s covenant not to compete is assignable where one business is transferred to another, that a merger does not constitute an assignment of a covenant not to compete, and that a covenant not to compete is enforceable by a successor to the employer where the assignment does not create an added burden of employment or other disadvantage to the employee. However, in some states such as Hawaii, it has also been held that a covenant not to compete is not assignable and under various statutes for various reasons that such covenants are not enforceable against an employee by a successor to the employer. Hawaii v. Gannett Pac. Corp. , 99 F. Supp. 2d 1241 (D. Haw. 1999)

It is vital to obtain the relevant law of the applicable state before drafting or attempting to enforce assignment rights in this particular area.

Conclusion:

In the current business world of fast changing structures, agreements, employees and projects, the ability to assign rights and obligations is essential to allow flexibility and adjustment to new situations. Conversely, the ability to hold a contracting party into the deal may be essential for the future of a party. Thus, the law of assignments and the restriction on same is a critical aspect of every agreement and every structure. This basic provision is often glanced at by the contracting parties, or scribbled into the deal at the last minute but can easily become the most vital part of the transaction.

As an example, one client of ours came into the office outraged that his co venturer on a sizable exporting agreement, who had excellent connections in Brazil, had elected to pursue another venture instead and assigned the agreement to a party unknown to our client and without the business contacts our client considered vital. When we examined the handwritten agreement our client had drafted in a restaurant in Sao Paolo, we discovered there was no restriction on assignment whatsoever…our client had not even considered that right when drafting the agreement after a full day of work.

One choses who one does business with carefully…to ensure that one’s choice remains the party on the other side of the contract, one must master the ability to negotiate proper assignment provisions.

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Understanding an assignment and assumption agreement

Need to assign your rights and duties under a contract? Learn more about the basics of an assignment and assumption agreement.

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by Belle Wong, J.D.

Belle Wong, is a freelance writer specializing in small business, personal finance, banking, and tech/SAAS. She ...

The assignment and assumption agreement

The basics of assignment and assumption, filling in the assignment and assumption agreement.

While every business should try its best to meet its contractual obligations, changes in circumstance can happen that could necessitate transferring your rights and duties under a contract to another party who would be better able to meet those obligations.

Person presenting documents to another person who is signing them

If you find yourself in such a situation, and your contract provides for the possibility of assignment, an assignment and assumption agreement can be a good option for preserving your relationship with the party you initially contracted with, while at the same time enabling you to pass on your contractual rights and duties to a third party.

An assignment and assumption agreement is used after a contract is signed, in order to transfer one of the contracting party's rights and obligations to a third party who was not originally a party to the contract. The party making the assignment is called the assignor, while the third party accepting the assignment is known as the assignee.

In order for an assignment and assumption agreement to be valid, the following criteria need to be met:

The initial contract must provide for the possibility of assignment by one of the initial contracting parties.
The assignor must agree to assign their rights and duties under the contract to the assignee.
The assignee must agree to accept, or "assume," those contractual rights and duties.
The other party to the initial contract must consent to the transfer of rights and obligations to the assignee.

A standard assignment and assumption contract is often a good starting point if you need to enter into an assignment and assumption agreement. However, for more complex situations, such as an assignment and amendment agreement in which several of the initial contract terms will be modified, or where only some, but not all, rights and duties will be assigned, it's a good idea to retain the services of an attorney who can help you draft an agreement that will meet all your needs.

When you're ready to enter into an assignment and assumption agreement, it's a good idea to have a firm grasp of the basics of assignment:

First, carefully read and understand the assignment and assumption provision in the initial contract. Contracts vary widely in their language on this topic, and each contract will have specific criteria that must be met in order for a valid assignment of rights to take place.
All parties to the agreement should carefully review the document to make sure they each know what they're agreeing to, and to help ensure that all important terms and conditions have been addressed in the agreement.
Until the agreement is signed by all the parties involved, the assignor will still be obligated for all responsibilities stated in the initial contract. If you are the assignor, you need to ensure that you continue with business as usual until the assignment and assumption agreement has been properly executed.

Unless you're dealing with a complex assignment situation, working with a template often is a good way to begin drafting an assignment and assumption agreement that will meet your needs. Generally speaking, your agreement should include the following information:

Identification of the existing agreement, including details such as the date it was signed and the parties involved, and the parties' rights to assign under this initial agreement
The effective date of the assignment and assumption agreement
Identification of the party making the assignment (the assignor), and a statement of their desire to assign their rights under the initial contract
Identification of the third party accepting the assignment (the assignee), and a statement of their acceptance of the assignment
Identification of the other initial party to the contract, and a statement of their consent to the assignment and assumption agreement
A section stating that the initial contract is continued; meaning, that, other than the change to the parties involved, all terms and conditions in the original contract stay the same

In addition to these sections that are specific to an assignment and assumption agreement, your contract should also include standard contract language, such as clauses about indemnification, future amendments, and governing law.

Sometimes circumstances change, and as a business owner you may find yourself needing to assign your rights and duties under a contract to another party. A properly drafted assignment and assumption agreement can help you make the transfer smoothly while, at the same time, preserving the cordiality of your initial business relationship under the original contract.

Guaranty Agreement: Definition & Sample

Jump to section, what is a guaranty agreement.

A guaranty agreement is a contract between two parties where one party agrees to pay a debt or perform a duty in the event that the original party fails to do so. The party who makes the guaranty is called the guarantor. An agreement of this nature is often used in real estate, insurance, or financial transactions.

A guaranty is sometimes called a guarantee or a warranty. A guaranty agreement can be absolute, meaning the guarantor will assume the obligation for any reason. Or it can be conditional, meaning the guarantor will assume the obligation under specific circumstances.

Common Sections in Guaranty Agreement

Below is a list of common sections included in Guaranty Agreement. These sections are linked to the below sample agreement for you to explore.

Guaranty Agreement Sample

Reference : Security Exchange Commission - Edgar Database, EX-99.1 2 dex991.htm GUARANTY AGREEMENT , Viewed October 13, 2021, View Source on SEC .

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Berkson is a dedicated, practical, and detail-oriented attorney licensed to practice in every state court of Oklahoma and the United States Northern and Eastern District Courts. He graduated from the University of Tulsa College of Law with Honors. While there, he received awards for highest grade in trial practice, legal research, and civil procedure. He was also the Executive Notes and Comments Editor for the Energy Law Journal, the official journal of the Energy Bar Association in Washington, D.C. The Energy Law Journal is one of the few peer-reviewed journals in the legal profession. Prior to becoming an attorney, Howard Berkson held executive positions involving a wide range of business and human resources management functions. He has in-depth knowledge of both business and HR practices. During his business career, Berkson negotiated, wrote, red-lined, and disputed contracts. He has answered charges, handled inspections, and supervised audits involving numerous agencies including the Department of Labor, the Equal Employment Opportunity Commission, the National Labor Relations Board, the Occupational Safety and Health Administration, and various state agencies. Berkson honed his analytical and writing skills while earning his Bachelor of Arts degree in Philosophy from the University of Washington. He went on to obtain a Master of Arts in Labor and Industrial Relations from the University of Illinois. Berkson’s work can be found in such publications as The Energy Law Journal, Human Resource Management Review and Personnel Psychology. He is a member of Phi Alpha Delta law fraternity and of Phi Kappa Phi honor society.

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Contract Law
Contracts and Agreements

A guide to Contract of Guarantee

This article is written by Suryash Kumar , graduated from Bangalore Institute of legal studies. The article talks about the Contract of Guarantee.

Table of Contents

Guarantee contract

Contract of Guarantee is a specific performance contract. It is called specific performance because it is an equitable relief. This is not the usual legal remedy where compensation for damages is adequate. Damages and specific performance are both remedies available upon breach of obligations by a party to the contract; the former is a ‘substitutional remedy’, and the latter a ‘specific remedy’.

The law prescribes that in an event where the actual damage for not performing the contract cannot be measured or monetary compensation is not adequate, one party can ask the court to direct the other party to fulfil the requirements of the contract.

It is also a discretionary relief, that is, it is left to the court to decide whether specific performance should be given to a party asking for it.

Why Contract of Guarantee is Specific performance?

Contract of Guarantee is Specific performance because the remedy is not the damages awarded by the court. The party has to fulfil its obligation under the contract i.e. perform a certain action he promised to do, instead of just paying money for his failure to fulfil obligations under the contract. It is the guarantor who commits to pay in case of default by the person for whom he has guaranteed. The nature of relief is of specific nature since guarantor has to perform the specific obligation, which he had undertaken under the agreement i.e. pay the assured.

Contract of Guarantee

Section 126 defines the Contract of Guarantee – A contract of guarantee involves three parties. It relates to the performance of contract on behalf of the third person whereby fulfilling his obligation under the contract by the guarantor

The person who gives the guarantee is called the ‘’Surety’’; the person in respect of whose default the guarantee is given is called the ‘’Principal Debtor’’, and the person to whom the guarantee is given is called the “Creditor”. A guarantee may be either oral or written.

Purpose of Contract of Guarantee

It enables a person to get a loan, or goods on credit or employment. Some person comes forward and ensures the lender or the supplier or the employer that he may be trusted and in case of any untoward incident, “I undertake to be responsible”.

In the old case of Birkmyr v Darnell the court said: Where a collateral guarantee arises when two persons come to shop, one of them to buy, the other to give credit, thereby promising the seller stating if he doesn’t pay I will’’. This is a collateral guarantee.

In English law, a guarantee is defined as ‘’a promise to pay for the debt, default or failure of another’’. “Guarantees are a backup when the principal fails the guarantee act as second pockets’’.

The person who gives the guarantee is called the Surety, the person in respect of whose default the guarantee is given is called the Principal Debtor and the person to whom the guarantee is given is called the Creditor.

Independent liability different from guarantee

There must be a conditional promise to be liable on the default of the principal debtor. A liability which is incurred independently of a default is not within the definition of guarantee.

This principle was applied in Taylor v Lee where a landlord and his tenant went to the plaintiff’s store. The landlord said to the plaintiff: Mr Parker will be on our land this year, and you will sell him anything he wants, and I will see it paid.

This was held to be an original promise and not a collateral promise to be liable for the default of another and, therefore, not a guarantee.

Essential Features of Guarantee

Principal debt: “A contract of guarantee is a tripartite agreement which contemplates the principal debtor, the creditor and the surety’’. There should exist an independent debt. It is critical that there should be a principal debtor who has taken debt from the creditor. There can’t be a surety without a principal debtor.
Consideration: One of the essential elements of contract is consideration which should be present in a contract of guarantee. It can be in any form which largely benefits the principal debtor.

Illustration: A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year, and promise that, if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C’s promise.

Misrepresentation and concealment: A contract of guarantee is not a contract uberrimae fides or one of complete good faith.. Where a customer had a precarious credit position. The surety wasn’t aware of this and acted as a guarantor of the customer. It was held that the bank is under no obligation to disclose this fact to the surety. However, it is the duty of a party taking guarantee to provide the surety with important facts so that he can make an informed decision. Facts which will affect his responsibility under the contract of guarantee.
Writing not necessary: Section 126 says that a guarantee may be either oral or written. In England, guarantee is not enforceable unless it is “In writing and signed by the party to be charged”.

The extent of the Surety’s Liability

Section 128 speaks about one of the cardinal principles relating to the contract of guarantee. It states that the liability of the surety is co-extensive with that of the principal debtor. The surety may, however, by an agreement place a limit upon his liability.

Section 128- The liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract.

Illustration- A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C. A is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.

Co-extensive: The first principle governing surety’s liability is that it is co-extensive or common with that of the principal debtor. He is liable for the whole amount for which the principal debtor is liable and he is liable for no more. Where the principal debtor acknowledges liability and this has the effect of extending the period of limitation against him the surety also becomes affected by it.
Condition precedent: Where there is a condition precedent to the surety’s liability, he will not be liable unless that condition is first fulfilled. Section 144 to an extent is based on this principle: Where a person gives a guarantee upon a contract that creditor shall not act upon it until another person has joined it as co-surety, the guarantee is not valid if that other person does not join.

An illustration in point is National Provincial Bank of England v Brackenbury: The defendant signed a guarantee which was intended to be a joint and several guarantees of three other persons with him. One of them did not sign. There is no agreement between the bank and the co-guarantors to dispense with his signature, the defendant was held not liable.

Proceeding against surety without exhausting remedies against the debtor

The defendant guaranteed a bank’s loan. A default had taken place, the defendant was sued. The trial court decreed that the bank shall enforce the guarantee in question only after having exhausted its remedies against the principal debtor. The Supreme Court overruled it stating that the very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. Solvency of the principal is not a sufficient ground for restraining execution of the decree against the surety.

Suit against surety alone

A suit against the surety without even prosecuting the principal debtor has been held to be maintainable. In this case, the creditor, in his affidavit, had shown sufficient reasons for not proceeding against the principal debtor.

Death of Principal debtor

A suit was filed against the principal debtor and surety. The suit against the principal debtor was found to be void ab initio because of his death even before the institution of the suit. The surety was held to be not discharged.

Surety’s right to limit his liability or make it conditional

The surety may restrict his liability in the agreement. He can do this by expressly declaring his guarantee to be limited to a fixed amount. In such a case the surety cannot be liable for any amount beyond what is stated in the agreement. There might be a possibility that the principal debtor owes a greater amount but the surety will not be responsible for the amount exceeding what is stated in the agreement.

Impossibility of main contract

A loan for development and maintenance of bee culture was guaranteed. The surety undertook to be liable jointly and severally to pay off his instalments in case of failure on the part of the debtor. The bees died in consequence of a viral infection. There was a total failure of business. The debtor became disabled from paying instalments. The surety could not escape liability under the doctrine of impossibility of performance.

The creditor’s right to recover money from the guarantor doesn’t depend on the possibility of guarantor able to recover the amount from the principal debtor.

Continuing Guarantee

Continuing Guarantee- A guarantee which operates on a number of transactions within a particular period, is called a ‘’Continuing Guarantee’’.

This type of guarantee includes a number of transactions over a period of time. A creditor can hold the surety responsible for the default of the principal debtor for transactions that happen within a period of time.

Illustration- A guarantees payment to B, a mobile dealer, to the amount of $100, for any mobile he may supply to C as required by C over a period of time. B supplies C with mobile above the value of $100, and C pays B for it. Afterwards B supplies C with mobile to the value of $200 . C fails to pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to the extent of $100.

The essential feature of a continuing guarantee is that it doesn’t restrict to a specific number of transactions, but to any number of them and makes the surety liable for the unpaid balance at the end of the guarantee.

In Chorley & Tucker the distinction is explained: “A specific guarantee provides for securing of a specific advance or for advances up to a fixed sum, and ceases to be effective on the repayment thereof, while a continuing guarantee covers a fluctuating account such as ordinary current account at a bank, and secures the balance owing at any time within the limits of the guarantee…’’

A guarantee for the conduct of a servant appointed to collect rents has been held by the Calcutta High Court to be a continuing guarantee.

Joint -Debtors and suretyship

Section 132- This Section speaks about a situation when there are two guarantors who are liable to the creditor as joint-debtors. It says that the liability of the creditor is not affected by any private arrangement (Order of their liability) between the two debtors regarding one being the surety of the other even if the creditor knows of this arrangement. The creditor is not concerned with their mutual agreement that on would be a principal and the other surety.

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Discharge of Surety From Liability

When the surety is no longer liable under the agreement the surety is said to be discharged from liability.

The Act recognises the following modes of discharge:

By Revocation ( Section-130 )Revocation of continuing guarantee: The surety can revoke continuing guarantee by notifying the creditor with respect to the future transactions.

Revocation becomes effective for the future transactions while the surety remains liable for transactions already entered into.

Illustration- A guarantees for B making purchases from C to an extent of 10000rupees. After one month A revokes guarantee by giving notice to C. A will be liable for the supplies till the point he revoked his guarantee. Let’s say until revocation C supplied B with goods worth 6000rupees. A is under obligation to pay 6000 to C.

By death of surety ( Section 131 ): A continuing guarantee is also terminated by the death of the surety unless parties have expressed contrary intention.The termination is only with respect to the future transactions and the heirs of surety are liable for transactions that have already taken place.
By variance ( Section 133 )- The contract of guarantee once formed becomes a contract of utmost good faith. This duty is imposed on the creditor. The surety is held discharged when, without his consent, the creditor makes any charge in the nature or terms of his contract with the principal debtor. ‘’The surety is discharged as soon as the original contract is altered without his consent’’.
Discharge of surety by release or discharge of principal debtor (Section 134) – A surety can be discharged if there is any contract between principal debtor and the creditor, which releases the principal debtor. Any act or failure on creditor’s part which has the legal effect of discharging the principal debtor also absolves surety.

Illustration- A contracts with B for a fixed price to build a house for B within a given time, B supplying the necessary timber, C guarantees A’s performance of the contract. B omits to supply the timber. C is discharged from his suretyship.

Release of principal debtor: The Section provides for two kinds of discharge from liability. The first one where creditor enters into an agreement with the principal debtor by which the latter is released, the surety is discharged. Where the creditor arrives at a compromise and releases the principal debtor, the surety is likewise released.
Act or omission: The second scenario envisaged by the Section is when the creditor does ‘’any act or failure the legal effect of which is the absolve the principal debtor,’’ the surety would also be released from his liability. For example, Where the payment of rent due under a lease is guaranteed and the creditor terminates the lease, the effect would be the release of the surety also.

Discharge: ( Section 135 ) Discharge of surety when creditor compounds with, gives time to or agrees not to sue principal debtor-. A contract where the creditor and principal debtor arrive at an arrangement which results in creditor making a composition with grants principal debtor with more time or undertakes not to sue the principal debtor absolves the surety. For this to operate the surety shouldn’t have assented to this arrangement between creditor and principal debtor.

The Section provides for three modes of discharge from liability:

Composition

Promise to give time, and
Promise not to sue the principal debtor

If the creditor makes a composition with the principal debtor, without consulting the surety, the latter is discharged. Composition results in altering the original contract, and, therefore, the surety is discharged.

For Example- A settlement was entered into between the principal borrower and bank for one-time settlement without reference to the guarantor. The court said that this resulted to novation of the contract between the creditor and principal debtor to the exclusion of guarantor. The liability of the guarantor ceased to exist.

Promise to give time- Promise to give time: when there is a fixed time, according to the agreement for the repayment of the debt. It is one of the duties of the creditor towards the surety not to allow the principal debtor more time for payment. Although, giving time to the principal will benefit the surety but it will be against the spirit of the contract of guarantee, without the consent of the surety.

Thus, where the principal debtor was to make payment for gas supplied within fourteen days and on one occasion he having failed to pay, the supplier took a promissory note from him, this amounted to extension of time and thereupon the surety was discharged.

By impairing surety’s remedy ( Section 139 ): The creditor shouldn’t act in a way which is prejudice to surety’s interest. The remedy of the surety shouldn’t be affected by creditor’s action otherwise surety may be discharged.

It is one of the fundamental duties of the creditor not to do anything inconsistent with the rights of the surety. A surety after paying off the creditor, to secure his payment from the principal debtor.

This responsibility also directs the creditor to preserve the securities, if any, which he has against the principal debtor.

In Darwen&Pearce, The principal debtor was a shareholder in a company. His shares were partly paid and the payment of the unpaid balance was guaranteed by the surety. The shareholder defaulted in the payment of calls and the company forfeited his shares.

By reason of the forfeiture, the shares became the property of the company. If they had not been forfeited they would have belonged to the surety on payment of the outstanding calls. Thus, the forfeiture deprived the surety of his right to the shares and he was accordingly discharged.

Rights of Surety

Rights against the principal debtor

Right of Subrogation(S.140) :

Rights of surety on payment or performance- The surety after paying the creditor or fulfilling his obligation under the contract takes the place of the creditor. He has all rights vested in him which the creditor had against the principal debtor.

When the surety has carried out all his obligations under the contract, he is conferred with all the rights which the creditor had against the principal debtor. The surety steps into the shoes of the creditor.

In Babu Rao Ramchandra Rao v Babu Manaklal Nehmal: “If the liability of the surety is coextensive with that of the principal debtor, his right is not less coextensive with that of the creditor after he satisfies the creditor’s debt’’.

Rights before payment

The surety may possess certain rights even before payment. We have a case where the Calcutta High Court decided on similar lines. The surety found that the amount had become due, the principal debtor was disposing of his personal properties one after the other lest the surety, after paying, may seize them and sought a temporary injunction to prevent the principal debtor from doing so. The court granted the injunction.

Right to indemnity:

Section (145) Implied promise to indemnify surety- In every contract of guarantee, there is an implicit promise by the principal debtor to save the surety from harm. The surety is entitled to claim from the principal debtor whatever sum he had agreed to pay under the guarantee, but no sums which he wasn’t obligated to pay under the contract.

Illustration: A guarantees to C, to the extent of 2000 rupees, payment for the rice to be supplied by C to B. C supplies to B rice to a less amount than 2000 rupees, but obtains from A payment of the sum of 2000 rupees in respect of the rice supplied. A cannot recover from B more than the price of the rice actually supplied.

Rights Against creditor

Right to securities- Surety’s right to benefit of creditor’s securities(Section 141) : Surety has a right over the security which the creditor has in his possession at the time when the contract of guarantee was constructed. It doesn’t matter whether surety was aware of the security or not. The creditor, if without the consent of the surety gets rid of the security, the surety’s obligation is reduced to the extent of the value of the security disposed of.

The Section identifies the general rule of equity as observed in a case that the surety is entitled to redress which the creditor has against the principal debtor, including enforcement of every security.

On paying off the creditor the surety is exactly in the same positions as the creditor was against the principal debtor. The right exists irrespective of the fact whether the surety knows of the existence of such security or not.

The plaintiffs lent to B and P, who were traders, $300 for the payment of which the defendant became surety. At the time of the loan B and P assigned by deed as security for the debt, the lease of their business premises and plant, fixtures and things thereon. The plaintiff had the right to sell on default by giving a month’s notice. The default took place, but the defendant did not enter into possession. He received notice of the debtor’s insolvency but allowed them to continue in possession. Consequently, the assets were seized and sold by the receiver. It was held that the plaintiffs, by their omission to seize the property assigned on default, had deprived themselves of the power to assign the security to the surety. He was, therefore, discharged to the amount that the goods were worth.

Right of set-off: If the creditor owes anything to the principal debtor, the amount owed can be adjusted in the creditor’s claim against the surety. The surety can charge from the amount to be given to the creditor if the creditor has to pay the principal debtor back.
Right to share reduction:Reduction here refers to insolvency. A gives loan to B, C is the guarantor. Subsequently, B becomes insolvent. The property of B is attached to recover the loan he had taken. The official receiver in this particular case will create a list of creditors and pay them proportionate to the sum lent by them. The surety can ask the receiver about the amount given to A. The amount received by A through this process can be deducted by the surety.

For example, B was given the loan by the A of rupees 10,000/-, C, who is a surety in this contract gave a guarantee. A, became insolvent and when his property and assets was realised, when it was distributed by the official receiver and assignee, A got 1,000/- rupees. Now surety who is C in this case when he will make a payment to the A of rupees 10,000/-will ask the A to deduct the rupees 1,000/- which he has received from the official receiver and assignee. This right is the right available with the surety and it is known as a right to share reduction.

Right against Co-sureties

Where a debt has been guaranteed by more than one person, they are called co-sureties.

Effect of releasing a Surety( Section 138): Release of one co-surety does not discharge others – If there are co-sureties involved and one of them is released by the creditor, the others are still liable and the surety so released is responsible to other co-sureties in the event of default.

The released co-surety will remain liable to others for contribution in the event of default.

Right to contribution( Section 146) : Co-sureties liable to contribute equally-.This Section says when there are two or more co-sureties then each has to contribute equally to the debt or a part of the debt. If there is no inconsistent agreement between the co-sureties.

Illustration: A and B are co-sureties for the sum of 2000 rupees which has been given to D by the bank. D defaults, A and B are liable 1000 rupees each among themselves.

Liability of co-sureties bound in different sums: Co-sureties who have different obligations with respect to the amount is liable to pay equally as long as it isn’t beyond their respective obligation.

Illustration: A, B and C as sureties for D, enter into three several Bonds each in a different penalty, namely, A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D’s duly accounting to E. D makes default to the extent of 30,000 rupees. A, B and C are liable to pay 10, 000 rupees.

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skill.

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Understanding Letters of Guarantee

Letter of guarantee for a call writer, example of a letter of guarantee, when are letters of guarantee used, how much does a letter of guarantee cost, what is the difference between a letter of credit and letter of guarantee, how do i get a letter of guarantee, the bottom line.

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Advanced Strategies & Instruments

Letter of Guarantee: Definition, Purposes, and Example

James Chen, CMT is an expert trader, investment adviser, and global market strategist.

A bank typically issues a letter of guarantee on behalf of a client who has entered into a contract to buy goods from a supplier. The letter contractually guarantees to pay the recipient even if the client should default. To get a letter of guarantee, the customer will need to apply for it, like a loan. If the bank is comfortable with the risk, it will back the customer with the letter for an annual fee. Letters of guarantee are used in importing and exporting, commercial contracts, margin trades, major purchases, real estate investments, mergers and acquisitions, and other significant financial transactions.

Key Takeaways

A letter of guarantee is a contract issued by a bank on behalf of a customer who has entered into a contract to buy goods from a supplier.
Letters of guarantee tell suppliers they will be paid even if the customer of the bank defaults.
A bank may issue a letter of guarantee for a call writer guaranteeing that the writer owns the underlying asset and that the bank will deliver the underlying securities should the call be exercised.
Letters of guarantee are often used when one party in a transaction is uncertain whether the other party can pay. This is commonly when purchases of costly equipment or other property are involved.
Letters of guarantee are used in assorted business situations, including contracting and construction, financing, and declarations needed while importing or exporting.

A letter of guarantee may also be issued by a bank on behalf of a call writer when assuring another party that the writer owns the underlying asset and that the bank will deliver the underlying securities should the call be exercised. Call writers will frequently use a letter of guarantee when the underlying asset of a call option is not held in their brokerage account.

Letters of guarantee are often used when one party in a transaction is uncertain that the other party can meet their financial obligation. This is especially common when buying costly equipment or other property. However, a letter of guarantee may not cover the whole value of the property at issue. For example, a letter of guarantee in a bond issue may promise either interest or principal repayment, but not both.

The bank will negotiate how much it will cover for their client. Banks charge an annual fee for this service, typically a percentage of how much the bank would owe should the client default.

Letters of guarantee are used in a wide variety of business situations. These include contracting and construction, financing from a financial institution, or declarations during export and import processes.

Because many institutional investors maintain investment accounts at custodian banks rather than at broker-dealers, brokers will accept a letter of guarantee for call writers with short options as a replacement for holding cash or securities. The letter of guarantee must be in a form that the exchange and, potentially, the Options Clearing Corporation accept. The issuing bank agrees to give the broker the underlying securities if the call writer’s account is assigned.

To obtain a letter of guarantee, a customer must apply for it, much like a loan.

Assume Company XYZ is buying a large piece of customized equipment for $1 million. The equipment supplier will need to fabricate it, and it won't be ready for several months. The buyer doesn't want to pay right now, but the supplier also doesn't want to spend time and resources building the equipment without guaranteeing that the buyer will pay for it and has the resources to do so. The company can go to its bank and get a letter of guarantee. This is all the supplier should need to go forward since the bank guarantees it will pay should the buyer not do so.

For another example, suppose a call writer has 10 short contracts on the stock in Company XYZ, which equals 1000 shares. If the stock price rises, the short positions will lose money. The loss could theoretically be infinite since there is no cap on how far a stock can rise. But if the call writer owns 1000 shares of a stock, then the risk is mitigated. This is a covered call . To short the stock in the first place, the writer may have had to produce a letter of guarantee that they own the stock in another account if the broker thought an uncovered short call was too risky.

When someone buys from a new supplier, the supplier may request a letter of guarantee because they lack familiarity with the customer. Startup companies may also use letters of guarantee to prove they can afford large purchases despite a limited operating history.

The fee for a letter of guarantee varies from issuer to issuer but is traditionally a percentage of the amount being guaranteed. Typical fees range from 0.5% to 1.5% of the amount.

A letter of credit is like a letter of guarantee, assuring that a borrower can pay what they owe. Typically, letters of credit are more commonly used in international trade, while letters of guarantee are used for domestic purposes, such as real estate contracts.

To get a letter of guarantee, you need to apply for one from a financial institution, such as a bank. While you can get one from any bank, the issuer will want to examine your finances closely before offering the letter. For this reason, you'll likely find it much easier to work with a bank with which you already have a relationship.

A letter of guarantee acts as a form of insurance, giving suppliers confidence that they'll get paid for the goods or services they provide. If the customer fails to pay the bill, the bank issuing the letter will step in to pay. This makes letters of guarantee important for businesses that want to work with new suppliers or make especially large purchases and need proof that they can afford them.

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Assignments: why you need to serve a notice of assignment

Catherine phillips.

PSL Principal Associate

It's the day of completion; security is taken, assignments are completed and funds move. Everyone breathes a sigh of relief. At this point, no-one wants to create unnecessary paperwork - not even the lawyers! Notices of assignment are, in some circumstances, optional. However, in other transactions they could be crucial to a lender's enforcement strategy. In the article below, we have given you the facts you need to consider when deciding whether or not you need to serve notice of assignment.

What issues are there with serving notice of assignment?

Assignments are useful tools for adding flexibility to banking transactions. They enable the transfer of one party's rights under a contract to a new party (for example, the right to receive an income stream or a debt) and allow security to be taken over intangible assets which might be unsuitable targets for a fixed charge. A lender's security net will often include assignments over contracts (such as insurance or material contracts), intellectual property rights, investments or receivables.

An assignment can be a legal assignment or an equitable assignment. If a legal assignment is required, the assignment must comply with a set of formalities set out in s136 of the Law of Property Act 1925, which include the requirement to give notice to the contract counterparty.

The main difference between legal and equitable assignments (other than the formalities required to create them) is that with a legal assignment, the assignee can usually bring an action against the contract counterparty in its own name following assignment. However, with an equitable assignment, the assignee will usually be required to join in proceedings with the assignor (unless the assignee has been granted specific powers to circumvent that). That may be problematic if the assignor is no longer available or interested in participating.

Why should we serve a notice of assignment?

The legal status of the assignment may affect the credit scoring that can be given to a particular class of assets. It may also affect a lender's ability to effect part of its exit strategy if that strategy requires the lender to be able to deal directly with the contract counterparty.

The case of General Nutrition Investment Company (GNIC) v Holland and Barrett International Ltd and another (H&B) provides an example of an equitable assignee being unable to deal directly with a contract counterparty as a result of a failure to provide a notice of assignment.

The case concerned the assignment of a trade mark licence to GNIC . The other party to the licence agreement was H&B. H&B had not received notice of the assignment. GNIC tried to terminate the licence agreement for breach by serving a notice of termination. H&B disputed the termination. By this point in time the original licensor had been dissolved and so was unable to assist.

At a hearing of preliminary issues, the High Court held that the notices of termination served by GNIC , as an equitable assignee, were invalid, because no notice of the assignment had been given to the licensee. Although only a High Court decision, this follows a Court of Appeal decision in the Warner Bros Records Inc v Rollgreen Ltd case, which was decided in the context of the attempt to exercise an option.

In both cases, an equitable assignee attempted to exercise a contractual right that would change the contractual relationship between the parties (i.e. by terminating the contractual relationship or exercising an option to extend the term of a licence). The judge in GNIC felt that "in each case, the counterparty (the recipient of the relevant notice) is entitled to see that the potential change in his contractual position is brought about by a person who is entitled, and whom he can see to be entitled, to bring about that change".

In a security context, this could hamper the ability of a lender to maximise the value of the secured assets but yet is a constraint that, in most transactions, could be easily avoided.

Why not serve notice?

Sometimes it's just not necessary or desirable. For example:

If security is being taken over a large number of low value receivables or contracts, the time and cost involved in giving notice may be disproportionate to the additional value gained by obtaining a legal rather than an equitable assignment.
If enforcement action were required, the equitable assignee typically has the option to join in the assignor to any proceedings (if it could not be waived by the court) and provision could be made in the assignment deed for the assignor to assist in such situations. Powers of attorney are also typically granted so that a lender can bring an action in the assignor's name.
Enforcement is often not considered to be a significant issue given that the vast majority of assignees will never need to bring claims against the contract counterparty.

Care should however, be taken in all circumstances where the underlying contract contains a ban on assignment, as the contract counterparty would not have to recognise an assignment that is made in contravention of that ban. Furthermore, that contravention in itself may trigger termination and/or other rights in the assigned contract, that could affect the value of any underlying security.

What about acknowledgements of notices?

A simple acknowledgement of service of notice is simply evidence of the notice having been received. However, these documents often contain commitments or assurances by the contract counterparty which increase their value to the assignee.

Best practice for serving notice of assignment

Each transaction is different and the weighting given to each element of the security package will depend upon the nature of the debt and the borrower's business. The service of a notice of assignment may be a necessity or an optional extra. In each case, the question of whether to serve notice is best considered with your advisers at the start of a transaction to allow time for the lender's priorities to be highlighted to the borrowers and captured within the documents.

For further advice on serving notice of assignment please contact Kirsty Barnes or Catherine Phillips from our Banking & Finance team.

NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as, legal advice. You should not rely on, or take or fail to take any action based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. Gowling WLG professionals will be pleased to discuss resolutions to specific legal concerns you may have.

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Refund Guarantee for Shipbuilding Contracts

Refund guarantees are an integral part of a shipbuilding project. Whilst they are not part of the shipbuilding contract as such, it is unlikely that any ship building contract would be signed if there was no such guarantee for the buyer. The refund guarantee is often regarded as the “financial cornerstone” of a shipbuilding project.

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Sample copy of Refund Guarantee for Shipbuilding Contracts

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The construction of the ship is paid in advance in instalments between the date of contract and the delivery of the ship. The purpose of the refund guarantee is to provide the buyer with a safe option to recover the instalments already paid in case the shipbuilding contract is terminated due to the builder’s default and the ship is not delivered.

The BIMCO Refund Guarantee for Shipbuilding Contracts is intended to be a balanced instrument designed to protect the interests of all parties involved in the project - the builder, the buyer and the issuing bank.

It can be used with all typical shipbuilding contracts, including NEWBUILDCON, SAJ and Chinese forms. It provides legal certainty for the parties in an area which can involve some legal complexity. It is important to note that the Refund Guarantee should be read and operated in conjunction with the shipbuilding contract pursuant to which it is issued, and be consistent with it.

It is important that anyone contemplating using the guarantee should carefully read these explanatory notes prior to using it.

The latest edition of this contract is the BIMCO Refund Guarantee for Shipbuilding Contracts, issued in 2021.

Drafting team

The BIMCO Refund Guarantee for Shipbuilding Contracts has been developed by a team comprised of shipyards, banks, owners and legal experts. BIMCO is grateful to the following individuals for assisting us with this important project:

Ian Gaunt (Chairperson)
David Lan, ICBC
Insu Chung, Hyundai Heavy Industries (HHI)
Min Han, Ewha Womans University
Klaus Vilstrup, Dampskibsselskabet NORDEN A/S
Yu Yang, Innomarine
Richard Lord, QC
Chris Kidd, Ince Gordon Dadds LLP
Sean Gibbons, Stephenson Harwood LLP

BIMCO secretariat support was provided by Nina Stuhrmann, Manager, Contracts & Clauses and Mads Wacher Kjærgaard, Manager, Contracts & Clauses.

Explanatory Notes

BIMCO is aware that contracts are a result of negotiations and therefore compromises are made to reach an agreement. Whilst the majority of BIMCO contracts are standard forms and changes and amendments are made to reflect individual projects, this is not what we recommend for the Refund Guarantee. This is because English law is complex when it comes to guarantees and there are many legal principles and judgments to be taken into account. In case the wording of the guarantee is not crystal clear when it comes to the nature of the guarantee, this has to be decided by arbitration tribunals or the courts.

Due to the complexity of the subject, it is recommended that parties act cautiously and obtain legal advice before amending the guarantee to ensure that they fully understand the consequences of amendments.

Why is it of utmost importance for a buyer to understand the nature of the guarantee?

It is important to understand the nature of the guarantee and the different types of guarantees which can be issued. This has a significant impact on whether and when the guarantor has to pay. There are two principal types of guarantees often described as “demand/performance bonds” and “primary obligation guarantees” on the one hand and, on the other, “secondary liability guarantees” and “secondary obligation guarantees” sometimes described as “see-to-it guarantees”. The names are sometimes used interchangeably and the mere name of the guarantee does not always determine its legal characterisation. The material and decisive difference is in the wording of the guarantee, sometimes construed in the context of the “factual matrix” which forms the background to the issue of the guarantee.

The difference between these two types of guarantee instruments might seem to be legalistic at first sight but it can have a significant practical impact when it comes to a dispute under a shipbuilding contract. Under a guarantee which is a secondary liability guarantee, the payment obligation and the primary liability rests with the builder under the shipbuilding contract. This means that the bank will only have to pay under the guarantee when it has been ascertained that the builder is liable to repay under the shipbuilding contract.

The position is different under a demand guarantee/performance bond. A demand bond or guarantee may in principle be called on immediately and the guarantor is obliged to make payment, even if there is a dispute under the shipbuilding contract as to whether the events giving rise to payment have occurred. The guarantor cannot use any defences under the shipbuilding contract and would have to make the payment. Consequently, it would be preferable for a buyer to receive a demand guarantee/performance bond. This mechanism, however, could expose the guarantor to fraudulent or improper demands when the conditions to draw down under the guarantee are not met and there is a dispute between the buyer and the seller on whether the instalments should be refunded. To address this and to protect the guarantor and the parties to the shipbuilding contract, Clause 5 of the guarantee contains a right to delay payment pending the outcome of the arbitration or court proceedings relating to the correctness of the termination of the buyer’s termination of the shipbuilding contract.

The term “guarantee” has been retained in the title of the document but the intention of the instrument is clearly to provide for an on demand instrument with a possible postponement of payment pending the outcome of arbitration or court proceedings relating to the buyer’s right to terminate the underlying shipbuilding contract.

The parties should be aware when making changes to the BIMCO Refund Guarantee which could result in the guarantee becoming a secondary liability guarantee. What is often overlooked in practice is that any changes to the shipbuilding contract which have a material impact on the guarantor might, in the case of a secondary liability guarantee, discharge the guarantor’s liability. In practice this means that if a guarantee is a secondary liability and the parties, for example, move the delivery date, which commonly happens, the guarantor potentially could validly reject the payment unless it has agreed to the changes.

Things to keep in mind

Disclosing the shipbuilding contract to the guarantor to avoid any potential arguments on whether the guarantor can escape liability for alleged unusual provisions.

Avoiding any backdating of the shipbuilding contract.
Checking the enforceability of the guarantee in the place of registration of the guarantor.
Checking for local requirements to ensure that the guarantee can be validly enforced.

Clause 1 – Definitions

Definition of “Contract” – Material amendments and changes to the shipbuilding contract such as changes to the delivery or termination date and the price of the instalments should be made very cautiously and we recommend obtaining legal advice before such changes are made to ensure they do not result in the guarantor becoming entitled to reject payment under the guarantee.

Material amendments and changes to the shipbuilding contract such as changes to the delivery or termination date and the amount/number of the instalments should be made very cautiously and we recommend obtaining legal advice before such changes are made to ensure they do not result in the guarantor becoming entitled to reject payment under the guarantee.

Definition of “Demand” – The demand should be accompanied by a statement of one of the buyer’s officers. This is a formal requirement intended to provide the bank with certainty that a valid demand has been made. It should prevent fraudulent or otherwise improper demands. There is no legal definition of “officers” but we intend it to mean a person who has the appropriate authority in an organization to issue such a statement. Alternatively, the wording might be amended to substitute “authorised signatory” for “officer”.

This definition is limited to the first demand under the guarantee. In cases where a dispute as to the builder’s liability to repay the paid instalments under the shipbuilding contract has been referred to the courts or arbitration, a so called “further demand” needs to be made. This demand has to be accompanied by a copy of the award or judgment and is further described in Clause 5.

Definition of “Maximum Liability” – The parties are required to agree and state a maximum liability amount. Legal costs are not covered under the maximum liability. The parties should amend the guarantee if they want legal costs to be included.

Effectiveness of the guarantee and payment obligation - The guarantee becomes effective once the builder has received the first instalment. The end of the validity period is dealt with in Clause 4 which determines that the guarantee will remain in force until one of the listed events occurs (for more, see Clause 4 below).

Nature of the guarantee - This clause determines the nature of the guarantee. It has been included to make it clear that the guarantee is an demand guarantee.

Duration of the guarantee - The guarantee will come into force once the first instalment has been paid (see Clause 2) and will remain so until one of the three listed events occur.

The first event is when the ship is delivered under the contract and the second event is when the instalments have been refunded to the buyer by the builder or the guarantor.

The third event is a date the parties have to insert. It has to be calculated in accordance with the terms of the shipbuilding contract which will need to be carefully reviewed to take account of the potential duration of the contract, the extent to which the delivery date may be extended for permissible delay under the contract and the agreed rights for the buyer to cancel, rescind or terminate the contract. Consideration should also be given to allowing additional time for the buyer to make a decision as to how to proceed in relation to a possible termination of the shipbuilding contract and then make a valid demand under the contract and the guarantee as it may need to obtain board approval and consult with any financing bank. We recommend obtaining legal advice before agreeing the expiry date.

We recommend inserting a fixed date and not a reference to a number of days after the contractual delivery date to avoid any uncertainties as to when the demand has to be made.

It is very important to make the demand before the end of the validity period. Any demand after the validity period has lapsed will be invalid and the guarantee will not be able to be drawn on. Consequently, the guarantor is not obliged to refund the instalments.

This clause also gives the guarantor the right to delay payment. The guarantor can do so in situations where either the buyer or the builder have started legal proceedings. To give the guarantor the right to delay the payment, the dispute must relate to the right to repayment of the sums guaranteed and as stated in the demand.

Clause 5 - Postponement of payment in the event of a dispute

This clause deals with the consequences when a “Notice of Dispute” under Clause 4 has been sent. It is important to note that after a final and unappealable award has been handed down, a further demand with the amount finally awarded should be sent to the guarantor.

The guarantee does not cover settlement agreements and the parties need to amend it if they want to include such agreements.

Grossing up provision - This clause is self-explanatory.

Currency - This clause is self-explanatory.

Assignment - This provision is intended to reflect the industry practice on the assignment of refund guarantees. We recommend that you review the assignment provision under the shipbuilding contract to ensure that it is aligned with the guarantee.

This provision needs to be read in conjunction with Clause 2. Clause 8 does not deal with how payment has to be made to an assignee (usually following an event of default under an underlying finance contract between buyer and its bank). This will be dealt with in a separate assignment agreement and notice of assignment.

The guarantee does not address a novation of the guarantee in case of a novation of the shipbuilding contract. In practice, a new guarantee would need to be issued in such circumstances since the novation operates as a discharge and replacement of the parties and their respective contractual obligations.

Law and Arbitration - The clause provides for two options as to the forum in which disputes under the guarantee are to be referred. Both have in common that the governing law is English law. This reflects the fact that most international shipbuilding contracts are governed by English law.

The first jurisdiction option is based on the English law option in the BIMCO Law and Arbitration Clause 2020. This clause does not include the LMAA Small and Intermediate Claims procedures. The reason is that the amount under this guarantee will invariably be higher than the default limits set out in these procedures. The clause also does not provide options for arbitration venues other than London, but parties can adapt if they wish to refer to another venue. The explanatory notes for the BIMCO Law and Arbitration Clause 2020 .

The second jurisdiction option is the High Court of England and Wales. In case neither of the options are deleted, the clause will default to option (a) which is arbitration.

In choosing between arbitration or court proceedings for resolution of disputes it is important to consider the enforceability of an arbitration award or court judgement in the country where the guarantor has its principal place of business or assets. Arbitration awards are generally enforceable in over 160 countries which are parties to the 1958 New York Convention whereas the recognition of foreign court judgements is likely to be based on more restricted multilateral international conventions (such as the Lugano convention) or bilateral treaties or on principles of reciprocity. It may also be considered that the underlying shipbuilding contract will almost invariably subject disputes to arbitration and it may be convenient for proceedings involving a dispute under the refund guarantee to be dealt with in arbitration simultaneously with an arbitration under the relevant shipbuilding contract by consolidation or through an order of the tribunals for concurrent conduct of the arbitrations.

Notices - This clause determines how notices, claims, demands and the Notice of Dispute can validly be given. If the parties wish to use another method to deliver any notices under the guarantee, this method needs to be added to the clause. It should be noted that notice of arbitration is covered under Clause 9.

We strongly recommend stating a generic email address (such as [email protected] ) and not personal email addresses.

Attention should be paid to the delivery of the Demand under the guarantee as it has to be received by the guarantor within a certain time. The definition of “Demand” states that it has to be accompanied by a statement from one of the buyer’s officers. Since the SWIFT system has been updated, attachments can be sent via the system as well. Sending the demand by SWIFT is the safest way to ensure that it will be received by the guarantor. In practice however, due to time pressure and a potential refusal of the buyer’s bank to send such documents, the demand might in practice need to be sent by email. Despite the fact that receipt of an email can be established, it is recommended practice to send the demand by courier as well.

Warranties of the guarantor - This clause reflects that the guarantee is part of an international transaction and potentially local legal requirements or formalities need to be met for it to be valid. In case of any doubt, we recommend obtaining legal advice locally from where the guarantor is registered to clarify whether there are special requirements which need to be met.

Approvals and authorisations - At the time of drafting this guarantee, it is understood that no exchange control registration in China is required for a guarantee issued by a registered bank. However, it is recommended that parties check the current position before the guarantee is provided.

If the guarantor is in breach of this warranty, and has not obtained the necessary approvals and authorisations, and does not have to or is not allowed under local law to make payment under the guarantee, it may be liable in damages under English law for breach of the warranty. In practice, however, it might be difficult to enforce such a claim and get recovery from the bank.

Conditions of Use

BIMCO is the author of and has copyright in the BIMCO Refund Guarantee for Shipbuilding Contracts and has sole worldwide distribution rights. Use of the BIMCO Refund Guarantee for Shipbuilding Contracts is free of charge but is subject to acceptance of and compliance with the following conditions:

You are permitted to use Microsoft Word™ copies of the BIMCO Refund Guarantee for Shipbuilding Contracts for your own business to business purposes but may not otherwise distribute copies by sale, donation or lending. A Microsoft Word™ copy of the BIMCO Refund Guarantee for Shipbuilding Contracts may be obtained by contacting [email protected] .

The master copy of the BIMCO Refund Guarantee for Shipbuilding Contracts form you use must be obtained from and authenticated by BIMCO. You may delete and/or amend the original wording of the BIMCO Refund Guarantee for Shipbuilding Contracts and/or add new wording provided that such changes are clearly marked to distinguish them from the original printed text.

You are not permitted to produce any new term sheet derived from the Refund Guarantee.

You may add your own corporate branding to the BIMCO Refund Guarantee for Shipbuilding Contracts but you may not remove or amend the BIMCO logo.

We reserve the right, at our sole discretion, to modify or replace these Conditions of Use at any time. We will try to provide at least 30 days' notice prior to any new or modified Conditions of Use taking effect. Notice will be posted on BIMCO’s website at www.bimco.org.

By using the Refund Guarantee you agree to be bound by these Conditions of Use. If you disagree with any part of the Conditions of Use you may not use the BIMCO Refund Guarantee for Shipbuilding Contracts.

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Title 7 —Agriculture
Subtitle B —Regulations of the Department of Agriculture
Chapter VII —Farm Service Agency, Department of Agriculture
Subchapter D —Special Programs
Part 762 —Guaranteed Farm Loans

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5 U.S.C. 301 and 7 U.S.C. 1989 .

64 FR 7378 , Feb. 12, 1999, unless otherwise noted.

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Editorial Note on Part 762

Editorial note:.

Nomenclature changes to part 762 appear at 72 FR 63297 , Nov. 8, 2007.

§ 762.160 Assignment of guarantee.

( a ) The following general requirements apply to assigning guaranteed loans:

( 1 ) Subject to Agency concurrence, the lender may assign all or part of the guaranteed portion of the loan to one or more holders at or after loan closing, if the loan is not in default. However, a line of credit cannot be assigned. The lender must always retain the unguaranteed portion in their portfolio, regardless of how the loan is funded.

( 2 ) The Agency may refuse to execute the Assignment of Guarantee and prohibit the assignment in case of the following:

( i ) The Agency purchased and is holder of a loan that was assigned by the lender that is requesting the assignment.

( ii ) The lender has not complied with the reimbursement requirements of § 762.144(c)(7) , except when the 180 day reimbursement or liquidation requirement has been waived by the Agency.

( 3 ) The lender will provide the Agency with copies of all appropriate forms used in the assignment.

( 4 ) The guaranteed portion of the loan may not be assigned by the lender until the loan has been fully disbursed to the borrower.

( 5 ) The lender is not permitted to assign any amount of the guaranteed or unguaranteed portion of the loan to the applicant or borrower, or members of their immediate families, their officers, directors, stockholders, other owners, or any parent, subsidiary, or affiliate.

( 6 ) Upon the lender's assignment of the guaranteed portion of the loan, the lender will remain bound to all obligations indicated in the Guarantee, Lender's Agreement, the Agency program regulations, and to future program regulations not inconsistent with the provisions of the Lenders Agreement. The lender retains all rights under the security instruments for the protection of the lender and the United States.

( b ) The following will occur upon the lender's assignment of the guaranteed portion of the loan:

( 1 ) The holder will succeed to all rights of the Guarantee pertaining to the portion of the loan assigned.

( 2 ) The lender will send the holder the borrower's executed note attached to the Guarantee.

( 3 ) The holder, upon written notice to the lender and the Agency, may assign the unpaid guaranteed portion of the loan. The holder must assign the guaranteed portion back to the original lender if requested for servicing or liquidation of the account.

( 4 ) The Guarantee or Assignment of Guarantee in the holder's possession does not cover:

( i ) Interest accruing 90 days after the holder has demanded repurchase by the lender, except as provided in the Assignment of Guarantee and § 762.144(c)(3)(iii) .

( ii ) Interest accruing 90 days after the lender or the Agency has requested the holder to surrender evidence of debt repurchase, if the holder has not previously demanded repurchase.

( c ) Negotiations concerning premiums, fees, and additional payments for loans are to take place between the holder and the lender. The Agency will participate in such negotiations only as a provider of information.

[ 70 FR 56107 , Sept. 26, 2005]

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The importance of refund guarantees in shipbuilding contracts

Refund guarantees are commonly provided in new build vessel transactions. Given that the purchaser will normally be paying for a substantial part of the vessel in advance of delivery actually taking place, the refund guarantee provides a form of security in respect of those instalments.

By virtue of the refund guarantee, the builder’s bank undertakes that in the event the purchaser ends the contract for good reason (for example, due to the builder’s insolvency), if the builder for any reason fails to refund the advance instalments of the contract price the bank will refund those instalments on the builder’s behalf. Where the purchaser has taken a loan to finance the instalments, the purchaser will usually be required to assign the benefit of the refund guarantee to the financier. In this situation it is important to check that such an assignment is not prohibited in the refund guarantee.

In the current economic climate, it is likely that shipbuilders will experience difficulties in financing new orders, making refund guarantees a very important tool in protecting the purchaser and its lender’s interests. It is therefore vital for the purchaser to ensure that the refund guarantee provides as much protection as possible and, importantly, that the refund guarantee is actually enforceable.

Negotiating the Refund Guarantee

The refund guarantee will normally be in place throughout the vessel’s construction and outfitting period and will have a cut-off date, which will usually make allowances for potential delays. It is important for the purchaser to ensure that the cut-off date takes into account any delay which could occur as a result of the arbitration of any disputes.

Negotiation is often required in relation to the question of whether the guarantee can be called up on demand from the purchaser, or whether it should only be called up when an arbitrator or court has held that the builder should be liable. The purchaser and its lender will prefer the former, due to the fact that legal or arbitration proceedings can be lengthy and they will want reimbursed as quickly as possible.

Often the purchaser’s financing arrangements will state the loan is repayable when the purchaser rescinds the contract, therefore it will be in the particular interests of the purchaser for the refund guarantee to be called up on demand. The builder on the other hand, will wish to avoid the situation where the guarantee is cancellable even though the purchaser’s rescission is being contested.

In most cases the calling up provisions will be in the builder’s favour. The builder’s bank will make the guarantee expressly conditional on either the builder’s admission in writing that it is liable to make the refund or an arbitration award or court judgment determining the liability.

It is essential that clear language in relation to calling up procedures is used in the refund guarantee, as illustrated in the 2001 case of Caja de Ahorros del Mediterraneo and others v Gold Coast Limited (2001 )1. In the case, a refund guarantee stated that the builder’s bank would repay an instalment “ if and when the instalment becomes refundable from the builder under and pursuant to the terms of the shipbuilding contract”. Confusingly, the bank also undertook in the guarantee to make payment to the purchaser on receipt of a certificate from the purchaser’s bank in the event of the purchaser choosing to rescind the contract.

The purchaser rescinded due to delay in delivery of the vessel, and steps were taken to begin arbitration proceedings as a result. While the arbitration was pending, the lender issued a certificate as stated in the refund guarantee, demanding repayment.

The refund guarantor argued that on its true interpretation, this did not allow the purchasers to demand payment without the builder’s liability being independently determined by an arbitrator.

However, on appeal the court held in favour of the purchaser, stating that the wording of the refund guarantee created an on demand obligation which arose independently of the shipbuilding contract. In making the judgment, the court was influenced by the omission in the refund guarantee of any reference to the builder’s liability in the shipbuilding contract.

It is therefore essential that the wording of the refund guarantee clearly sets out the procedure in relation to calling up the guarantee. In this case the purchaser benefited from unclear wording.

Is the Refund Guarantee valid?

The August 2008 English case of Sea Emerald SA v Prominvestbank2 serves as a timely reminder to purchasers of vessels to ensure that refund guarantees which are issued with shipbuilding contracts have been properly signed by a person who has authority to sign on the bank’s behalf. Failure to do so could invalidate the refund guarantee and expose the purchaser and the purchaser’s bank to a serious risk.

In the case, the purchaser purchased 19 vessels from a Ukrainian builder’s yard. The purchase price was in excess of $200million.

The contract stated that the yard had to provide the purchaser with a refund guarantee. The refund guarantee had to be signed on behalf of the builder’s bank, Prominvestbank. It was signed by the head of one of the bank’s regional departments.

The yard subsequently ran into difficulty and was unable to obtain the necessary funds to construct the vessels. Some time later it went into administrative bankruptcy. The yard failed to complete and deliver one of the vessels purchased by Sea Emerald. At this point, Sea Emerald had paid at least $17million in advance payments to the yard. As a result, Sea Emerald held the yard to be in default and sought to make a claim under the refund guarantee.

However, the yard’s bank argued that their employee did not have the authority to sign on its behalf, thus invalidating the refund guarantee.

In considering whether or not the employee had such authority, the court examined the bank’s articles of association. These provided that the bank’s departments should have delegated to them rights to carry out operations in foreign currencies and that those rights included the right to:

“effect settlements connected with clients’ export and import operations in foreign currencies in the form of a documentary letter of credit, collection of payments or bank transfer, and in other formats used in international banking practice”

The articles also provided that:

“the right of signature of foreign economic agreements to be entered into by a department on behalf of the bank shall be granted to the head of the department, without a power of attorney, with subsequent notification of the bank”

Sea Emerald argued that the articles were open to a wide interpretation and provided that the employee had actual authority to enter into the refund guarantee on the bank’s behalf. Further, they argued that the employee had ostensible authority to give the refund guarantee and that the bank had ratified this.

Unfortunately for Sea Emerald, the court found in favour of the bank and held that the articles did not provide that the bank employee had an express or implied power to issue the refund guarantee. The articles were not broad enough to encompass issuing a refund guarantee. A refund guarantee was considered to be a contractual commitment rather than a method of making payment.

The court also held that it was not within the scope of the employee’s usual authority to enter into a refund guarantee and that the bank had not held the employee out as having the authority to do so. In order for the bank to have ratified the refund guarantee, the chairman of the bank or its management board would have had to have adopted it, and there was insufficient evidence to show that this had taken place.

It is therefore vital to ensure that refund guarantees have been signed on behalf of the bank in question by someone who has the necessary power. Failure to do so will result in the guarantee being invalid and the performance of the contact will not be guaranteed.

Purchasers and lenders must ensure that the refund guarantee is drafted to provide them with as much protection as possible in order to limit their exposure to risk during the construction period. This is particularly relevant during turbulent times where cash-strapped builders will find it more difficult to comply with their obligations under shipbuilding contracts.

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Morton Fraser MacRoberts
Arbitration award
Arbitral tribunal

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Out-Law Guide 3 min. read

Guarantees on lease assignment: implications for tenants

25 Aug 2011, 4:54 pm

The Court of Appeal has confirmed that, when a lease is assigned to a third party, the outgoing tenant's guarantor can guarantee the outgoing tenant's liabilities under an authorised guarantee agreement (AGA). In doing so, the guarantor can indirectly guarantee the incoming tenant's obligations.

This guide considers the implications of a recent case for tenants. For the implications for landlords and their lenders, please see our separate Out-Law guide .

What is an authorised guarantee agreement?

Authorised guarantee agreements (AGAs) were created by the Landlord and Tenant (Covenants) Act, and their content is strictly regulated by statute.

Tenants and their guarantors are automatically released from liability to the landlord when a lease is lawfully assigned to a third party. Landlords can, however, require outgoing tenants to enter into AGAs guaranteeing the liabilities of the new tenant under a lease. There are no provisions allowing guarantors to do so as well.

The Landlord and Tenant (Covenants) Act applies to leases granted on or after 1 January 1996, unless the lease was granted under an agreement or court order made before that date. It includes anti-avoidance provisions which invalidate contractual provisions designed to work around it.

Recent case law

There were heated debates about the validity of guarantees of leasehold liabilities following the High Court's decision in the Good Harvest case in 2010 that a guarantee of an assignee given by the outgoing tenant's guarantor was void. This was considered again later that same year in a case between landlord K/S Victoria Street and House of Fraser (Store Management) Ltd.

In January 2006 K/S Victoria Street agreed to the sale and leaseback of a property in Wolverhampton to a company in the House of Fraser group. Under the agreement, the store management company was to take a lease guaranteed by the group holding company. The Agreement for Lease also required it to assign the lease to another group company by April 2006, but no assignment ever took place. In March 2010, the landlord brought proceedings against all three of the House of Fraser companies seeking to enforce the assignment.

House of Fraser relied on the Good Harvest decision to argue that the agreement was unenforceable. The High Court agreed, deciding that the guarantee to be given by the parent company as the outgoing guarantor in respect of the new tenant's liabilities under the lease was invalid. It also doubted whether sub-guarantees - that is, guarantees by outgoing guarantors in respect of outgoing tenants' liabilities under AGAs - were effective. The decision caused difficulties for landlords and tenants, and meant that in many cases groups of companies could no longer make assignments between themselves.

The Court of Appeal clarified the law and upheld the validity of sub-guarantees. The decision confirms that:

an outgoing tenant's guarantor can guarantee an outgoing tenant's liabilities under an AGA – but not the liabilities of the incoming tenant to which the lease was assigned;
once released from liability by an assignment, guarantors can provide fresh guarantees in respect of subsequent assignees.

Grant of a lease

During negotiations, it is going to be more difficult for a tenant to object to a landlord's requirement for a guarantor to guarantee its AGA now that the Court of Appeal has confirmed that such arrangements are valid.

Assignment of a lease

A guarantor cannot guarantee the obligations of the new tenant to which the lease is assigned even if it wants to. This poses a particular problem for intra-group assignments. A tenant should anticipate that it will be a common condition on assignment that a guarantor is asked to guarantee its obligations in an AGA.

There is a suggestion that a tenant may not be able to assign its lease to its guarantor. It may be advisable to avoid this scenario until the position is clarified.

Intra-group assignments

The Court of Appeal confirmed that an outgoing tenant's guarantor cannot directly guarantee the liabilities of the incoming tenant when a lease is assigned.

This has important consequences for alienation provisions which allow the landlord to control the assignment by a tenant of its lease. Corporate tenants often request provisions in leases which will allow assignments between companies in the same group without the landlord's permission. Landlords often agree to these arrangements, subject to a condition that the tenant's guarantor continues to guarantee the incoming tenant's liabilities under the lease. The decisions in the Good Harvest and K/S Victoria Street cases prevent this because:

it will be impossible to obtain a further guarantee from the same guarantor for the incoming tenant;
the Landlord and Tenant (Covenants) Act provides that it is only possible to obtain an AGA from an outgoing tenant, for which the outgoing guarantor can then be a guarantor, if the lease prevents the tenant from assigning the premises without the landlord's consent.

As a result of this, landlords may seek to prevent assignments between companies in the same group without their consent in order to obtain a sub-guarantee from an existing guarantor. Alternatively, landlords may attempt to impose some other form of control – for example, a financial test – to ensure that an assignee is suitable.

Note too that the Court of Appeal did not say whether tenants can validly offer the same guarantor through a string of intra-group assignments using a series of guarantees and sub-guarantees, or more complex arrangements, in order to provide a fresh guarantee from an outgoing guarantor.

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Assignment of a lease. A guarantor cannot guarantee the obligations of the new tenant to which the lease is assigned even if it wants to. This poses a particular problem for intra-group assignments. A tenant should anticipate that it will be a common condition on assignment that a guarantor is asked to guarantee its obligations in an AGA.

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