Parent Company Guarantees

Dean Suttling

January 28th, 2022
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Suppose you have concerns about a company you may be entering into a contract with; perhaps it’s their ability to fund the project or the size of their workforce in a new region. How can you manage this risk if they are part of a larger group of companies?

You could explore a Parent Company Guarantee (PCG) to provide you with additional security. PCG terms are variable unless a standard form is used, but, in many cases, these are varied to suit the client’s needs.
Understanding the obligations of a PCG and how parties seek to limit these obligations will allow you to navigate through the terms and reach an agreement that is reasonable and matches your requirements in the event a PCG needs to be called upon.

What are they used for / what is the purpose?

A PCG is a legally binding commitment from a parent company. The parent guarantees that the performance of the party the client contracted with will meet their contractual obligations. The responsibilities are often back-to-back, i.e., the parent company carries no greater or wider obligations than those placed on the contractor but can at times be greater.

Range of liability

Liability for the parent company will need to be backed against an obligation in the main contract; therefore, the PCG provides a secondary liability or contingency for the employer to call upon. Unlike on-demand performance bonds, where the client can contact the issuer and trigger payment on demand through the unilateral presentation of documents, under a PCG, liability must be established first, usually by acknowledgement between the parties that a breach has occurred. The PCG can be invoked only once ascertained under the contract, and the parent company steps in to meet the contractors’ obligations.

Standard wording or amendment?

For PCGs to be legally enforceable, they must comply with the Statute of Frauds Act. Therefore, they must contain an offer, acceptance, consideration, and the intent for the parties to create a legally binding agreement.

In terms of standard forms, there is the ABI Model Form of Guarantee. First published in 1995, the Association of British Insurers (ABI) issued its first common form of a guarantee bond, but it is based on performance instead of being on-demand.
By reference to the above, the breach will need to be established first before the guarantor can be held against their obligation to discharge their duties to cover the costs of such a breach. The wording in the bond around guarantees includes the following:

“The Guarantor guarantees to the Employer that in the event of a breach of the Contract by the Contractor the Guarantor shall subject to the provisions of this Guarantee Bond satisfy and discharge the damages sustained by the Employer as established and ascertained pursuant to and in accordance with the provisions of or by reference to the Contract and taking into account all sums due or to become due to the Contractor.”

Be wary of non-standard versions or standard versions that have been amended as the obligations may be more significant. For example, a guarantee is the parent company’s promise to ensure an obligation is performed, whereas indemnity is provided to ensure the obligation is fulfilled. However, the critical difference is that where PCGs end when the contract is terminated or deemed invalid, an indemnity survives such actions, making the liability for an indemnity over a PCG greater.

In terms of amended PCGs, it is common practice to see hybrid versions. The employer seeks to create both a guarantee and an indemnity, and in these cases, caution should be applied and a thorough review undertaken.

What about if the works vary?

As noted above, PCGs and the obligations placed on the parent company are all based on the underlying contract. If the PCG is called upon, the parent company may argue that the works have varied and are do not represent the same project or obligations they originally entered. In this instance, the PCG could be void.

The way around this is to ensure the terms in the PCG cover this point off by allowing the variation of the works and such variation to be extended into the obligation coverage of the PCG. Wording such as “the PCG is deemed to include and expressly allow for amendments, variations, and instructions under the header contract without affecting the PCG” are commonplace to mitigate this risk.

Notification of Breach

When reviewing the PCG, make sure there is a notification procedure that includes the address the notice is to be sent, the format it should be notified, and most importantly, the particulars you are to report.

In legal terms serving a valid notice is imperative if your claim is accepted and therefore recognised. You do not want to find yourself in the position where a deadline passes between the alleged breach and serving of the notice.

When do the parties get paid?

Payment is not always a one solution answer. The terms of the PCG might read that payment is due upon the breach being established, which would operate on similar terms to an on-demand bond. Alternatively, payment through a PCG is conditional on the terms of the underlying header contract being met. After the breach has occurred, the parties will need to address the situation, calculate, and then demonstrate loss before recovering the losses under the terms of the PCG.

Notwithstanding the above, the issuer of the PCG, if they can operate under the same terms of the underlying contract, will have the same right to challenge the breach and who is responsible, should the incident in question be ambiguous.

What periods do they cover?

What party you represent will determine the end date included in the PCG. For a contractor, your preferred position will be practical completion on the basis completion has been awarded, and therefore from this perspective, the obligations are complete.

However, from an employer’s perspective, the end of the defect’s liability period will be the point that you will acknowledge the obligations have been met, save for any latent defects that might be found post-completion and defects certificate being issued. Therefore this is the date you will be seeking in the PCG.

Checking the parent company’s financial standing

If a PCG is offered, it goes without saying you need to investigate the company and review its finances objectively. If the guarantee needs to be called upon, you do not want to find the company has no assets and in the event of your breach notice decides to wind itself up, the PCG is in effect worthless.

Doing your due diligence is critical if you genuinely back off the liability you think you are.

Case Law

An interesting case from 2019 concerning PCGs occurred between Rubicon Vantage International Pte Ltd and Krisenergy Ltd. Rubicon commissioned an FSO facility (floating storage and offloading facility) to Kris Energy (Gulf of Thailand) Ltd (“Kegot”). The latter was a subsidiary company of Krisenergy.

The terms of entering the contract were that Kegot was required to procure a PCG from their parent company, Krisenergy. In terms of the PCG, no standard form was used.

In 2015, Rubicon issued invoices to Kegot for $1.8m, claiming the costs were for works on the FSO facility before delivery. Kegot disputed the invoices and the liability to pay them. What ensued was legal wrangling for three years before Rubicon then served a notice against the parent company for the total amount. Krisenergy did not pay presumably as they also disagreed on the liability. What followed was a second demand being issued against the PCG for the same amount plus interest.

The payment dispute centred on the terms of the guarantee, specifically whether it was on-demand or conditional. The interpretation of the clauses referred to in regards to this. Krisenergy believed that as a bank or financial institution did not issue the bond, the on-demand part was not applicable.

The ruling was that it was accepted by both parties the guarantee was in fact, or at least in part, an on-demand guarantee and taking a ruling from a previous case (Marubeni Hong Kong v Mongolian Government [2005]), it was considered, upon a review of the terms of the guarantee, that if the amounts were not in dispute then Krisenergy would be liable to pay the sum demanded within 48 hours of notification but notwithstanding this, if the amounts claimed were in dispute then it was still responsible for paying the amount demanded but up to a cap of $3m.

There were alternative arguments regarding the serving of notices being enforceable. Even though notices were served correctly but disputed, the responsibility to pay was acknowledged but the amount claimed (quantum) was in dispute. However, these were rejected by the court presumably because the terms, once interpreted by the court, were not subject to these points and the amount demanded was therefore payable.

Alternatives

Alternatives to PCGs include performance bonds which can be on-demand or conditional. Conditional bonds are broadly similar in establishing that the contractor has not performed or met the obligations under the contract, following which loss must be considered once proven.

On-demand bonds, however, are as they say, on-demand. The employer can notify the issuer that a breach has occurred, there are little to no preconditions to meet, and they can trigger the value of the bond to be paid out. These are less common in the UK construction industry, and if you can source one, they are likely to be prohibitively expensive versus the likelihood that you will need to call upon it and therefore, PCGs provide a low-cost solution to reduce project risks.

Photo by Dan Dennis on Unsplash

About Dean Suttling

A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.

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