Parent company guarantees (PCGs)

In writing

According to section 4 of the ancient Statute of Frauds Act 1677, a guarantee (whether a PCG or a bond) must be in writing and be signed. Furthermore, if the PCG is not in the form of a deed, consideration will be required (although this can be a nominal consideration of £1).

Parent company's obligations

In a PCG it is usual that the parent company guarantees to the employer:

1. that its subsidiary contractor will perform its obligations under, and comply with the terms of, the underlying building contract, failing which, the parent company will ensure the contract is completed; and
2. that it will secure the employer's financial interests by promising to pay sums due under the contract should they become payable and the contractor is unable to meet them.

The parent company would, potentially, be liable for all losses for which the contractor would be liable with the result that damages could be unlimited.

As the case of Sabah Shipyard v The Islamic Republic of Pakistan [2007] All ER (D) 193 (Nov) illustrates, if it is the intention of the parties that the parent company honours an award made against the contractor (whether by a court, an adjudicator or an arbitrator), include clear words to this effect in the PCG (this principle applies equally to a bond).

Sabah Shipyard ('Sabah') entered into an agreement with The Islamic Republic of Pakistan ('Pakistan') to supply electricity to Karachi Electricity Supply Corporation ('Karachi') using a barge-mounted electric power plant. Sabah provided a letter of credit in favour of Karachi and Pakistan in turn had provided a written guarantee to Sabah.

Karachi drew down on the letter of credit on the basis that Sabah had failed to bring the plant into operation. Sabah claimed that the drawdown on the letter of credit was a breach of contract by Karachi and obtained an arbitration award against Karachi for repayment of the sums drawn down. Sabah then applied for summary judgment against Pakistan seeking payment under the written guarantee of the sums awarded at arbitration. Pakistan submitted (amongst other points) that they were not bound by the arbitration award and thus were entitled to have the case proved against it.

Although the written guarantee extended to any 'monetary damages arising out of any failure by KECS or the Fuel Supplier to perform its [contractual] obligations', Mr Justice Clarke held that:

'I do not regard the fact that the clause extends to monetary damages arising out of a failure to perform obligations under the agreement as amounting to the very clear words indeed required to make a surety liable to honour an award made against[Karachi]. They are perfectly apt to make clear that the surety's obligation is not limited to paying any debts of[Karachi] but extends to paying any amount which [Karachi]is bound to pay in respect of damages for breach of contract'.

The judge went on to say that:

'... it would have been very easy to insert a provision that [Pakistan's] obligations extended to guaranteeing the performance of any Award against [Karachi] or that any such Award should be evidence (conclusive or otherwise) against the surety. The fact that ...the clause fails to do so militates against a construction of the guarantee which would extend to coverage of an Award'.

The court held that Pakistan was entitled to have the case against it proved.

No greater liability

To ensure that its potential obligations and liability under the PCG are no greater than the contractor's under the underlying building contract, it is usual for the parent company to insist on the inclusion of a 'no greater liability' clause. Additionally, to create equivalent rights to those of the contractor, the parent company should request a 'same defences' provision within this clause, so that it can invoke the defences that would be available to the contractor in the event of a call on the bond.

Variation

It is important for an employer to have a provision in the PCG that allows the underlying contract to be amended or varied without the consent of the parent company providing the PCG.

In Holme v Brunskill [1878] 3 QBD 495 the court held that where the underlying contract is amended or varied without the consent of the parent company, or where the employer grants an extension of time to the contractor, whether or not this affects the guarantor adversely, the parent company will no longer be liable for its obligations under the PCG unless there are words to the contrary contained in the PCG.

Expiry of liability

A PCG will usually contain an expiry date or event which makes clear when the liability of the parent company comes to an end. For example, a PCG may be said to expire on the issue of the notice of making good defects, when all obligations etc to be carried out or performed by the contractor under the contract have been discharged or, as is most commonly the case, on expiry of the contractor's liability under the contract (usually 12 years from practical completion).

This differs from performance bonds which typically expire at practical completion or on the issue of the certificate of making good defects.

If no date or event is specified and the PCG is executed as a deed, the expiry period will generally be 12 years (under section 8 of the Limitation Act 1980. For practical purposes, the latest date from which the period would run would be the date of practical completion, this being the latest date at which the contractor could correct any breach before offering the building as complete in accordance with the contract documents (see Borough Council of South Tyneside v John Mowlem & Co, Stent Foundations Ltd and Solocompact SA (1997)).

As with a bond, a clause is usually inserted stating that expiry of the PCG will only apply in relation to claims not notified before expiry.

Notices

It is not unusual for a parent company to try to impose strict notice requirements in a PCG so that it is only liable for claims notified to it within a certain period of time from the cause of action arising. The employer would want to resist the inclusion of any such provision.

Adjudication

As with a bond, a PCG is not a 'construction contract' for the purposes of the Housing Grants Construction and Regeneration Act 1996. So, as the right to refer a dispute to adjudication is not implied, it may be prudent for the parties to include express provisions to permit this.