Parent Company Guarantees
A parent company guarantee (PCG) is a promise to answer a liability being a debt or default of another ….. in construction terms the parent company will be answering the debt or default of a contractor, noting that PCG’s are used in a variety of procurement situations, including outsourcing contracts.
The essential characteristics of a contract of guarantee are:
– The Surety undertakes to be responsible, in addition to the contractor, for the due performance by the contractor of his obligations to the developer if there is a failure or performance by the contractor
– A key difference between a bond and a guarantee is that the liability of the Surety under the guarantee is always ancillary, or secondary to that of the contractor who remains primarily liable under the building contract to the developer
– The Surety’s liability to the developer is to the same extent as the liability of the contractor to the developer under the building contract; this is the so-called “principle of co-extensiveness”.
In terms of protecting against risks a PCG may also provide protection on insolvency and will also provide protection against latent defects. It is stating the obvious that a PCG will only be of value if the parent company has assets. This will require extensive due diligence to ensure that this is the case. Also, if a subsidiary becomes insolvent there is always the possibility that the parent company will also be in financial difficulty and therefore the PCG may be worthless.
There are some serious considerations when a PCG is thought to be part of an answer to a risk mitigation strategy. These considerations include:
a) The purchaser should ensure that all the contractor’s primary obligations under the contract are covered so that the parent company’s obligations extend to latent defects
b) It must be ensured that the parent company has a continuing obligation under the guarantee which will only expire when the contractor ceases to be liable under the contract, e.g. in a construction contract 6 – 12 years from practical completion
c) A PCG should be drafted so that it covers any variations under the contract and that it operates when the contractor goes into liquidation or if the contract is otherwise determined in accordance with the appropriate provisions within the contract
d) Provisions that all other remedies have been exhausted against the contractor before making a claim under the guarantee should be avoided
e) The benefit of the guarantee should be assignable when the contract is assignable
f) Bearing in mind that there is a track record of PCG’s and Bonds more generally suffering from bad and ambiguous drafting and which has led to many problems, reported and unreported! In this respect there is the thought about who drafted them in the first place (this could be a topic in its own right but for the moment there is the inevitable thought that not all legal advice is fool-proof). An example of significance arose in the case of Alfred McAlpine Construction Ltd v Unex Corporation [1994] 70 BLR 26. Panatown employed McAlpine on a construction project and Unex entered into a so-called Parent Company Guarantee which provided:
“If Panatown shall in any respect fail to execute the contract or commits any breach of its obligations thereunder then Unex will indemnify McAlpine against all losses, damages, costs and expenses which may be incurred by McAlpine by reason of any default on the part of Panatown in performing and observing the agreements and provisions on its part contained the contract PROVIDED ALWAYS that Unex shall not be under any greater liability to McAlpine that Panatown would have been liable in contract pursuant to the express terms of the contract.”
The Court of Appeal held that the liability of Unex to McAlpine under the Parent Company Guarantee was not co-extensive with the liability of Panatown under the building contract. There were no words in the agreement which made Unex liable for amounts awarded in the arbitration.. “..the wording does (not) have the effect of defining the extent of Unex’s obligations to McAlpine by reference to what is determined in arbitration proceedings between McAlpine and Panatown….”
g) Consideration should be given to the place of business of the parent company, particularly when they are domiciled off-shore. The intervention of overseas companies and recourse to foreign courts will inevitably lead to additional costs and legal complications. In BFL experience these facets will require detailed consideration at PCG drafting, negotiations and will have to involve the parent company’s legal advisers at some stage.
In summary, PCG’s have an undoubted place in risk mitigation strategies. They should be approached with caution and exercised with great care, otherwise what was thought as a solution may not be the case.
About Brian Farrington
Brian Farrington is one of the world’s longest established procurement and supply chain consultancy and executive training specialists. 33 of the current FTSE100 have retained our services, as well as leading organisations in the UK, North America, southern Africa and Asia.
Established in 1978, we have proven expertise and experience in strategic procurement, sustainability and risk management.
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