Do parent company guarantees mean that you never need to worry about your partner going bust? Well, as you might have guessed, there's no such thing as 100% security.
I suspect that, notwithstanding the eventual enactment of the Contracts (Rights of Third Parties) Bill, parties to construction contracts – particularly those funding the project – will still want the comfort of pieces of paper establishing contractual relationships between them, rather than relying on statutory rights.

In addition to collateral warranties, there are, of course, a number of other documents that are often included in contracts for development projects and that are broadly intended to serve the same function. One such document is the parent company guarantee. This particular piece of paper is intended to act as a guarantor of the obligations of, for example, the contractor to the employer or client.

The parent company guarantee is not to be confused with other pieces of paper intended to provide comfort and reassurance that, should the contractor fail to carry out its obligations (usually because it has become insolvent), somebody else will step into its shoes.

You will be familiar with these other documents, often called guarantees, guarantee bonds, performance bonds, on-demand bonds, default bonds or a mixture of all of the above. Under these arrangements, a third party guarantees the performance of the contractor to the beneficiary of the bond or guarantee holder. In the event of non-performance by the contractor, either on demand or on proof of loss incurred, the surety will discharge the contractor's outstanding obligations.

A parent company guarantee comes into play where, for example, a holding company has formed a subsidiary to carry out a particular project, or a contractor is one of a number of group companies under an ultimate parent company.

There are a number of issues that need to be borne in mind when examining a parent company guarantee or considering its inclusion in the contract documentation:

  • Some parent company guarantees cannot be activated until all the available potential remedies against the defaulting contractor have been tried. Is the wording in your guarantee unduly restrictive in this way?

  • Does your parent company guarantee operate on an on-demand basis or on proof of damage or default? Obviously, if you are an employer, you would prefer the former. If you are a contractor, you (and your bank) would prefer the latter

  • Is the parent company itself an intermediate company in a corporate structure and therefore of little substance? Do not assume that the parent company giving the guarantee is actually a company of substance itself

  • Check the place of business of the parent company providing the guarantee – it may be more difficult to recover against a company based overseas

  • Does the parent company guarantee apply to the contractor that is actually carrying out the work? This may seem fairly obvious, but you never know

  • What is the cut-off date for the guarantee?

    • There are a number of potential pitfalls with parent company guarantees
    • Ensure that the parent company guarantee does what it says it can do

  • Is there a cap on the level of recoverable losses?

  • Ensure that the guarantee is signed by the guarantor. This is a requirement of the Statute of Frauds 1677 (yes, it is still in force), together with the necessity for the guarantee to be in writing.

    Many of these issues are common to any collateral contract such as a bond or warranty. Parent company guarantees are, in this respect, no exception. They are also subject to the general principle that the mere description of something in a document is not conclusive evidence of its legal function.

    For example, simply describing someone as an expert or an arbitrator does not necessarily mean that they are an expert or arbitrator.

    You still have to look at what they are actually required to do in the relevant circumstances.1 This issue arose in the context of a purported parent company guarantee in Alfred McAlpine Construction Limited vs Unex Corporation Limited.2 McAlpine was the main contractor under a design-and-build contract that was subject to the usual JCT arbitration clause. McAlpine's employment was determined and disputes arose between it and the client Panatown. These disputes were referred to arbitration. Unex had provided a parent company guarantee for Panatown.

    This guarantee was couched in the following terms: "If Panatown (unless relieved from the performance by any clause of the contract or by statute or by the decision of a tribunal of competent jurisdiction) 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 in the contract provided always that Unex shall not be under any greater liability to McAlpine than Panatown would have been liable in contract pursuant to the express terms of the contract."

    McAlpine sought to enforce the parent company guarantee against Unex. Unex tried to stay the proceedings to arbitration under section 4 of the Arbitration Act 1950 (as it then was).

    The Court of Appeal decided that the parent company guarantee was not a guarantee at all, but a contract of indemnity.

    Unex had undertaken to indemnify McAlpine in respect of any losses, irrespective of the outcome of any arbitration proceedings. Unex was acting as a surety in this regard and found itself therefore outside the provisions of the Arbitration Act. It could not seek to stay proceedings to arbitration because it was not a person claiming through or under Panatown.

    To summarise: check your parent company guarantees, whether you are the sender or the recipient of them. Used properly, they can provide a measure of protection for their beneficiaries but, as is the case with any contract documentation, ambiguities or inconsistencies in the drafting usually leads to trouble.

    1 Langham House Developments Limited vs Brompton Securities Limited (1980) 265 Estates Gazette.

    • Postscript

    Simon Lewis is a partner in solicitor Dickinson Dees in Newcastle upon Tyne.