Enforceability of foreign parent guarantees
WHO SHOULD READ THIS
- Anyone considering accepting a parent company guarantee from a foreign counter-party.
THINGS YOU NEED TO KNOW
- Governing law and jurisdiction clauses are critical provisions which affect the enforceability of guarantees given by foreign domiciled entities.
- Not all international courts will enforce Australian judgments relating to parent company guarantees.
Counter-party risk or “default risk” is a critical issue in any commercial transaction. Each party to a commercial transaction must make an assessment of the ability of the other party or parties to the transaction to meet their obligations under the contract. The parties must also assess the ability of the counter-party to meet any claims under the contract in the event the counter-party fails to meet their contractual obligations. This is particularly relevant where the contracting entities are subsidiaries of a larger corporate group and the subsidiary itself has very few assets.
One mechanism for mitigating counter-party risk is to require a parent company guarantee. A parent company guarantee is a declaration issued by a parent company regarding one of its subsidiaries. This type of guarantee usually provides assurance that the parent company will step in and honor the terms of the contract if the subsidiary defaults, or is unable to perform the contract. The parent company guarantee is normally given by the head company or another entity in a corporate group with a stronger balance sheet than the relevant subsidiary.
Parent company guarantees have become commonplace in commercial transactions, and even more so at a time when project specific entities are divesting of major assets, leaving the entities themselves with very little in the way of assets to fund a warranty or other contractual claim.
When considering the provision by a counter-party of a parent company guarantee, the critical issues to consider are the strength of the covenant given by the guarantor and whether the guarantee will be enforceable.
Enforceability is particularly relevant where the guarantor is a company based overseas. The ability to enforce a guarantee against a foreign company will depend on the terms of the guarantee and whether the relevant foreign court will enforce an Australian judgment against the guarantor.
Enforcing a guarantee
Where a parent company fails to perform under a guarantee (after being provided with notice) the beneficiary may commence court proceedings for breach of contract. It is at this stage that the question arises as to where these court proceedings might be commenced.
For example, where the parent company is a foreign entity, it might be faster and more cost-effective to commence proceedings where the company is based or where the company’s assets are located, particularly if security has been granted over those assets. With that said, the jurisdiction in which proceedings may be commenced will ultimately depend on the terms of the guarantee and any choice of law clause included in the underlying contract between the parties.
Often during the negotiation and drafting process, little consideration is given to boilerplate governing law and jurisdiction clauses. These clauses are critical in seeking to enforce any contractual term, including any underlying guarantees given by foreign companies.
The governing law clause of a contract determines the substantive law to be applied in determining the rights and obligations of parties to that contract. Jurisdiction clauses prescribe what courts of a named country will have authority to hear disputes arising under the contract.
Jurisdiction clauses can be ‘exclusive’ or ‘non-exclusive’. A ‘non-exclusive’ jurisdiction clause means the parties will submit to the jurisdiction of the named court, but parties can also commence proceedings in other jurisdictions. Non-exclusive jurisdiction clauses afford the most flexibility and allow for proceedings to be brought against the parent company in various jurisdictions, including where it is a resident or incorporated, or where it is most convenient for the party seeking to enforce the guarantee.
Alternatively, an exclusive jurisdiction clause means that the parties agree that only a specified court has jurisdiction to hear disputes arising out of the contract, including in calling on a parent company guarantee. Beneficiaries of guarantees should be cautious in agreeing to exclusive jurisdiction clauses, which may preclude the beneficiary from suing in any other forum (including where the parent company is located). For example, if the guarantee named Queensland courts as having exclusive jurisdiction, any proceeding in relation to the guarantee would need to be commenced in Queensland. Once judgment was granted in Queensland, the successful party may then need to consider steps to enforce the judgment elsewhere. A party which commences proceedings in breach of an exclusive jurisdiction clause can be prevented from proceeding with its case by the other party.
The Hague Convention on the Recognition and Enforcement of Foreign Judgments in Civil and Commercial Matters is a multilateral treaty intended to govern the enforcement of judgments made by one nation’s legal authorities in other signatory nations. However, a number of countries, including Australia, are yet to sign the Hague Convention. In the absence of a convention, treaty or domestic laws governing enforcement of foreign judgments, courts of a foreign country are under no obligation to recognise or enforce the judgments handed down by Australian courts. Therefore, depending on where the parent company is located or registered, it may be difficult for a beneficiary to enforce an Australian judgment against a foreign guarantor.
In Australia, foreign judgments from superior courts of certain countries are able to be registered and enforced under the Foreign Judgments Act 1991 (Cth) and Regulations. But for judgments from courts in countries not listed in the Regulations, such as China or the United States, a party must rely on the common law to register and enforce a foreign judgment in Australia.
A guarantee provided by a foreign parent company is generally separate, independent and distinct from that of the principal contract. There are some practical considerations to consider when drafting a guarantee that will be provided by a foreign company, namely:
- will the guarantee be effective legally and commercially?
- will the chosen court take jurisdiction just because the parties have chosen it?
- will a judgment from the chosen court be enforceable in the place where the foreign company’s assets are located?
To prevent the risk and associated costs of enforcing an Australian judgment overseas, due diligence should be conducted on the parent company prior to executing a foreign parent guarantee. This due diligence may include considering the assets and wealth of the parent company, requirements for execution, form requirements for the guarantee under the foreign country’s laws, and whether reciprocal arrangements for the enforcement of a guarantee or foreign judgment exist in the parent company’s jurisdiction.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.