Parent pledges

Under what conditions can a Parent Company Guarantee be requested? Dennis Brand outlines explains the basics of this contractual device.

COMMENT, MEP

A Parent Company Guarantee (PCG) is often asked for when a contractor's financial strength is considered to be insufficient for the project to be undertaken.

In fact it is not at all unusual today, given the size of some projects, for a client or employer to ask a contractor to provide a performance guarantee, financial guarantee and a PCG.

The reason for this is simply that a client or employer is keen to ensure that its project is completed. The fact that the contractor will have been required to provide a form of financial performance guarantee is of little comfort to a client.

If its project is delayed or at risk of not being completed, all that will be recovered is the amount of a performance bond, which may be a small percentage of the total cost of the project at risk.

In the oil and gas industry it is not unusual for a client or owner to require a contractor to provide a PCG rather than a form of financial guarantee. This is because delays or the non-completion of a project will result in the loss of production, and in oil and gas terms that can translate into a very substantial financial loss.

Group benefits

Often a contractor will be a member of a group of firms. In such cases it is always of comfort to a client or employer to know that the contractor has sufficient financial strength behind it. In the event of contractor failure, the financial strength of their group members cannot be called upon or compelled to support them unless the client or employer has the benefit of a PCG.

When deciding whether to ask a contractor to provide a PCG, it must be considered whether the parent firm being proposed is one of several, as is often the case in larger groups of firms. The contractor should be required to provide a PCG from the ultimate parent.

Where there are several parent firms it is unlikely that the immediate one will have the necessary financial strength to support the contractor in the event that it fails to perform the contract or defaults in its contractual obligations.

Moreover, there are firms that would allow the contractor and its immediate parent to go into liquidation in order to defeat a claim or judgment against the contractor, particularly where large value claims are involved.

The PCG in action

When considering requesting a PCG one must keep in mind that it is a guarantee not an indemnity, therefore any right of action is in the first instance against the contractor not the parent.

From the client or employer view, the preference is that the PCG be drawn as widely as possible to enable claims to be made against the parent without limit of time or value.

In such cases, claims made against a PCG that is widely drawn could result in a parent being asked to compensate a client or employer for sums in excess of that intended or which is allowed under the contract with its contracting subsidiary.

It is therefore important from the parent's view to provide a PCG that does not exceed the limit of liability of the contracting subsidiary under its contract with the client or employer, and that the terms are conditional.

This may be explained further by way of example: a contract with a limited liability that is a percentage of the contract price or limitation for a defined period should not be extended or exceeded in any way in the terms of a PCG.

Moreover, with regards to making a PCG conditional, it would be reasonable for a parent firm to require that that any claim made by a client against the guarantee it gives them in respect to the contract granted to its subsidiary be subject to enforcement only after the issue of judgment by a court or arbitration award.

To ask a parent to provide a guarantee without such or similar condition would mean that they would have to compensate a client in respect of a claim that could be substantially exaggerated or have little or no merit at all.

Another point for consideration is the duration of the proposed PCG. Ideally it should be for a period that equates to, but does not exceed, that of obligation and liability as contained in the contract between the parent's subsidiary and the client.

Finally, it is not unusual that a contractor's parent will be incorporated or domiciled in a jurisdiction different from that of its subsidiary. In such cases where a guarantee is needed from a parent, it should be made the subject of a legal opinion obtained by the beneficiary to ensure that it is enforceable in the jurisdiction where the parent firm is registered or domiciled.

Dennis Brand is senior legal advisor with HBJ Gateley Wareing.

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