The claim is brought by a Hong Kong company ("MHK”) that carries on business as an import/export and general trading company. It is a wholly owned subsidiary of Marubeni Corporation ("Marubeni") a Japanese company with its principal place of business in Japan. The defendant is the Mongolian Government acting through its Ministry of Finance (“MMOF”).

The claim is made on a letter dated 11 May 1996 (“the MMOF Letter” or “the guarantee”), which was addressed to MHK and signed by the Minister of Finance at the time, Mr Byambajav.

On about 29 March 1996 MHK entered into a Deferred Payment Sales Contract (the “DPS1 Contract”) with Buyan Holding Company Limited (“Buyan”), a Mongolian company. Pursuant to the DPS 1 Contract Buyan agreed to buy and the claimant agreed to sell machinery, equipment and materials for a cashmere processing plant. The purchase price was US$18,811,670. The first instalment of the price was to be paid within 60 days of the signature of the DPS 1 Contract, and the remaining amount was to be paid in 12 equal semi-annual instalments. The first of these was due on 19 October 1998.

Pursuant to Article 7 of the DPS 1 Contract Buyan arranged the provision of the MMOF Letter dated 11 May 1996 in the following terms:

“To: MARUBENI HONG KONG LTD

In consideration of you entering into the Deferred Payment Sales Contract No 258500 (hereinafter called the "agreement") with Buyan Holding Company Ltd, a company duly organized and existing under the laws of Mongolia, with its principal office at I-4000-68-4 Ulaanbaatar, Mongolia (hereinafter called the "Buyer ") for sales and purchase of a textile plant the contact (sic) price of which is United States Dollars Eighteen Million Eight Hundred Eleven Thousand Six Hundred Seventy (USD18, 811,670. -), the undersigned Ministry of Finance of Mongolia unconditionally pledges to pay to you upon your simple demand all amounts payable under the Agreement if not paid when the same becomes due (whether at stated maturity, by acceleration or otherwise) and further pledges the full and timely performance and observance by the Buyer of all the terms and conditions of the Agreement. Further Ministry of Finance undertakes to hold indemnify and hold you harmless from and against any cost and damage which may be incurred by or asserted against you in connection with any obligations of the Buyer to pay any amount under the Agreement when the same becomes due and payable (whether at stated maturity, by acceleration or otherwise) or to perform or observe any term or condition of the Agreement or in connection with any invalidity or unenforceability of or impossibility of performance of any such obligations of the Buyer.

This covenant shall come to force from the date of implementation of this agreement and remain in full force and effect until all amounts due to you by the Buyer under the Agreement have been paid in full and all the terms and conditions of the Agreement have been fully performed and observed by the Buyer.

The Ministry of Finance hereby waives any right to require you to proceed against the Buyer or against any security received from the Buyer or any third party or to pursue any other remedy available to you.

All payments under this pledge shall be made in United States Dollars by means of telegraphic transfer remittance to the mutually agreed bank account.

All disputes related to this pledge shall correlate in accordance with the jurisdiction courts of England. The Ministry of Finance shall not participate in any legal action which may arise out of or relating to obligation of the Seller and Buyer."

It is common ground that the putative proper law of this contract is English law.

The defendant says that Mr Byambajav did not have authority to bind the defendant, and that the guarantee has not subsequently been adopted or ratified by the Mongolian Government. The claimant says that the MMOF Letter was issued on behalf of the defendant with express actual authority, alternatively that Mr Byambajav had usual authority or the defendant held him out as having apparent/ostensible authority, or the defendant ratified the MMOF Letter. The claimant says that on a true construction of the MMOF Letter, the defendant undertook a primary liability (joint and/or several) to the claimant. The defendant says that on a true construction of the MMOF Letter it did not undertake a primary liability. The defendant says that it was discharged from liability under the guarantee. The claimant disputes this.

On the same date as the MMOF Letter (11 May 1996), the Deputy Minister of Justice of Mongolia, Mr Dulamyn Sugar, signed a document entitled "Legal Opinion of the Minister of Justice of the Government of Mongolia". This document was addressed to the claimant (then called: Marubeni Hong Kong Limited). The letter stated:

“LEGAL OPINION OF THE MINISTER OF JUSTICE OF THE GOVERNMENT OF MONGOLIA

To: MARUBENI HONG KONG LTD

I am Minister of Justice of the Government of Mongolia and as such have advised upon a Guarantee dated May, 1996 given by the Ministry of Finance of Mongolia, acting for and on behalf of the Government of Mongolia to you (the Guarantee). All terms and expressions defined in the Guarantee shall bear the same respective meanings herein save where the context otherwise requires. This legal opinion is furnished to you pursuant to the Guarantee.

In connection therewith, I have examined executed copies of each of Guarantee and the agreement documents as I have deemed necessary or advisable.

I am accordingly of the opinion that:

(1)

The Guarantor and the Buyer each has full power and authority to enter into, and to perform their terms and conditions of the Guarantee and the Agreement, respectively.

The Guarantor and the Buyer each has taken and completed all necessary legal action to authorize it to execute, deliver and perform the Guarantee and the agreement, respectively and has obtained or completed all authorizations, licenses, approvals or consents of and all registrations, recordations or filings with the Guarantor's country or any agency, department or commission thereof or therein necessary or advisable for the execution, delivery and performance of the Guarantee and the agreement, respectively and for the validity and enforceability thereof

(2)

The Guarantee and the agreement have been duly executed and delivered by the duly authorized representatives of the Guarantor and Buyer, respectively, and constitute the legal, valid and binding obligations of the Guarantor and the Buyer, respectively, enforceable in accordance with their terms.

(3)

The executions, delivery and performance of the Guarantee or the agreement do not and will not contravene, violate or constitute a default under the Constitution of the Guarantor's country or any treaty, law or regulation applicable to the Guarantor or the Buyer or any provision of any agreement or other instrument to which the Guarantor or the Buyer is or may be bound, nor will the same result in the creation of any encumbrance on any asset or right of the Guarantor or the Buyer.

(4)

Their representatives and warranties set out in the Guarantee are true."

The claimant relies on this document as proof of the authority of the Minister of Finance, Mr Byambajav, to sign the MMOF Letter on behalf of the Government.

The original copies of the MMOF Letter and the Legal Opinion (the MMOJ Letter) were handed over to MHK on 14 May 1996. A letter dated 27 May 1996 from MHK to the Minister of Finance referring to the guarantee was signed by Mr Byambajav (Minister of Finance) and by Mr Sugar (for the Minister of Justice). An Assignment and Security Agreement was entered into between Buyan, MHK and Bank of Tokyo-Mitsubishi Trust Company on 3 June 1996. The DPS 1 Contract became effective on 18 June 1996.

By an agreement between (i) the Ministry of Finance (ii) the Ministry of Trade and Industry and (iii) Buyan (“the Trilateral Agreement”) made in about April or May 1996 it was provided: -

“4.3.

Loan should be paid back in time with company’s own income, as agreed with Japanese side upon pay back schedule and its term. Demanded amount of fine or interest from Japanese side shall be paid by the company in case of deferred payment.

4.4.

By this contract the Ministry of Finance is given the right to take the company’s means from its accounts through closing the company’s accounts in the commercial banks in case of full or part default of contract and, furthermore if it fails to pay back the loan or its interest in due time as agreed with Japanese side. (appendix).

4.5.

Items listed in the appendix of this contract are possessed by the Ministry of Finance as guarantee and the Ministry of Finance is granted to pay the amount through seizing property except those in 4.4 provision of this contract, if the company fails to pay the amount in time.”

The Appendix to the Trilateral Agreement listed Buildings, Structures, Houses, Automobiles and Equipment of Buyan.

Between October 1996 and May 1997 the claimant supplied machinery, equipment and materials to Buyan under the DPS 1 Contract. A dispute arose as to the quality and fitness for purpose of Mitsuboshi machines supplied by MHK to Buyan.

In 1998 there was a Rescheduling contained in six agreements dated 4 February 1998 between MHK and/or Marubeni and Buyan and in 1999 there was a further Rescheduling contained in five agreements of about April 1999 between MHK and/or Marubeni and Buyan. The defendant says that these refinancing packages involved a material variation of the transaction to which the guarantee related, such as to result in the discharge of the defendant’s obligations under the MMOF Letter. The claimant says that there was no such material variation and the obligations were not discharged.

It is MHK's case that Buyan repeatedly failed to pay instalments due under the DPS 1 Contract and has made no payments at all after 19 April 2000. MHK gave formal notice to the defendant on 5 November 2001, requiring repayment of the sum of US$13,796,556 together with accrued interest by 12 November 2001. No payment was made.

These proceedings were issued in August 2001.

David Steel J granted permission to serve out of the jurisdiction on 21 November 2001. An application by the defendant challenging the jurisdiction was dismissed on 2 August 2002 by Aikens J ([2002] 2 All ER (Comm) 873).

Mongolia

The Mongolian People’s Revolutionary Party (MPRP) was the sole political party from 1924 to 1990. Demonstrations in favour of political and economic reform began in December 1989 and led to changes in the MPRP leadership in March 1990. The MPRP’s constitutionally guaranteed monopoly of power was subsequently relinquished, and the introduction of a multiparty system was approved by the Great People’s Hural (parliament). The MPRP won the first multiparty elections held in July 1990, and the second held in June 1992. The country’s first direct presidential election was held in 1993 and won by the incumbent Punsalmaagiyn Ochirbat, who stood as an opposition candidate after the MPRP refused to endorse him as its candidate; he was ousted in 1997 by the leader of the MPRP, Natsagyn Bagabandi, who won a second term of office in 2001, obtaining 58.13 per cent of the votes cast. The 1996 legislative election was won by the Democratic Union Coalition (Mongolian National Democratic Party and Mongolian Social Democratic Party). The legislative election held in July 2000 resulted in victory for the MPRP, who gained 72 seats.

A new constitution was approved in January 1992 which established a democratic parliamentary system of government. The president is directly elected for a term of four years. The unicameral legislature is the State Great Hural (Ulsyn Ikh Khural), which has 76 members elected for four-year terms by a simple majority amounting to at least 25 per cent of the votes cast. In July 2000 a constitutional amendment came into force which gives the president the right to dissolve the Great State Hural if it is unable to reach agreement on appointing a prime minister.

AGREED LIST OF ISSUES

Whether the Defendant is bound by issue of the Ministry of Finance Letter 11 May 1996 (the “MMOF Letter”) - Initial Validity

Whether the MMOF Letter was issued on behalf of the defendant by the then Minister of Finance and Economy of the Mongolian Government, Mr. Byambajav, with express actual authority; in particular:

Whether in answering this question it is permissible for the Court to look behind the Cabinet Minutes of 3 April 1996. The claimant and defendant agree this is a question of English law (procedural and/or substantive law);

Whether as a matter of Mongolian law the “Government approval” (or permission) required by Article 14(2) of the Budget Law of Mongolia had to be in the form of a Government decree (or resolution) or Prime Minister’s Ordinance;

If approval did not have to be in a particular form, whether Mr. Byambajav had “Government approval” (or permission) to issue the MMOF Letter, such approval (or permission) being given either at the meeting of the Mongolian Cabinet on 27 March 1996 or at its meeting on 3 April 1996.

If Mr. Byambajav lacked express actual authority, whether any issues of usual / apparent / ostensible authority and ratification should be determined by reference to the putative proper law of the MMOF Letter, which is agreed to be English law, or by reference to Mongolian law.

If the answer to Issue 2 is English law, whether:

Mr. Byambajav had usual authority, and/or

The defendant held out Mr. Byambajav as having apparent/ ostensible authority, and/or

The defendant by Minister Ulaan ratified the MMOF Letter.

If the answer to Issue 2 is Mongolian law, whether by reference to Mongolian law the claimant may enforce the MMOF Letter, irrespective of whether or not Mr. Byambajav acted with actual authority, in particular:

Whether at the relevant time (May 1996) Mongolian law recognised or contained or gave effect to the concepts of usual / apparent/ ostensible authority;

If not, does the application of the Civil Law of Mongolia (in particular Article 44 and 65 thereof) involve concepts similar to usual/ apparent / ostensible authority and if so what considerations would be relevant to the application thereof (with particular reference to the Ministry of Justice (MMOJ) Opinion Letter dated 11 May 1996, the Trilateral Agreement, the MMOF Letter and the MMOF/ MMOJ Letter of 27 May 1996).

What are the requirements under Article 59(4) of the Civil Law of Mongolia for the giving of approval or for the adopting of an unauthorised transaction? Was the MMOF Letter approved or adopted by the defendant for the purposes of Article 59(4) of the Civil Law?

Subsequent discharge of the MMOF Letter

If the defendant is bound by the issue of the MMOF Letter, whether it was discharged as the result of refinancing agreements between the claimant and Buyan in February 1998 and April 1999; in particular:

Whether, on a true construction of the MMOF Letter, the defendant has undertaken a primary liability (joint and/or several) to the claimant so that the rule in Holme v Brunskill (1878) 3 Q.B.D. 495 has no application.

If the answer to 5(1) is no, whether the refinancing packages of February 1998 and April 1999 involved any material variation in the transaction to which the guarantee related such as to result in the discharge of the entirety of the defendant’s obligations under the MMOF Letter.

Mr Goto was from April 1993 until March 1998 the General Manager of International Legal Section II of Marubeni. His duties included the legal documentation and management of legal matters concerning Marubeni’s interests in Asia and the Middle East, which included Mongolia.

Mr Goto had overall responsibility from a legal perspective for the documents relating to the Buyan project and for the documents relating to the refinancing of Buyan in February 1998. Mr Goto said that it has long been his experience that Governmental guarantees of the type in question are provided by the Ministry of Finance. However, it is the standard practice of the International Legal Section to require a legal opinion confirming the power of the Minister to grant the guarantee in question. These opinions are often provided by independent counsel, but an opinion from the Ministry of Justice is acceptable.

Mr Kazuhisa Fujimoto

From April 1996 Mr Fujimoto was the manager of Marubeni’s Textile Plant Section I of the Textile Plant Department (Plant Division). In October 2000 Mr Fujimoto was made manager of the Asset and Liability Management team, the name of which was changed to the Loan Workout Section in October 2001.

Mr Fujimoto attended a meeting in Tokyo on 22 February 2001 with Mr Ulaan, the Minister of Finance of Mongolia. According to Mr Fujimoto’s account of the meeting, Mr Ulaan admitted that the Ministry of Finance had not conducted its obligations under the Trilateral Agreement up to February 2001, but promised that it would do so from then on. According to Mr Fujimoto, Mr Ulaan said that the guarantee dated 11 May 1996 had been issued through the proper legal procedures and the fact that a copy of the guarantee did not exist in the archives of the Ministry of Finance was an internal administrative issue on the Mongolian side. According to Mr Fujimoto, Mr Ulaan agreed to issue a letter confirming that the guarantee had been validly and lawfully issued and acknowledging the Mongolian Government’s payment obligations under it. In the event no such letter was forthcoming.

Mr Koji Yamaguchi

From April 1994 to May 1996 Mr Yamaguchi was the Assistant General Manager of Marubeni’s Textile Machinery Department.

Mr Yamaguchi explained the events leading to the DPS 1 Contract between MHK and Buyan. Mr Yamaguchi strongly disagreed with the suggestion that the machinery, equipment and materials supplied to Buyan were defective. He did not accept that there were any delays in the supply of machinery, equipment or materials under the contract. Mr Yamaguchi was concerned with the 1998 and 1999 Reschedulings.

Mr Yamaguchi said that on 29 March 1996 he signed the DPS 1 Contract on behalf on MHK in Tokyo. On that occasion Mr Jargalsaikhan of Buyan handed over a copy of a letter written in Mongolian dated 29 March 1996. Mr Jargalsaikhan explained that the Ministry of Finance would issue the guarantee instead of the Bank of Mongolia. An internal Marubeni memorandum of the same date referred to the forthcoming elections in Mongolia and the need to keep the letter of guarantee issued by the Ministry of Finance dated 29 March secret from personnel working in Mongolia.

Mr Yamaguchi was referred to an internal Marubeni note of a meeting on 30 October 1997 attended by representatives of the Textile Plant Department (including Mr Yamaguchi), the Legal Department and the Inspection Department which included the following paragraph: -

“According to the Legal Department, “If the guarantee granted by the Mongolian government is to be exercised, there is every likelihood that our company and the government could, as there were errors in the agreement itself (please see below), render the agreement invalid and if we presume that the agreement is invalid, there are concerns that the application for issuance of a guarantee will also be invalid”.

Mr Yamaguchi was referred to an internal Marubeni document bearing the date stamp 7 November 1997 which read: -

“There is a problem in that the knitting machines … have not operated according to initial expectations … we shipped 36 knitting machines made by the bankrupt Mitsuboshi Manufacturing which we had in stock. When it came to selecting the type of machine, the customer finally agreed but it seems that the selection process was in fact a difficult one in which, in order to obtain financing from us, our inventory problems were taken into account. In fact these Mitsuboshi Manufacturing knitting machines were designed for a special process called ‘inter-shear’ and were not suitable for the mass production of cashmere by way of shaped knitting that the customer needed. … ”

Mr Erdeniin Byambajav and Mr Dulamyn Sugar

The witness statements of Mr Byambajav and Mr Sugar were admitted under the Civil Evidence Act 1995.

In his statement Mr Byambajav said that he thought he was acting within his powers and within the law in signing the letter of guarantee in favour of MHK. He said: -

“On 27 March 1996 the Cabinet discussed an agenda item at the request of NIC, the Mongolian State petroleum company, that due to the failure of the Ministry of Finance to provide a guarantee to NIC the company was in financial difficulties. I recall that Mr Ulaan (the current Minister of Finance) who was at that time Chairman of the State Development Committee thought that there might be occasions when it would be appropriate to provide guarantees. It is reflected in the minutes of the meeting.

At the Cabinet meeting on 3 April 1996 we spoke about measures to support the development of Mongolian industry. The question of the provision of guarantees and the issue of NIC were again raised. The Prime Minister remarked that a guarantee should be not limited to NIC or other petroleum companies, and a guarantee could be provided if particular projects met certain requirements. There were seven requirements for a project to qualify for the possible provisions of a guarantee; economic profitability, the project would be a significant potential contributor to the State budget, the initial investment would be recouped within 3 years, promotion of exports, promotion of gold excavation, creation of resources to import petroleum products, and the Minister of Finance could ascertain that the company could meet its obligations from its own resources. In my view, if the above criteria could be met, the Minister for Finance was able to give a guarantee under the terms of the minutes from that meeting after examining the proposals from the company in question.”

In his witness statement Mr Sugar (who was Deputy Minister for Justice at the time) said that since the Minister of Finance had already signed the guarantee, he felt that it was in order for him to sign the legal opinion.

Evidence on behalf of the Defendant

Mr Chultemiin Ulaan

Between 1992 and 1996 Mr Ulaan was Minister for the National Development Board. Since 11 August 2000 Mr Ulaan has been the Minister of Finance and Economy in Mongolia.

In a memorandum to the Minister for Justice dated 23 January 2001 Mr Ulaan wrote: -

“… we think that the former Minister for Finance issued the loan guarantee himself because there was not a Government decision, resolution or minutes made on the issue relating to guarantee issuance at that time.

Once the Minister for Finance issued the guarantee, indeed the Government will have an obligation in respect of it. Thus, we suggest the establishment of a working group to scrutinise the way in which the Government can conclude this situation with minimum damage within the scope of the law.”

Mr Ulaan’s account of the meeting with representatives of Marubeni in Tokyo on 22 February 2001 was as follows. Mr Ulaan said that he indicated that whilst the guarantee dated 11 May 1996 had been issued in the sense that there was a letter setting it out, the Government was considering the situation but had not yet concluded its investigation. Mr Ulann said that he told the representatives of Marubeni that he could not comment on whether the guarantee had been properly given, but the Government, and in particular the Ministry of Justice, was considering the giving of the guarantee and legal opinion against the laws and regulations in force at the time. He said he indicated that he would revert to Marubeni in due course. He denied confirming to Marubeni that either the guarantee or legal opinion had been properly given or were valid.

On 19 February 2001 N. Tumendemberel, a state secretary in the Ministry of Finance, wrote to Buyan in relation to Buyan’s obligations under the Trilateral Agreement as follows: -

“… the Ministry of Finance issued a guarantee on the basis of this legally valid document [the Trilateral Agreement] and as a result, the loan was allocated to your company.

Over a period of time, the Ministry of Finance has concluded that your company has not fulfilled its obligations under the contract, so the Ministry will operate within its legal rights to ensure the performance of the obligations agreed between the lender and the borrower. In particular, clause 2.2 of the contract provides that the Ministry of Finance will supervise the fulfilment of Buyan’s obligations and take relevant measures in the case of default and to draw conclusions, where necessary, on the performance of obligations during the term of this contract and shall also make appropriate demands to the Buyan company.”

In a memorandum dated 24 May 2001 to the Head of the Government Secretariat, Mr Ulaan wrote;-

“We have studied the issue and have stated that the minutes of the Government Cabinet meeting dated 3rd April 1996 authorised the Minister for Finance to take relevant measures to study the application of supporting industry for enterprises and organisations who would be responsible for their own actions, that had high economical profits, that were important for the state budget and which would be able to compensate their investment within three years, especially in the field of exports, gold-mining, imports of oil production and taking a loan from foreign companies and banks, according to the decision of the Government Cabinet meeting dated 28^th March 1996. ”

At one point in his evidence Mr Ulaan said that when he sent the above memorandum he did not read the minutes of the Cabinet meeting on 3 April. I find it impossible to accept this.

On 5 June 2001 Mr Ulaan wrote to MHK: -

“The Ministry of Justice and Home Affairs [concluded] that the letter of guarantee, as well as the legal opinion, have violated the laws and regulations, … in force at that time in Mongolia.

Since the Ministry of Justice and Home Affairs have made such conclusion, we have considered that the matter should be settled by the Cabinet Meeting and we have sent related materials for the Cabinet Meeting.”

When giving evidence Mr Ulaan said that to date the Mongolian Cabinet has not made any decision as to whether the guarantee was valid or invalid.

Mr Puntsag Jasrai

Mr Jasrai was Prime Minister of Mongolia between 1992 and the election in 1996.

Mr Jasrai said that he did not recall whether he read at the time the abbreviated minutes of the 3 April 1996 Cabinet meeting which contained a reference to a discussion having taken place at the previous week’s Cabinet meeting on 27 March 1996. Mr Jasrai said that on no occasion did he ever give either approval or a direction to Mr Byambajav to sign a guarantee on behalf of the Government in favour of Marubeni, and that Mr Byambajav did not mention the guarantee to him or ask his opinion about whether he should sign it. Mr Jasrai was unable to say why Mr Byambajav signed the guarantee in favour of MHK, but said that this action was outside Mr Byambajav’s powers as there was no proper basis for it to be signed. Mr Jasrai added that he did not know about the legal opinion signed by Mr Sugar until about the end of 2001.

In his witness statement Mr Jasrai said that a Government decision can only take the form of a Prime Minister’s decree or a government resolution. There was an elaborate procedure for formalising Cabinet decisions. A resolution is first prepared. A Minister with whose department the decision is most closely connected, will check and sign the resolution. The Head of the Government Secretariat will then check that the resolution accurately reflects the Cabinet decision that was made. Only at this stage would the Prime Minister sign the resolution. On some occasions a Cabinet decision could be in the form of Cabinet meeting minutes. However, this would only be the case if there already existed a law, resolution or Prime Minister’s decree setting out the course of action in relation to a framework which had already been agreed and set out in principle, so that the Cabinet minutes related to the implementation of a decision which had already been taken.

At one point in his evidence Mr Jasrai said in relation to the minutes of the Cabinet meeting on 3 April 1996, that government guarantees to export oriented industries were discussed. He said “yes, I mentioned that we should first speak to IMF on this issue.”

Mr Namsraijav Luvsanjav

Between August 1992 and August 1996 Mr Luvsanjav was Minister of Justice of Mongolia. Mr Sugar was the Deputy Minister of Justice at the time.

Mr Luvsanjav said that the purpose of a legal opinion signed by the Ministry of Justice would be to provide assurance to an overseas lender that the borrowing made to either the State or to an individual Ministry was in accordance with Mongolian laws and procedures. There would typically be a provision in the loan agreement in question requiring the State or the Ministry involved to ensure that a legal opinion was given. However Mr Luvsanjav said that he was neither involved in, nor aware of, any practice on the part of the Mongolian Government to provide legal opinions, in relation to loans being made to privately-owned Mongolian companies such as Buyan, on behalf of those companies. Accordingly, any legal opinion given by the Ministry of Justice in relation to a loan by a bank or company to a Mongolian private company would be invalid, as there was no proper basis for such a legal opinion to be given on behalf of such a company.

Mr Luvsanjav said that if the legal opinion had been signed by Mr Sugar properly, he would have been aware of it, and would have expected there to be a file at the Ministry of Justice documenting the chain of approval leading to its signature. Mr Luvsanjav added that he was unaware of the existence of the Trilateral Agreement before Mr Sugar told him about it in late 2001 or early 2002.

Mr Luvsanjav agreed that the purpose of a legal opinion was to provide assurance that the agreement was made in accordance with the laws (of Mongolia) and to confirm that according to the law or to the agreement the parties would meet their contractual obligations.

Mr B Jargalsaikhan

Mr Jargalsaikhan established Buyan prior to the advent of democracy in Mongolia. He is the Chairman of one of the Mongolian political parties, the Republican Party. The Republican Party is a small party compared with the ruling MPRP and the current opposition party, the Social Democratic Party.

Mr Jargalsaikhan gave evidence as to a number of matters including events before and after the signing of the DPS 1 Contract, delays under the contract and defects in the machinery supplied.

Mr Samdan Banzragch

From 1993 to 1996 Mr Banzragch was Head of the Government Secretariat. Mr Banzragch said that Mr Purevdorj informed him that at the 27 March 1996 Cabinet meeting the issue of supporting state-owned industries had been agreed by the ministers who had attended that meeting. According to Mr Banzragch, Mr Purevdorj informed him that it was his duty, as Head of the Government Secretariat, to make a note of this in the abbreviated minutes of the 27 March meeting. Mr Purevdorj gave him a typed draft of the wording of a note to be included in the abbreviated minutes, which had however already been prepared and distributed. According to Mr Banzragch, following the Cabinet meeting on 3 April 1996 he gave a copy of Mr Purevdorj’s note to an official and instructed that official to include the wording of the note as an item in the abbreviated minutes of the 3 April meeting. Mr Purevdorj died on 1 October 1998. Mr Banzragch did not suggest that Mr Purevdorj had behaved improperly. Mr Banzragch considered that Mr Purevdorj acted in accordance with his role.

Mr Demchigjav Molomjamts

Between 1992 and 1996 Mr Molomjamts was Governor of the Bank of Mongolia. He had an obligation to attend the weekly Cabinet meetings on a regular basis, unless urgent business precluded his attendance. In a letter dated 10 February 2004 Richards Butler confirmed that a review of the abbreviated and detailed minutes of the Cabinet meeting on 3 April 1996 did not reveal any contribution by Mr Molomjamts or any reference to him attending. Mr Molomjamts did contribute at the meeting on 27 March. In his witness statement Mr Molomjamts said that there was no discussion at either the 27 March or 3 April meetings about the Government providing either guarantees or financial support to private companies.

Minutes of the interrogation of Mr Molomjamts by the police (dated 27 February 2003) included a question about “minutes on supporting a loan of US $18,000,000 from the Mongol Bank to Buyan Holding executed in Mr Molomjamt’s office.”

Mr Tsend Munh-Orgil

Mr Munh-Orgil has been the Deputy Minister for Justice and Home Affairs of Mongolia since 2000.

According to Mr Munh-Orgil in 1993 Mongolia entered into an agreement with the International Monetary Fund for the provision of finance to assist with development projects in Mongolia. Under this agreement, “…the [Mongolian] authorities are committed to prudent external borrowing policies and will refrain from contracting or guaranteeing commercial borrowing during the programme period.”

Mr Munh-Orgil said that the police commenced an investigation into possibly corrupt conduct of Mr Byambajav and Mr Sugar in March 2002.

Evidence admitted under the Civil Evidence Act

Statements from the following persons were admitted under the Civil Evidence Act: Mr Jugnee Amarsaana, Mr Luvsanbaldan Nyamsambuu, Mr Tserenpil Gombosuren, Mr I Buyan-Ulzii, Mr Dugersuren Davaadorj, Mr Tseveenjaviin Uuld, Mr Nambar Enkhbayar, Mr Namjil Tumendemberel, Mr Tsend Nyamdorj, Mr Erdene Gombojav and Mr Tserendash Damiran.

Mr Gombosuren was Minister for External Relations from 1988 to 1996. Mr Uuld was Minister for Food and Agriculture from 1992 to 1996. Mr Enkhbayar was Minister of Culture from 1992 to 1996 and is now Prime Minister of Mongolia. Mr Nyamdorj is the current Minister of Justice. Mr Gombojav was Minister of Population and Labour between 1992 and 1996. Mr Damiran was Vice Minister of the Ministry of Infrastructure between 1994 and 1996.

Expert Evidence

Professor Naranchimeg was called by the defendant. Professor Narangerel was called by the claimant.

I turn to consider the agreed issues.

A. Whether the Defendant is bound by issue of the Ministry of Finance Letter 11 May 1996 (the “MMOF Letter”) - Initial Validity

1.

Whether the MMOF Letter was issued on behalf of the defendant by the then Minister of Finance and Economy of the Mongolian Government, Mr. Byambajav, with express actual authority; in particular:

(1)

Whether in answering this question it is permissible for the Court to look behind the Cabinet Minutes of 3 April 1996. The claimant and defendant agree this is a question of English law (procedural and/or substantive law);

(2)

Whether as a matter of Mongolian law the “Government approval” (or permission) required by Article 14(2) of the Budget Law of Mongolia had to be in the form of a Government decree (or resolution) or Prime Minister’s Ordinance;

(3)

If approval did not have to be in a particular form, whether Mr. Byambajav had “Government approval” (or permission) to issue the MMOF Letter, such approval (or permission) being given either at the meeting of the Mongolian Cabinet on 27 March 1996 or at its meeting on 3 April 1996.

It is common ground that Issue 1(2) is to be determined by reference to Mongolian law. The defendant contends that the issue in paragraph 1 (3) is a mixed question of fact and of Mongolian law. The claimant does not accept that it is a question of Mongolian law.

Before considering Issue 1, I make the following general observations about this case.

i)

The Commercial Court has jurisdiction in this case for the reasons explained by Aikens J. in his judgment, to which I refer. The dispute is between MHK and the Mongolian Government. The Commercial Court frequently hears disputes where neither side has any connection with England and Wales, but where there is a jurisdiction clause providing for the jurisdiction of the Court.

ii)

I made it clear to the parties throughout the trial that I felt uncomfortable about being asked to adjudicate as to what happened at Cabinet meetings of a foreign friendly government and related issues. This is a most unusual situation. In the ordinary way the court would not adjudicate upon such matters. On this occasion it is in the defendant’s litigation interests to invite the court to do so. Although the defendant by its defence invites the court to look behind the Cabinet minutes of 3 April 1996 and to adjudicate upon issues sensitive to the internal workings of the Mongolian Government (and Aikens J in paragraph 69 of his judgment contemplated that the court would do so), I approach these issues with a sense of restraint inherent in the nature of the judicial process.

iii)

The MMOF Letter was issued shortly before a general election. Some of the issues raised were politically sensitive in 1996 and are politically sensitive now. It is very difficult for an English judge to assess the extent to which the evidence from Mongolian witnesses may (consciously or unconsciously) have been affected by political considerations.

iv)

There has been a criminal investigation in Mongolia relating to the circumstances in which the MMOF Letter was issued. I formed the distinct impression listening to several of the witnesses from Mongolia, that their evidence (consciously or subconsciously) was affected by concerns relating to the criminal investigation.

v)

Although I emphasise that this is no criticism of the interpreters, there were real difficulties with interpretation in the present case. It was not easy to distinguish between instances where a witness did not answer a question because he or she did not understand it as interpreted, and instances where a witness understood the question but declined to answer it.

vi)

Mr White QC for the defendant in opening said (a) that the police investigation had found no evidence of corruption; (b) that the defendant did not make any such allegation; and (c) that it is possible that on Mr Banzragch’s evidence there was a mistake.

vii)

A central witness Mr Purevdorj, the Deputy Prime Minister of Mongolia in 1996, is dead. Further a great deal of material was admitted under the Civil Evidence Act and not tested in cross- examination.

viii)

I have not seen a number of important documents. By way of example only I refer to (a) the papers before the Cabinet at the two critical meetings; (b) the note which Mr Banzragch alleges was handed to him by Mr Purevdorj; and (c) materials showing how the Trilateral Agreement came to be prepared.

ix)

As Bingham J observed in The Zinovia [1984] 2 Lloyd’s Rep. 264 at 278: “… demeanour and personal impression are … an unreliable pointer to the truth, particularly where foreign witnesses are giving evidence through an interpreter in the strange surroundings of an English Court. So one must look for more reliable pointers.”

I turn to consider issue 1(1), with the above considerations in mind.

The Mongolian Government submit that that the court should look behind the Cabinet minutes of 3 April 1996. The claimant submits that the court should conclude that it is either not permissible to go behind the 3 April 1996 minutes or, alternatively, that the defendant has not demonstrated that the minutes do not accurately record the permission given to Mr Byambajav on 27 March or 3 April 1996.

In his judgment on the jurisdiction application Aikens J said at paragraph 69: -

“The English Court, as a neutral forum, will be able to consider the aspects of Mongolian public law and practice and what went on in Mongolian Cabinet Meetings in a manner which is completely neutral as between the Mongolian Government on one side and the Hong Kong claimant corporation on the other. I appreciate that this means that the English Court might be forced to pass judgment on what was said or done by the Cabinet of a friendly foreign country.”

I accordingly answer the first issue in the affirmative, but subject to the general observations set out above.

It is convenient at this point in the judgment to consider whether the disputed minutes accurately recorded the decision arrived at, at one or both of the relevant meetings.

The minutes of the Cabinet Meeting held on 3 April 1996 record: -

“Other Issues

…

2.

At its meeting held on 27 March 1996, the Government discussed the question of issuing budget guarantees to economic entities and organisations which want to obtain loans from foreign banks and entities to implement projects of high economic feasibility which would be able to contribute to the state budget on a stable basis and recoup the initial investment within the first three years, including the export oriented industries, gold production and import of petroleum products. On the basis of these discussions, the Ministry of Finance was instructed to review the requests and, if the requesting party can fulfil their contract obligations from their own resources, take relevant measures when necessary aimed at issuing budget guarantees on the basis of a contract. ” (emphasis added).

It is to be noted that the minute of the Cabinet Meeting on 3 April 1996 did not on its face authorise the Minister of Finance to undertake (on behalf of the defendant) a primary liability (joint and/or several).

I have carefully considered all the evidence and materials before the court and the submissions of the parties. The defendant has not persuaded me, on a balance of probability, that I should find that this minute did not accurately record the decision arrived at, at one or both of the relevant meetings.

In reaching this conclusion I have had regard to, among others, the following matters.

(a)

A Cabinet minute prepared by the Government Secretariat (if not corrected at the time) would be expected to be accurate.

(b)

It is important to remember that the MMOF Letter and MMOJ Letter were not the only documents executed at the time. The Trilateral Agreement expressly referred to Cabinet Meeting minute number 15 of 3 April 1996. The MMOF Letter was signed by the Minister of Finance. The MMOJ Letter was signed by the Deputy Minister of Justice. The Trilateral Agreement was signed by the Minister of Trade and Industry (Mr Tsogt) and the Minister of Finance. The MHK letter dated 27 May 1996 (“we highly appreciate your issuance of a letter of guarantee dated May 11 1996 …”) was signed by the Minister of Finance and the Deputy Minister of Justice. The probability is that all persons concerned who signed the four documents referred to above on behalf of their respective Ministries, thought that they were authorised to sign, following a decision taken in Cabinet evidenced by the disputed minute. There is no basis for any finding of dishonesty.

(c)

The question of a possible guarantee in respect of Buyan’s obligations to MHK was under consideration at the time. The Central Bank of Mongolia declined to provide a guarantee. An earlier guarantee was apparently signed on 29 March (two days after the Cabinet meeting on 27 March). (See further the draft of about 24 April 1996).

(d)

The Cabinet Meetings on 27 March and 3 April 1996 were long meetings by European standards. The meeting on 27 March commenced at 12.10 and concluded at 24.10. The meeting on 3 April started at 9.00 am that day and finished at 3.00 am on 4 April. Although there is an Attendance Register, it is not easy or possible to determine who was present at certain times. Although the defendant relies on the full minutes, I am not persuaded that these minutes necessarily recorded everything that was discussed in meetings of the length referred to above.

(e)

The most reliable pointer to what happened is found in the contemporary documents referred to above, including the minute prepared at the time by the Government Secretariat.

I turn to consider Issue 1(2)

Whether as a matter of Mongolian law the “Government approval” (or permission) required by Article 14(2) of the Budget Law of Mongolia had to be in the form of a Government decree (or resolution) or Prime Minister’s Ordinance?

The claimant’s case is that Article 14(2) of the Budget Law did not prescribe any formality for the giving of approval and a Cabinet decision was sufficient.

The defendant’s case is that no actual authority was conferred on Mr Byambajav to issue the MMOF Letter, since Article 14(2) required a Government resolution or Prime Minister’s ordinance (and there was no such resolution or ordinance).

Mr Joseph QC submitted as follows.

The Minister of Finance had authority to issue a loan guarantee such as the MMOF Letter if he had “government approval” – Budget Law Article 14(2). Article 14(2) does not prescribe any formality for the giving of such approval. Article 30 of the Law on Government refers to “decisions” (a different Mongolian word to the word in Article 14(2) “approvals”). The second sentence of Article 14(2) enables amendments to the Budget to be made with the Minister of Finance’s “approval”. No formality for that is prescribed either. The same word for “approval”/“permission” is found in Article 16 of the Regulations on Government Meetings. In his witness statement Mr Jasrai accepted that Cabinet minutes could record a decision if there was a pre-existing law, resolution or Prime Minister’s decree. If every approval had to be in the form of a “decision” under Article 30, then each approval would be published: see Article 31 of the Law of Government. This strains the language of the Budget Law.

A “decision” under Article 30 is a prescribed process for government decisions. The Budget Law however requires “approval”. Linguistically, these are different concepts. The Regulations on Government Meetings refer to “decisions” and “approvals” being recorded in Cabinet minutes. Approval under an existing law which requires approval can be recorded in a Cabinet minute.

There is no suggestion that the word approval is a defined term. “Approval” bears its ordinary meaning. If the Cabinet give approval/permission for something to take place, that act takes place with government approval.

Mr White QC submitted as follows.

Article 14(2) of the Budget Law relates to the use of scarce public funds. Before the power to give a guarantee under Article 14(2) can be exercised the Government must make a decision to give approval. There cannot be “Government approval” without a Government decision to approve.

Article 24.1.1 of the Law on Government gives Ministers the power to implement “Government decisions” on behalf of the Government.

Article 30(1) of the Law on Government identifies only two types of Government decision – Government decrees/resolutions and Prime Minister’s ordinances. This is consistent with, and must be interpreted in the light of, Article 45 of the Constitution of Mongolia which provides: -

“The Government shall, in conformity with legislation, issue resolutions and ordinances in its power, which shall be signed by the Prime Minister and a Minister in charge of its implementation.”

Professor Naranchimeg points out that Article 45 of the Constitution and Article 30(1) of the Law on Government use the same two words ‘togtool’ (meaning resolution) and ‘zahiramj’ (meaning ordinance). When Article 24.1.1 of the Law on Government gives Ministers power to implement “Government decisions”, there is every reason to conclude that this is a reference to the same two kinds of Government decision identified in Article 45 of the Constitution and Article 30(1) of the Law on Government.

There is no reason why the Mongolian legislature should have intended that some less formal decision-making process was required in relation to the important matter of “Government approval” for the purposes of Article 14(2) of the Budget Law.

Issue 1(2): Analysis and conclusions.

The Budget Law Art 14 (Preparation and coordination of the budget proposals) provides: -

“1.

Process of preparation the fiscal plan and budget proposal should rely on measures conducted by the government in implementing this law and other legislative acts, social economic policy and budget norms, standards, price, tariff as well as treaties and agreements concluded with other countries on credit and grant.

2.

With Government approval the member of the Government responsible for the Finance, economic matters shall issue guarantee on repayment of loan. Agreements which would require additional budget financing can only be concluded with Minister for Finance’s consent.”

In Article 14.2 the same word (‘zevsheersneer’) is used where “approval” and “consent” appear in translation.

The Law on the Government of Mongolia by Article 24 (Powers of Members of the Government) provides: -

“I. A member of the Government shall have powers, issued by this Law and other laws and regulations including:

1.

To work out a state policy on issues within its charge and to execute the implementation of laws, Presidential decrees, and Government decisions on behalf of the Government and to be answerable alone for the development and current situation of as well the achievements in the relevant branches and industries to the Prime Minister, and to the State Great Hural, and to be jointly responsible for the activities of the Government to the State Great Hural; …

2.

A Minister of Mongolia shall issue ordinances on issues within his/her charge in conformity with laws, resolutions of the State Great Hural, Presidential decrees and government decrees, and secure their enforcement. …”

Article 30 (Government Decision) provides: -

“1.

The Government shall issue decrees on any issues within its competence and the Prime Minister shall issue ordinances on urgent problems…”

The word ‘shidver’ is used where “Decision” appears in translation.

Article 31 (Publication of Government Decisions) provides: -

“1.

Government decrees and ordinances of the Prime Minister shall be published with the consent of the Chairman of the Administration Department of the Government in the central State organ within three working days of signing by the Prime Minister and shall be made public by the Information Service of the Prime Minister through the newspapers and other means of communication. … ”

Article 29 (Meeting of Government) provides: -

“3.

The Government shall adopt the detailed regulations on the meeting of the Government under this Law.”

Article 16 of the Regulations on Meetings of the Government of Mongolia provides: -

“The hand written minutes of a meeting shall be either formal or verbatim and the abbreviated minutes shall include the name of a discussed issue, the name and title of a person presenting such issue and the relevant persons participating in the discussion of such issue, the decision made regarding such issue and tasks assigned or permissions issued to the relevant Ministries, Agencies and the Governors of Aimags and the Capital City/Executive Administration of the People’s Meeting of the Capital City.”

The word ‘zevsheersneer’ is used where “permissions” appear in translation.

I prefer the opinion of Professor Narangerel to the opinion of Professor Naranchimeg on this issue. Article 14(2) of the Budget Law refers to Government approval. The same Mongolian word is used for “approval” and “consent”. Article 30 sets out a prescribed process for government “decisions”. A different Mongolian word is used for “decisions”. The Budget Law only requires “approval”. Approval can be recorded in a Cabinet minute. In my view Professor Narangerel was right to emphasise the different use of language in Article 14 (2) of the Budget Law and Article 30 of the Law on the Government of Mongolia. Further I consider that Professor Narangerel’s opinion is supported by Article 16 of the Regulations on Meetings of the Government of Mongolia.

Accordingly I answer Issue 1(2) in the negative.

I now consider Issue 1(3).

If approval did not have to be in a particular form, whether Mr. Byambajav had “Government approval” (or permission) to issue the MMOF Letter, such approval (or permission) being given either at the meeting of the Mongolian Cabinet on 27 March 1996 or at its meeting on 3 April 1996?

For the reasons set out above I do not consider that approval had to be in a particular form. Mr Byambajav had government approval or permission to issue the MMOF Letter. Such approval/permission was given at the meeting of the Mongolian Cabinet on 27 March and/or 3 April 1996, as evidenced in the minutes of the meeting on 3 April 1996.

I have carefully considered all the evidence and materials before the court and the submissions of the parties. The defendant has not persuaded me on a balance of probability that I should find that the disputed minute did not accurately record the decision arrived at, at one or both of the relevant meetings.

It follows that I find that the MMOF Letter was issued on behalf of the defendant with express actual authority, provided that it is correctly characterised as a guarantee. The minute of the Cabinet Meeting on 3 April 1996 did not authorise the Minister of Finance to undertake (on behalf of the defendant) a primary liability (joint and/or several). It referred expressly to “guarantees.”

In view of my finding that Mr Byambajav had express actual authority, it is not strictly necessary to consider Issues 2 to 4. However in case I am wrong as to Issue 1 (and because these Issues were the subject of detailed submissions), I will consider Issues 2 to 4 to the extent set out below.

Issue 2

If Mr. Byambajav lacked express actual authority, whether any issues of usual / apparent / ostensible authority and ratification should be determined by reference to the putative proper law of the MMOF Letter, which is agreed to be English law, or by reference to Mongolian law?

Mr Joseph QC submitted as follows.

The rights and liabilities of the principal as regards third parties are governed by the putative proper law: Dicey and Morris Rule 198. The longstanding rule responds to the requirements of commercial intercourse. The rationale appears to be that where a third party deals with the principal’s agent, then the third party must be able to assume at least where the agent had no actual authority, that the agent’s authority covers everything which would be covered by the law of the country applicable to the dispute, in this case English law. The rationale for the rule has been approved by the Court of Appeal in Presentaciones Musicales S.A. v Secunda [1994] Ch. 271, 283 per Roch L.J.

The present case is a paradigm example of the absurdity of having Mongolian law determine the issue. If that were the case, the MMOJ Letter would have no force over and above the question of actual authority. The whole purpose of the letter was that from the perspective of the receiver of the letter, in accordance with the proper law of the contract, the giver of the letter could not go back and thereafter deny it.

The rule has been applied to principals that are private and public bodies, (see Merrill Lynch Capital Services Inc. v Municipality of Pireaus [1997] CLC 1214 at pages 1231-1233).

The defendant’s recourse to the language of capacity is misplaced. The defendant is or represents the Government of Mongolia. It is a necessary feature of society that the government of a country has unlimited capacity. Accordingly, contracts made with government departments are not subject to the ultra vires doctrine of limited capacity: New South Wales v Bardolph (1934) 52 C.L.R. 455. The defendant had capacity to enter into the MMOF Letter. The dispute is whether the Ministry of Finance, as agent of the defendant, had authority to exercise that capacity.

This distinction between capacity and authority applies to both English and foreign governmental entities: see Merrill Lynch Capital Services Inc v Municipality of Pireaus supra.

The defendant cannot invoke a “special position” in this context. The Crown can bind itself by a commercial contract. Such contracts do not violate the principle that public bodies should not fetter future executive action; Rederiaktiebolaget Amphitrite v The King [1921] 3 K.B. 500, 503 per Rowlatt J.

Mr White QC submitted as follows.

In the area of apparent authority special considerations apply to the Crown and public authorities (Chitty on Contracts 28^th edition vol 2 at 32-061). Where the Crown or a public authority is bound by the unauthorised acts of its agent, it is not easy to distinguish apparent authority from estoppel (Chitty vol 2 at 32-061 and Bowstead & Reynolds on Agency 17^th edition at para 8-044).

The difficulties involved in applying private law concepts of apparent authority to the Crown and governmental organisations are emphasised in the public law textbooks. See Wade and Forsyth on Administrative Law, 8^th edition at pp339-43 and 812-4. At p814 Wade and Forsyth observe: -

“Difficulty also arises over subjecting the Crown to the normal rule that the principal may be liable for an unauthorised contract made by the agent if the principal has given the agent ostensible authority, as by putting him in a position where the other contracting party might reasonably assume the agent was duly authorised. This rule in effect rests on the principle of estoppel; and as has been explained previously there are problems in applying this principle to Governmental powers exercised in the public interest, so that officers of the Crown can be safely assumed to have the powers which they purport to exercise. ”

Similarly in De Smith, Woolf and Jowell on Judicial Review of Administrative Action, 5^th Edition, it is stated at para 13-028: -

“The following principles may be asserted in respect of public law/powers: -

…

(3)

The general rules of agency apply in public law, except that an agent (a) cannot bind his principal to do what is ultra vires and probably (b) cannot bind his principal by exceeding his own authority if that authority is circumscribed by statute. ”

As Bowstead at para 8-044 points out, the interaction of public and private law principles makes this area a difficult one. That interaction was discussed in the judgments of Neill and Hobhouse LJJ in Credit Suisse v Allerdale Borough Council [1997] QB 306 at 340-44 and 350-57. Both judgments recognised that because the validity and legal effect of the acts of public authorities are governed by public law, the principles of public law may be relevant to the resolution of private law claims against such authorities. See in particular Neill LJ at 343 and Hobhouse LJ at 356-7. Once it is recognised that the principles of public law are relevant to the determination of the validity and legal effect of the acts of a public authority in private law proceedings against such an authority, the claimant’s contention that English law governs all questions of apparent/usual/ostensible authority in the present case must be regarded as unsatisfactory.

If Mr Byambajav did not have approval from the Mongolian Government when he issued the guarantee, he acted outside the powers of the Minister of Finance under Article 14(2) of the Budget Law. Mongolian law must provide the principles of public law relevant to any enquiry as to the validity and legal effect of that unauthorised act.

In claims against individuals or private law entities principles of apparent/usual/ostensible authority may operate to give legal effect to an unauthorised act. This is a form of estoppel. (See Egyptian International Foreign Trade Co v Soplex Wholesale Supplies Limited and another [1985] 2 Lloyd’s Rep 36 at p41 per Browne-Wilkinson LJ). Where the body sought to be held liable for an unauthorised act is a public authority, the private law concept of estoppel has, at least in English public law, been absorbed into the public law concepts of abuse of power and legitimate expectation. (See Reprotech (Pebsham) Ltd v East Sussex County Council [2003] 1 WLR 348 and South Bucks District Council v Flanagan [2002] 1 WLR 2601). The application of those public law concepts involves a consideration by the Court of the public interest. It is only by referring the issues of apparent/usual/ostensible authority and ratification to Mongolian law as the relevant system of public law, that a claim to hold a Mongolian public authority liable on an unauthorised transaction may be appropriately determined.

Dicey and Morris Rule 198 should not be applied in the case of a claim against a foreign governmental authority. In the Presentaciones Musicales case only Roch LJ applied this rule (at p283), and no Governmental entity was involved. In Merrill Lynch it was common ground between the parties that issues of apparent/usual/ostensible authority were governed by the putative proper law of the contract (p1228). That is not so in the present case.

Issues of apparent/usual/ostensible authority and ratification should be determined by reference to Mongolian law.

Issue 2: Analysis and conclusions.

The relationship between principal and agent is governed, in general, by Dicey Rule 197. The relationship between principal and third party is governed, in general, by Rule 198.

Rule 197 provides: -

“The rights and liabilities of principal and agent in relation to each other are governed by the law applicable to the contract between them, which law is, in general, the law chosen by the parties in accordance with Rule 173, or, to the extent that such law has not been so chosen, by the law of the country with which the contract is most closely connected in accordance with Rule 174”.

Rule 198 provides: -

“The rights and liabilities of the principal as regards third parties are, in general, governed by the law applicable to the contract concluded between the agent and the third party”.

Dicey at page 1475 states;-

“English conflicts rules. Where A lacks actual authority from P, it seems right, in principle, that the law applicable to the contract between A and T should determine whether P is bound (or entitled). In effect in this situation, one is asking whether A had apparent or ostensible authority to bind P. As between P and A, the scope of A’s authority to bind P and to confer rights upon him is necessarily determined by the law which governs their relationship, but third parties must be able to assume, at least where A has no actual authority from P, that A’s authority covers everything which would be covered by the authority of an agent appointed under the law applicable to the contract made between the agent and the third party. ”

A passage to the same effect in the 12^th edition of Dicey was approved by Roch L.J. in Presentaciones Musicales S.A. v Secunda supra. (See further Merrill Lynch Capital Services Inc. v Municipality of Piraeus supra where it was common ground that questions of ostensible authority, ratification and estoppel were governed by English law, the putative proper law).

In my judgment Rule 198 applies to both governmental/public entities and to private entities. There is a need for certainty and consistency in English conflict rules. To apply the law applicable to the contract concluded between the agent and the third party in the case of private entities but not in the case of governmental/public entities, would lead to inconsistencies and would not be in accord with the need for certainty in international commerce. The application of the rule may of course be affected by the nature of the entity concerned, but the rule applies to both public and private entities.

Issue 3

If the answer to Issue 2 is English law, whether:

(1)

Mr. Byambajav had usual authority, and/or

(2)

The defendant held out Mr. Byambajav as having apparent/ ostensible authority, and/or

(3)

The defendant by Minister Ulaan ratified the MMOF Letter?

I turn to consider Issue 3(2), without expressing an opinion on Issue 3(1).

Mr Joseph QC submitted as follows.

Ostensible authority requires a holding out of the agent’s authority by the principal or another agent authorised to act for the principal: Bowstead §8-018.

The MMOJ Letter unequivocally constitutes a holding out or a representation of Mr. Byambajav’s authority with respect to the guarantee. On behalf of the Government, the Ministry of Justice assured MHK that all the necessary formalities for the guarantee had been fulfilled and that all authorizations and approvals had been granted.

Mr. Luvsanjav stated that the purpose of such Opinion Letters is to provide such assurance. Mr. Luvsanjav accepted that such letters are extensively used in international finance, and that it would be reasonable for the recipient to rely on the letter as providing assurance that all necessary approvals and authorizations had been obtained. Mr Sugar had actual or apparent authority to issue the MMOF Letter. At the time of issue of the guarantee, the then Minister of Finance, Mr. Luvsanjav, was absent from Mongolia on an official visit. Mr Luvsanjav stated that Mr. Sugar had authority to sign documents on behalf of the Ministry of Justice. It was one of the functions of the Ministry of Justice to issue such opinion letters. Such opinion letters had been issued in the past. MHK relied on the MMOJ and MMOF letters.

Attorney-General of Ceylon v Silva [1953] A.C. 461 is authority for the proposition that the Crown can be bound by a holding out of one of its agents as having authority to perform an act, which that agent is not in fact authorised to perform.

Mr White QC submitted as follows.

Mr Byambajav could not hold himself out as having authority. The legal opinion signed by Mr Sugar, the Deputy Minister of Justice, could not operate as a holding out on behalf of the defendant that Mr Byambajav had authority.

At p479 of the Silva case it was stated: -

“No public officer, unless he possesses some special power, can hold out on behalf of the Crown that he or some other public officer has the right to enter into a contract in respect of the property of the Crown when in fact no such right exists.”

Similarly in Howell v Falmouth Boat Construction Limited [1951] AC 837 Lord Normand with the agreement of Lords Oaksey, Radcliffe and Tucker, said at p849: -

“… it is certain that neither a minister nor any subordinate officer of the Crown can by any conduct or representation bar the Crown from enforcing a statutory prohibition or entitle the subject to maintain that there has been no breach of it.”

See also Lord Simonds at pp844-5. See further Bowstead at para 8-060. .

Further, MHK is unable to rely upon any apparent or ostensible authority if the circumstances were such that it should have been put on enquiry or at least been suspicious to the extent that further enquiries would have been appropriate. See Chitty para 32-057 and Bowstead at para 8-052. MHK should have been put on enquiry or at least made suspicious by three features of the present case. First, the unexpected and apparently unexplained refusal of the Central Bank of Mongolia to sign the guarantee. Second, the advice which it appears to have received that the guarantee was politically controversial and must be kept secret. Third, the lack of any document number or reference number on the legal opinion.

If the former Minister of Finance of Mongolia purported to issue a guarantee under Article 14 (2) of the Budget Law without Governmental approval, the issue of the guarantee would have been ultra vires.

Issue 3(2): Analysis and Conclusions.

Formal transactional legal opinions play an important part in the law and practice of international finance. The provision of a legal opinion “is almost invariably a condition precedent to the advance of loans or … bond issue[s] and its terms are settled with as much attention to detail as the contractual documents themselves”. (Philip R Wood International Loans, Bonds and Securities Regulations 1995 at page 215 and following).

In the present case the legal opinion was signed by the Deputy Minister of Justice in relation to the MMOF Letter signed by the Minister of Finance.

I refer to the MMOJ Letter quoted above for its full terms and effect. It confirmed: -

(1)

that the defendant had full authority to enter into and perform the terms of the guarantee and that the defendant had taken all necessary legal action to authorise it to execute and perform the guarantee and had obtained all authorisations etc necessary for the execution of the guarantee and its validity;

(2)

that the guarantee had been duly executed by the duly authorised representatives of the defendant and constituted the binding obligation of the defendant;

(3)

that the execution of the guarantee did not contravene the constitution of the defendant or any treaty etc or any agreement.

As to the principles of English law as to apparent or ostensible authority:

1.

Where a person, by words or conduct, represents or permits it to be represented that another person has authority to act on his behalf, he is bound by the acts of that other person with respect to anyone dealing with him as an agent on the faith of any such representation, to the same extent as if such other person had the actual authority that he was represented to have, even though he had no such actual authority. (Bowstead Article 74 para 8-013).

2.

There must be a representation made. It may be express or implied from a course of dealing; or it may be made by permitting the agent to act in some way in the conduct of the principal’s business with other persons. (Bowstead para 8-017).

3.

If the doctrine is based on the idea of representation the cases can be divided into two types. First, cases where there is something that can be said to be a genuine representation by the principal of the agent’s authority, on which the third party relies - cases of “genuine apparent authority” are more easily (but not always perfectly) based on estoppel. Second, cases where the representation is only of a very general nature, and arises only from the principal’s putting the agent in a specific position carrying with it a usual authority. (Bowstead para 8-018).

4.

The representation as to authority need not be made by the principal himself: it may be made by an intermediate agent with actual authority to do so. An agent can have apparent authority to make representations as to the authority of other agents, provided that his own authority can finally be traced back to a representation by the principal or to a person with actual authority from the principal to make it. However, such apparent authority would in general only be attributed to a person who would normally have actual authority to act within that particular sphere of activity. (Bowstead para 8-021).

As to the Crown, Bowstead para 8-044 states: -

“Employees of the Crown are all servants of the Crown and do not employ each other. And apparent authority may be extremely difficult to prove in a Crown or other public agent, for in Att.-Gen for Ceylon v Silva it was said that “no public officer, unless he possesses some special power, can hold out on behalf of the Crown that he or some other public officer has the right to enter into a contract in respect of the property of the Crown when in fact no such right exists.” However, this was a clear case, inasmuch as the agent’s powers were limited by delegated legislation, and to hold otherwise would have been to give a Crown official a dispensing power to validate ultra vires acts. Another clear case occurs where to bind the Crown would be to permit an officer of the Crown to fetter the Crown’s freedom of action to do its public duty. Subject to these important reservations, however, it may be possible to establish apparent authority in the normal way; though where it is argued that one officer held out another as having authority, it will be necessary to establish the actual (or sometimes apparent) authority of that officer to do so. It may also be difficult to distinguish this form of estoppel from other estoppels, eg as to whether the relevant authority has taken a decision or an immunity has been waived. Further, if the supposed doctrine of usual authority is accepted as a separate notion from that of apparent authority (which it has been suggested is not so), the Crown could perhaps be held liable under it, since no specific holding out is required – unless it be suggested that policy reasons still make the doctrine inapplicable to the Crown. The interaction of public and private law principles makes the area a difficult one. ”

A ministry of justice in a foreign country would be expected to have authority to issue legal opinions on behalf of a foreign government in relation to transactions to be entered into by the foreign government.

I find that the Minister of Justice and Deputy Minister of Justice had actual or apparent authority to issue opinion letters. Examples of such letters in respect of other transactions (a Poverty Alleviation Project Loan Agreement, a Telecommunications Project Loan Agreement, and a Loan Agreement) are found in the trial bundles.

In my opinion the better view is that (if contrary to my finding, Mr Byambajav lacked express actual authority) the defendant by the MMOJ Letter held out Mr Byambajav as having apparent/ostensible authority to enter into a guarantee on behalf of the defendant. I find that the claimant (reasonably) relied and acted upon the representations contained in the MMOJ Letter to this effect and was not put on enquiry.

For completeness I add that I do not consider that the MMOJ Letter held out Mr Byambajav as having apparent/ostensible authority to undertake (on behalf of the defendant) a primary liability (joint and/or several).

Had it been necessary to decide Issue 3(3), I would have found that the evidence was not sufficiently clear to establish ratification by Minister Ulaan.

As my answer to Issue 2 is English law, it is not necessary to consider Issue 4.

B. Subsequent discharge of the MMOF Letter

Issue 5 (1)

If the defendant is bound by the issue of the MMOF Letter, whether it was discharged as the result of refinancing agreements between the claimant and Buyan in February 1998 and April 1999; in particular:

(1)

Whether, on a true construction of the MMOF Letter, the defendant has undertaken a primary liability (joint and/or several) to the claimant so that the rule in Holme v Brunskill (1878) 3 Q.B.D. 495 has no application?

Mr Joseph QC submitted as follows.

On a true construction of the MMOF Letter the defendant undertook a primary and unconditional obligation to pay sums upon the claimant’s simple demand, upon non-payment of instalments under the DPS 1 Contract, without condition. The trigger for payment by the defendant is the demand that sums have become payable and are not paid, not the claimant establishing that Buyan is indeed in breach of contract and is liable. The key and operative words are – “unconditionally pledges to pay upon your simple demand”. This is a clear, unconditional primary obligation on the part of the defendant. It is either to be classified as an instrument of the type considered in Hyundai v Pournaras [1978] 2 Lloyd’s Rep 502 and Hyundai v Papadopoulos [1980] 1 WLR 1129, alternatively it is an unconditional demand guarantee – sometimes called a performance bond. Irrespective of this question of classification, it is an unconditional obligation to pay the DPS 1 Contract instalments and amounts irrespective of any disputes or set-offs or counterclaims that might be raised as between Buyan and MHK under the DPS 1 Contract. The essence of the MMOF Letter is the obligation to pay upon demand without condition if the DPS 1 Contract payment schedule is not met by Buyan for whatever reason. It is a primary obligation and not secondary. Under a typical guarantee the trigger for payment is not demand but establishment that the principal debtor is liable (which itself brings into consideration any set-offs or counterclaims that might exist in the underlying transaction). Under the MMOF Letter, the defendant is not entitled to raise any set-offs, counterclaims in relation to the underlying DPS 1 Contract by way of defence to the claim for payment. The defendant has an unconditional obligation to pay, and this liability could be greater in some circumstances than that of the ultimate liability of Buyan.

Issue 5(1): Analysis and Conclusions

I turn to consider these submissions. In construing the MMOF Letter I apply the principles of construction set out by Lord Hoffman in ICS Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912 and following, as explained in subsequent authorities. My task is to decide the nature of the instrument by looking at it as a whole, without any preconceptions as to what it is.

In a contract of guarantee the surety assumes a secondary liability to answer for the debtor, who remains primarily liable. In a contract of indemnity the surety assumes a primary liability, either alone or jointly with the principal debtor.

I do not accept Mr Joseph’s submission that the MMOF Letter is of the type of instrument considered in the Hyundai v Pournaras and Hyundai v Papadopoulos cases.

In BOC Group plc v Centeon LLC and another [1999] 1 All ER (Comm) at 66 Rix J said: -

“The decisions [in Pournaras] and in Papadopoulos relate to the following factors: the inclusion in the guarantees of a [un] conditional agreement to pay; the accruing of the guarantor’s liability to pay at a time when the principal debtors did not yet have any arguable right of set-off (because the default preceded the termination of the ship building contract); the guarantor’s obligation to pay ‘forthwith’; and the overall context (factual matrix) of the contractual arrangements. … Among the special features of those cases was the possibility of a return of instalments following termination of the ship building contracts, and the critical issue in effect was whether the guarantors, whose obligations arose under entirely separate contracts, remained obliged to pay instalments in respect of which the primary debtors were in default, even if the instalments subsequently became repayable to the buyers”.

The instrument in question is not a Hyundai type of instrument. The wording of the MMOF Letter differed in a number of material respects from the wording of the instruments in the Hyundai cases. The background was very different.

Further I cannot accept Mr Joseph’s submission that the instrument in question is to be classified as a first demand bond. A first demand bond will typically provide that payment will be made up to a specified sum on first demand or on first demand supported by a specified document (e.g. a statement in specified terms signed by the beneficiary). In the case of first demand bonds the obligation to pay arises on first demand (or on first demand supported by the specified document) without any independent evidence of the validity of the claim (save only to the extent that such evidence may sometimes be provided by a specified document e.g. a certified copy of an arbitral award). For completeness I record that on day 1 of the trial Mr Joseph appeared to accept that the MMOF Letter was not a first demand bond.

The original copies of the MMOF Letter and the Legal Opinion (the MMOJ Letter) were handed over to MHK on 14 May 1996. The Legal Opinion contained numerous references to ‘Guarantor’ and ‘Guarantee’. The MMOF Letter was to be read with the MMOJ Letter. The latter confirmed that “The Guarantor … has full power and authority to enter into, and perform [the] terms and conditions of the Guarantee … ”. The MMOJ Letter was of considerable importance to the claimant. The claimant required confirmation from the MMOJ that the ‘Guarantor’ was bound by the ‘Guarantee’. Had the claimant regarded the guarantee as any other form of instrument, it would have been concerned to ensure that the Legal Opinion covered such other form of instrument. The MMOJ Letter showed how the parties regarded the MMOF Letter. (Further it is to be noted that the letter dated 27 May 1996 from MHK to the Ministry of Finance referred to “a letter of guarantee” and “your guarantee”).

Under the MMOF Letter the defendant’s obligation was by reference to the liabilities of Buyan. Thus the defendant agreed to pay “all amounts payable under the Agreement if not paid when the same becomes due” and further promised “the full and timely performance and observance by the Buyer of all the terms and conditions of the Agreement.” Thus the defendant assumed a secondary liability. The MMOF Letter does not contain a “principal debtor” clause. As to the final sentence of the first paragraph of the MMOF Letter (“Further Ministry of Finance undertakes to hold indemnify and hold you harmless from and against any cost and damage which may be incurred by or asserted against you in connection with any obligations of the Buyer to pay any amount under the Agreement when the same becomes due and payable (whether at stated maturity, by acceleration or otherwise) or to perform or observe any term or condition of the Agreement or in connection with any invalidity or unenforceability of or impossibility of performance of any such obligation of the Buyer.”), I emphasise the words underlined. The words underlined were by way of support for the secondary liability. The main burden of the instrument was a guarantee. Clear language is necessary to create primary liability. (See for example the terms of the instrument considered in Stadium Finance Co Ltd v Helm and Another (1965) 109 SJ 471, Lord Denning MR and Russell LJ). If and to the extent that the words “or in connection with any invalidity or unenforceability of or impossibility of performance of any such obligations of the Buyer” are properly regarded as containing elements of an indemnity, I would construe the MMOF Letter as a hybrid, generally being in the nature of a guarantee but containing elements of an indemnity.

For the reasons set out above, in my judgment on a true construction of the MMOF Letter, the defendant did not undertake a primary liability (joint and/or several) to the claimant. Further in my judgment the rule in Holme v Brunskill applies to the MMOF Letter.

Both experts in Mongolian law provided reports in this case on the basis that the instrument in question was a guarantee. By way of example Professor Narangerel in his first report at paragraph 3 asserts that “Article 14.2 of the Budget Law … provides that the Minister of Finance may, with the approval of the Government, issue guarantees …”.

If, contrary to the above, the defendant undertook a primary liability (joint and/or several) to the claimant, it does not follow that the principles underlying the rule in Holme v Brunskill have no application. The MMOJ Letter referred expressly to the DPS 1 Contract, not the (altered) commercial arrangements reflected in the 1998 and 1999 Reschedulings examined below.

Issue 5(2)

If the answer to 5(1) is no, whether the refinancing packages of February 1998 and April 1999 involved any material variation in the transaction to which the guarantee related such as to result in the discharge of the entirety of the defendant’s obligations under the MMOF Letter?

The defendant’s case is that the agreements comprising the 1998 Rescheduling (entered into by Buyan and the claimant without the knowledge or consent of the defendant) amounted to variations of the agreement between Buyan and the claimant to which the guarantee related, which had the potential to prejudice the position of the defendant as guarantor.

The defendant’s pleaded case is particularised as follows: -

(1)

Article 6 of the Settlement Agreement released MHK from any claims that Buyan might have had against it for breach of the DPS 1 Contract. In the event that the defendant as guarantor was called on to pay under the guarantee it would be entitled to raise against the claimant any claims that Buyan had against the claimant. The effect of clause 6 of the Settlement Agreement is that such claims have been released.

(2)

The overall indebtedness of Buyan to the claimant and Marubeni was increased, thereby increasing the risk that Buyan would be unable to meet and/or service its total indebtedness to the claimant. Buyan’s payment obligations under the DPS 1 Contract were rescheduled, giving Buyan time to pay by lending Buyan further money with which to meet its payment obligations.

(3)

The claimant’s security rights over Buyan’s assets were increased (and Marubeni’s added), thereby depreciating the value of the defendant’s right of indemnity against Buyan.

(4)

The amendments to the Assignment and Security Agreement varied the escrow account arrangements provided for in Article 7.2 of the DPS 1 Contract by: -

(i)

reducing the percentages of the aggregate amounts of forthcoming instalments of principal and interest which Buyan was obliged to maintain in the escrow account and the periods during which those percentages were required to be maintained in the escrow account; and

(ii)

creating security rights over the escrow account in relation to Buyan’s repayment obligations to MHK under the Loan Agreement and to Marubeni under the (further) Sales Contract 2.

The defendant contends that the potentially prejudicial variations set out above (made without the knowledge or consent of the defendant) were such as to discharge the defendant from any liability under the guarantee.

Further the defendant’s case is that the agreements comprising the 1999 Rescheduling (entered into by Buyan and the claimant without the knowledge or consent of the defendant) amounted to further variations of the agreement between Buyan and the claimant to which the guarantee related, which were potentially prejudicial to the position of the defendant as guarantor.

The defendant’s pleaded case is particularised as follows: -

(1)

The variations increased still further the overall indebtedness of Buyan to the claimant and Marubeni, thereby increasing the risk that Buyan would be unable to meet and/or service its total indebtedness to the claimant. Buyan’s payment obligations under the DPS 1 Contract were rescheduled, giving Buyan time to pay by lending Buyan further money with which to meet its payment obligations.

(2)

The claimant’s security rights over Buyan’s assets were increased (and Marubeni’s added), thereby depreciating the value of the defendant’s right of indemnity against Buyan.

(3)

The further amendments to the Assignment and Security Agreement varied still further the escrow account arrangements provided for in Article 7.2 of the DPS 1 Contract by: -

(i)

reducing the percentages of the aggregate amounts of forthcoming instalments of principal and interest which Buyan was required to maintain in the escrow account and the periods during which it was required to maintain such percentages in the account; and

(ii)

creating security rights over the escrow account in relation to Buyan’s repayment obligations to MHK under the Amended Loan Agreement.

If, contrary to its primary case, the guarantee is valid and effective, and the defendant’s liability as guarantor was not discharged by the variations which took place in February 1998, the defendant contends that it was discharged from liability under the guarantee by the variations which took place in April 1999 (made without the knowledge or consent of the defendant).

It is convenient to consider the defendant’s case as to subsequent discharge of the guarantee under the following headings.

(1)

The Settlement and Release.

(2)

Rescheduling of Buyan’s payment obligations.

(3)

Alterations of security rights.

(4)

Alterations of the Collateral Account arrangements.

The claimant’s submissions

Mr Joseph QC submitted as follows.

(1)

The Settlement and Release

The claim that the defendant states it was deprived of relates to the suitability of the Mitsuboshi machinery. Such a claim (a) could not operate as a defence to the payment of sums under the DPS 1 Contract – see Article 11 which provides for payment without set-off or deduction etc. (b) such a claim would fail under the terms of the DPS 1 Contract itself – see Article 14.2 and (c) it would fail on the evidence given by Mr. Jargalsaikhan that before buying the machinery he had spoken to Mitsuboshi but nonetheless knew that the machines were not suitable for cashmere processing.

(2)

Rescheduling of Buyan’s payment obligations

The grant of a new loan does not amount to a variation of the DPS 1 Contract. The Loan Agreement makes it clear that it is not a variation of the DPS 1 Contract. The defendant does not stand as surety to the indebtedness of Buyan in general.

The new financing arrangements were for the express and manifest benefit of the defendant. The potential benefit to the defendant under the express terms of the 1998 Rescheduling was that Buyan’s indebtedness under the DPS 1 Contract would be reduced by US$3.5m. The actual benefit to the defendant as a result of the 1998 Rescheduling was a reduction in the defendant’s exposure under the guarantee to the extent of US$2,830,716.27.

The potential benefit to the defendant under the express terms of the 1999 Rescheduling was that Buyan’s indebtedness under the DPS 1 Contract would be reduced by US$20m and therefore extinguished.

The actual benefit to the defendant under the terms of the 1999 Rescheduling was a reduction in the defendant’s exposure under the guarantee to the extent of US$6,422,380.67.

There is no potential prejudice. The refinancings in 1998 and 1999 were arrangements to the manifest benefit of the defendant.

(3)

Alterations of security rights

The taking of increased security by Marubeni from Buyan does not amount to either a variation of the DPS 1 Contract or a material alteration to the prejudice of the defendant. O’Donovan & Phillips, The Modern Contract of Guarantee English edn 2003, cites this as an example of a matter that is for the clear benefit of the surety and does not give rise to discharge: §7-15.

(4)

Alterations of the Collateral Account arrangements

The escrow arrangements did not form part of the bargain between the creditor and surety. Therefore this is a matter that can at best fall under the first limb of the principle enunciated in Carter v White (see below). There is no discharge by reason of prejudice. There is also no pro tanto discharge. No security held was released and no prejudice was suffered.

The escrow arrangements did not stand as security for the defendant’s obligations under the guarantee. If Buyan admitted default in payment, the defendant would have no answer on the guarantee. The defendant then could take such security held by the claimant. There could be no circumstances in which the defendant being asked to pay on the guarantee would have recourse to the escrow.

The new arrangements did not increase or have the potential to increase Buyan’s risk of default. Buyan was in default in February 1998. The variations in the escrow arrangements never reduced the amount to be paid in by Buyan to below 100% of its DPS 1 Contract liabilities. Therefore the amendments were immaterial to the defendant.

The defendant’s submissions

Mr White QC submitted as follows.

(1)

The Settlement and Release

Article 6 of the Settlement Agreement released MHK and Marubeni from all actions, causes of action, claims etc. This release was insisted on by MHK against the background of a genuine dispute as to whether MHK was to blame for the selection and supply of the Mitsuboshi knitting machines which had turned out to be wholly unsuitable for the processing of cashmere. Absent the release, if the defendant had been called on to pay under the guarantee it could have taken advantage of any claim Buyan had against MHK arising from this dispute.

The rule in Holme v Brunskill prevents the Court from enquiring into the strength and value of any claim which Buyan might have had against MHK. MHK’s and Marubeni’s internal documents from late 1997 provide ample evidence that some individuals within the sales department and legal department of MHK, who were in a far better position than this court to investigate the merits of Buyan’s complaints, were so concerned about a possible $7.8million claim by Buyan that they took a deliberate decision not to involve the defendant in the refinancing negotiations in case it learned of the dispute and used it to its advantage.

Article 11 of the DPS 1 Contract does not purport to prevent Buyan from advancing a cross claim. If called on to pay or sued under the guarantee the defendant could have raised any cross claim open to Buyan. Even if it could not operate as a defence by way of set-off it could lead to a stay of execution up to the amount of the cross claim – see the authorities discussed in the note at 14/4/14 of the Supreme Court Practice 1999. Nor would Article 14.2 read together with Article 23 of the DPS 1 Contract inevitably have provided a defence to any claim by Buyan. There was a genuine dispute as to whether MHK had represented that the Mitsuboshi machines could be modified so as to make them suitable for cashmere processing and insisted that Buyan purchase the machines if it wanted to obtain the loan.

There was the possibility of a claim for misrepresentation. Another possibility might have been a claim for breach of the DPS 1 Contract based on the definition of “products” in Article 1.1(a) (machinery, equipment and materials necessary for cashmere hair processing plant) and the fact that the Mitsuboshi machines were wholly unsuitable for cashmere hair processing. The court cannot investigate the strength and value of these potential claims.

The guarantee related to the DPS 1 Contract under which Buyan and MHK each enjoyed and were burdened with rights and obligations. MHK and Buyan struck a deal behind the guarantor’s back to alter the rights Buyan enjoyed, and of which the guarantor might have been able to take advantage if called on to pay under the guarantee.

Rescheduling Buyan’s payment obligations

The fact that the Mitsuboshi machines were unsuitable for the processing of cashmere led directly to Buyan’s inability to meet its repayment obligations under the DPS 1 Contract. Since Buyan could not meet its repayment obligations MHK was faced with a choice. It could either call on the defendant to pay under the guarantee or make some arrangement which had the effect of giving Buyan time to pay. It could not risk the former course since it feared that if the defendant found out about the problem with the Mitsuboshi machines it would refuse to pay and make use of whatever claims were available to Buyan. MHK therefore had no option but to arrange some form of rescheduling of Buyan’s debts. This it achieved by including, in the package of measures required by the Settlement Agreement, a new loan agreement. The effect of the Loan Agreement was that Buyan did not have to find the money due under the DPS 1 Contract on 24/12/97, 18/10/98 and 18/10/99 until 6 months after each of those dates.

In Rowlatt on Principal and Surety 5^th edn at para 8-08 in the section dealing with giving time to the principal debtor it is stated: -

“It is immaterial what form the giving of time takes, so long as there is a binding agreement by the creditor to suspend his rights.”

This is the correct approach. It is a matter of substance rather than form.

(3)

Alteration of security rights

The Security Agreement 2 and Mortgage created entirely new security rights in favour of MHK and Marubeni over Buyan’s receivables, inventory and semi-processed articles, equipment, and real property (Article 2.01). The equipment over which security rights were created included the equipment supplied under the original DPS 1 Contract, but not that supplied under Sales Contract 2. Security Agreement 3 created security rights over the equipment supplied under Sales Contract 2 (Article 2.01). Under both of these agreements the security rights created in favour of MHK and Marubeni related to Buyan’s payment obligations under the DPS 1 Contract, the (new) Loan Agreement, and Sales Contract 2 (see Article 3.01 of the Security Agreement 2 and Mortgage and Article 3.01 of Security Agreement 3).

At the time when the guarantee was provided the guarantor knew that MHK had taken limited security over Buyan’s assets in accordance with Article 7.2 of the DPS 1 Contract. At that stage, it was not contemplated by the parties that further security rights would be granted by Buyan to MHK or to Marubeni. The arrangement made behind the guarantor’s back involved MHK and Marubeni acquiring extensive security rights over Buyan’s real property and other assets. Only some of the new security rights put in place would be available to the guarantor by way of subrogation if it paid under the guarantee. The security rights granted to MHK in relation to the (new) Loan Agreement, and the security rights granted to Marubeni in relation to the Sales Contract 2, would not be available to the guarantor if it paid under the guarantee. Instead the defendant would be forced to compete with MHK and with Marubeni in any attempt to gain access to Buyan’s assets. This would have the potential to depreciate the value of the defendant’s right of indemnity against Buyan.

(4)

Alterations of the Collateral Account arrangements

The Settlement Agreement entered into between Buyan and MHK on 4 February 1998 provided in Articles 4 and 5 for the Assignment and Security Agreement to be amended. This had two important effects. First, it created security rights over the escrow account in relation to Buyan’s obligations under the (new) Loan Agreement and the (new) Sales Contract 2, under which the replacement machinery was supplied. Second, it altered the percentages of forthcoming instalments which Buyan was obliged to maintain in the escrow account, and the periods during which those percentages were required. Buyan was now only obliged to maintain 110% of a forthcoming instalment in the period of 30 days prior to the due date, and 100% in the period of 31 to 90 days. After a certain point in time, these percentages were to change to 150% for 30 days and 100% for 31 to 120 days.

The April 1999 variation provided for a further change in the percentages and periods. (See the Second Amendment to the Assignment and Security Agreement of April 1999). The new definitions of “Excess Funds” and “Required Balance” set the percentage at 110% during the period of 30 days prior to the instalment due date and 100% during the period 31 to 90 days.

These variations, of which the defendant was unaware, were potentially prejudicial to its position as guarantor in two ways. First, they reduced the amount of money which Buyan was required to maintain in the escrow account and the periods over which it had to be maintained. This had the potential to increase the risk of default by Buyan. Second, any monies deposited in the escrow account by Buyan became available as security not only for Buyan’s repayment obligations to MHK under the DPS 1 Contract, but also for its repayment obligations to MHK under the Loan Agreement and to Marubeni under Sales Contract 2.

These variations cannot be regarded as self-evidently unsubstantial or inevitably beneficial to the guarantor.

For these reasons (submitted Mr White) the package of measures put in place without any consultation with the defendant in February 1998: -

i)

Amounted to an agreement (or package of agreements) between the creditor and the debtor with reference to the contract guaranteed.

ii)

Cannot sensibly be classified as self-evidently unsubstantial.

iii)

Cannot be seen without enquiry to be an alteration which could not be prejudicial to the guarantor. Weighing up the potential advantages and disadvantages of the various elements of the package was a matter on which the guarantor was entitled to be the sole judge.

iv)

Since the package was put in place without consulting the guarantor it is entitled to be discharged from its obligations under the guarantee.

The same analysis (submitted Mr White) applies to the April 1999 Rescheduling, with the exception that there was no release of claims on that occasion. The other potentially prejudicial aspects of the refinancing package were the same as in February 1998. The defendant’s primary position is that the guarantee had already been discharged as a result of the February 1998 refinancing package, before the April 1999 package was put in place.

Issue 5(2): Analysis and Conclusions

It is necessary at the outset to analyse some of the material provisions of the 1996 Agreements between MHK and Buyan, the 1998 Rescheduling and the 1999 Rescheduling.

The 1996 Agreements between MHK and Buyan

(1)

The DPS 1 Contract.

I have already referred to some of the material terms of the DPS 1 Contract.

(2)

Assignment and Security Agreement dated 3 June 1996.

The Assignment and Security Agreement (which is referred to as “Security Agreement 1” in the 1998 and 1999 agreements) was entered into between Buyan, MHK and Bank of Tokyo-Mitsubishi Trust Company on 3 June 1996. Recital B to the Assignment and Security Agreement contemplated that Buyan and another person or entity (including Marubeni) would enter into a purchase agreement (“the Purchase Agreement”) pursuant to which Buyan would sell to the Buyer under the Purchase Agreement certain cashmere products. It seems that the Purchase Agreement was ultimately entered into between Buyan and Venti Uno.

The Assignment and Security Agreement provided that Buyan should cause the Buyer to make all payments due to Buyan under the Purchase Agreement (“Product Payments”) in dollars directly to the Collateral Agent (clause 7.1). The Collateral Agent (appointed by MHK – see clause 2) was required (by clause 7.3) to deposit in a Collateral Account the amounts received from the Buyer pursuant to clause 7.1 (and other provisions of the Assignment and Security Agreement). Clause 3 provided for the establishment of the Collateral Account at Bank of Tokyo-Mitsubishi Trust Company in New York. The Required Balance was defined as follows: -

“Required Balance: with respect to any Interest Period, (i) during the period of thirty days prior to the next scheduled Debt Service Date, an amount equal to 200% of the Debt Service Amount to be paid by Buyan on such Debt Service Date. (ii) during the period of 31 to 120 days prior to the next scheduled Debt Service Date, an amount equal to 150% of the Debt Service Amount to be paid by Buyan on such Debt Service Date and (iii) during the period of more than 120 days prior to the next scheduled Debt Service Date, an amount equal to 100% of the Debt Service Amount to be paid by Buyan on such Debt Service Date.”

Clause 6.2 provided for Shortfall Notices if the balance in the Collateral Account fell short of the Required Balance. If Buyan received a Shortfall Notice from the Collateral Agent, Buyan was required to pay cash to the Collateral Account within ten days after the date of such Shortfall Notice (clause 7.2). If Buyan failed to make any payment pursuant to clause 7.2 to cover any Shortfall, this was an Event of Default (clause 1, Event of Default, (vii)).

To secure timely payment of all amounts owed to MHK under the DPS 1 Contract and the punctual payment of all of Buyan’s other obligations under the DPS 1 Contract, the Assignment and Security Agreement and under any other document or agreement related thereto, Buyan assigned inter alia the Collateral Account to, and subjected the same to a security interest in favour of, the Collateral Agent for the benefit of MHK and the Collateral Agent (clause 4(a)).

Clause 8 provided for distributions. On each Debt Service Date, the Collateral Agent was required to allocate and retain or distribute all funds in the Collateral Account in the manner and order of priority set out in clause 8(b). The Collateral Agent was required to distribute from the Collateral Account to MHK at least one business day prior to the Debt Service Date, an amount equal to the Debt Service Amount due on such Debt Service Date (clause 8(b), Second). Thereafter, so long as the Collateral Agent had not received written notice from MHK of the existence of an Event of Default, the Collateral Agent would distribute to Buyan, at least one business day prior to the Debt Service Date, any excess funds remaining in the Collateral Account (clause 8(b), Third). It should be noted that there would not be any distribution of any excess funds unless the Required Balance (as defined above) was in place.

The 1998 Rescheduling

The 1998 Rescheduling was contained in the following six agreements dated 4 February 1998 all of which were entered into without any consultation with the defendant.

(1)

Settlement Agreement between Buyan and MHK and Marubeni.

The recital recorded that the Mitsuboshi machines purchased under the DPS 1 Contract were not adequate for Buyan’s purpose to produce cashmere product and that Buyan and MHK were at the time of the DPS 1 Contract both unaware that the Mitsuboshi machines lacked adequate cashmere processing production capacity as required by Buyan.

Article 1.01 provided that MHK and Marubeni would attempt to assist Buyan to sell the Mitsuboshi machines to a third party. Article 1.02 provided that MHK would make loans in an amount not to exceed US$3.5 million to Buyan pursuant to a Loan Agreement ((2) below) solely to permit Buyan to maintain the Original Payment Schedule in the DPS 1 Contract. Article 1.03 provided that Marubeni and Buyan would enter into a Deferred Payment Sales Contract ((3) below), whereby Marubeni would sell to Buyan new machines to replace the Mitsuboshi machines, on a deferred payment basis.

By Article 2.01 MHK agreed to reduce the applicable default interest rate for the payment by Buyan to MHK due on 24 December 1997.

Article 3 provided that MHK, Marubeni and Buyan would enter into Security Agreement 2 and Mortgage ((4) below) and Security Agreement 3 ((5) below) wherein Buyan would pledge and provide a perfected security interest in goods, inventory and receivables and provide a mortgage over real property and land use rights.

Article 4 provided that the Loan Agreement, Sales Contract 2, Security Agreement 2 and Security Agreement 3 should not act, or be construed in any manner or form to supplant, replace or vitiate commitments of Buyan or guarantees of security or support thereof provided by Buyan “including the governmental guarantee from the Ministry of Finance and the legal opinion from the Ministry of Justice to MHK” in the DPS 1 Contract or the Assignment and Security Agreement between Buyan and MHK of 3 June 1996 (Security Agreement 1) and the Amendment Agreement to Security Agreement 1 ((6) below).

By Article 5.01 Buyan, MHK and Marubeni agreed to adhere to all of the terms of Security Agreement 1 including the collateral account and payment terms provided for in Security Agreement 1 as amended and agreed that Security Agreement 1 should constitute the controlling document for payment obligations to the collateral account therein created arising under the DPS 1 Contract, Sales Contract 2, the Loan Agreement, Security Agreement 2, Security Agreement 3 and the Settlement Agreement.

Article 6 contained a release and discharge in extremely wide terms as follows: -

“… Buyan hereby forever releases and discharges MHK and Marubeni from all actions, causes of action, suits, debts, dues, sums of money, accounts, reckoning, bonds, bills, specialties, covenants, contracts, controversies, executions, claims, and demands whatsoever, in law, admiralty or equity, which Buyan and its heirs, executors, administrators, successors and assigns now or may hereafter have against MHK, Marubeni or its successors or assigns for, upon or by reason of any matter, cause or thing whatsoever arising out of, in connection with or relating to any matter from the beginning of the world.”

Article 8.01 provided that the Settlement Agreement should be governed by and construed in accordance with the law of Japan, with arbitration in Japan.

(2)

Loan Agreement between Buyan and MHK.

By Article 2.01 MHK agreed to make a loan commitment available to Buyan in an aggregate principal amount of up to US$3.5 million solely for the purposes set forth in Article 11.01(a).

Article 8.01 provided that in order to secure the payment by Buyan of the Loan, accrued interest etc. and as security for compliance with Buyan’s obligations, Buyan, MHK and Marubeni would enter into Security Agreement 2 including the Mortgage Agreement and Buyan, MHK and Marubeni would enter into Security Agreement 3.

Article 8.01(f) provided that the Loan Agreement, Sales Agreement 2, Security Agreement 2 and Security Agreement 3 should not act or function or be construed in any manner or form to supplant, replace or vitiate commitments of Buyan or guarantees of security provided by Buyan to MHK pursuant to the DPS 1 Contract and Security Agreement 1.

By Article 11.01(a) Buyan covenanted that each of the first, second and third disbursements borrowed pursuant to the Loan Agreement would be utilised by Buyan solely for the purpose of the second payment of interest due on 24 December 1997 together with deferred interest, the first instalment payment together with interest due on 18 October 1998 and the third instalment together with interest due on 18 October 1999, each payable by Buyan to MHK under the DPS 1 Contract.

(3)

Deferred Payment Sales Contract between Buyan and Marubeni (“Sales Contract 2”).

Article 2.01 of Sales Contract 2 provided that Marubeni should sell and deliver the machines and equipment necessary for the cashmere knitting process and other items listed in Appendix 1 Schedule C (Shima Seiki knitting machines etc). The total value of Sales Contract 2 was J.Yen 250 million. (Article 3.01).

(4)

Security Agreement 2 and Mortgage between Buyan and MHK and Marubeni.

By Article 2.01(a) of Security Agreement 2 and Mortgage in order to secure performance of Buyan’s contractual obligations under the Loan Agreement, the Settlement Agreement, the DPS 1 Contract and Sales Contract 2, Buyan irrevocably granted, pledged and assigned to MHK and Marubeni a security interest with power of sale in the following: -

(i)

receivables;

(ii)

inventory and semi-processed articles; and

(iii)

equipment.

Equipment was defined as all present and hereafter acquired equipment wherever located, including, but not limited to the Products 1 and the Products 2 listed in Appendix 1, Schedule A and Schedule B. The equipment included the equipment sold under the DPS 1 Contract. Real property was mortgaged.

(5)

Security Agreement 3 between Buyan and MHK and Marubeni.

Article 2.01(a) of Security Agreement 3 provided that in order to secure performance of Buyan’s contractual obligations under the Loan Agreement, the DPS 1 Contract, the Settlement Agreement and Sales Contract 2, Buyan irrevocably granted, pledged and assigned to MHK and Marubeni a security interest in

(i)

equipment the subject of Sales Contract 2 (i.e. the Shima Seiki knitting machines etc).

(6)

Amendment to Assignment and Security Agreement (dated 3 June 1996) between Buyan, MHK, Marubeni and Bank of Tokyo – Mitsubishi Trust Company.

Article 2.02 of the Amendment to Assignment and Security Agreement (dated 3 June) replaced the definition of “Contract” in Security Agreement 1 with a new definition of “Contract” being collectively the DPS 1 Contract, the Loan Agreement and Sales Contract 2. Thus the expression “Debt Service Amount” now included all sums due to MHK and Marubeni under these three contracts.

Article 2.05 replaced the definition of “Required Balance” in Security Agreement 1 with the following: -

“Required Balance: (1) for the period commencing with the execution of this Agreement up to and including the Adjustment Date with respect to any Interest Period, (i) during the period of 30 days prior to the next scheduled Debt Service Date, an amount equal to 110% of the Debt Service Amount to be paid by Buyan on such Debt Service Date, and (ii) during the period of 31 to 90 days prior to the next scheduled Debt Service Date, an amount equal to 100% of the Debt Service Amount to be paid by Buyan on such Debt Service Date; and (II) for the period after the Adjustment, with respect to any Interest Period (i) during the period 30 days prior to the next scheduled Debt Service Date, an amount equal to 150% of the Debt Service Amount to be paid by Buyan on such Debt Service Date, and (ii) during the period of 31 to 120 days prior to the next scheduled Debt Service Date, an amount equal to 100% of the Debt Service Amount to be paid by Buyan on such Debt Service Date.”

The 1999 Rescheduling

The 1999 Rescheduling was contained in the following five agreements of about April 1999, all of which were entered into without any consultation with the defendant.

(1)

Amendment to Loan Agreement (dated 4 February 1998) between Buyan and MHK.

Because of Buyan’s financial difficulties, Buyan requested MHK to amend the Loan Agreement (dated 4 February 1998) to allow Buyan to borrow an amount from MHK not to exceed US$20 million for payment of debts incurred by Buyan to MHK under the terms of the DPS 1 Contract (Amendment to Recitals Article 2.01). Article 2.01 of the Loan Agreement was amended to refer to a Loan Commitment in an aggregate principal amount of up to US$20 million solely for the purposes set forth in Article 11.01(a). Article 11.01(a) of the Loan Agreement was amended to read:

“(a)

The first Disbursement borrowed pursuant to this Loan Agreement shall be utilized by the Borrower solely for the purpose of the second payment of interest due on 24 December 1997 together with default interest under the [DPS 1 Contract] and all other disbursements hereunder should be utilized by the Borrower solely for the purpose of the relevant instalment payment together with interest payable on each Disbursement Date by the Borrower to the Lender under the [DPS 1 Contract]. ”

The Disbursement Schedule (Exhibit A) to the Amendment to the Loan Agreement listed 11 disbursements of the loan of up to US$20 million between 6 March 1998 and 18 April 2003. Article 5.1 of the Loan Agreement was amended to provide for repayment dates between 18 October 2002 and 18 October 2007.

(2)

Amendment to Deferred Payment Sales Contract (Sales Contract 2) (dated 4 February 1998 as amended on 18 June 1998) between Buyan and Marubeni.

(3)

Amendment to Security Agreement 2 and Mortgage (dated 4 February 1999) between Buyan and MHK and Marubeni.

(4)

Amendment to Security Agreement 3 (dated 4 February 1999) between Buyan and MHK and Marubeni.

(5)

Second Amendment to Assignment and Security Agreement between Marubeni, MHK, Buyan and Bank of Tokyo-Mitsubishi Trust Company.

The definition of “Required Balance” contained in Section 1 of Security Agreement 1 was amended to read:

“Required Balance with a respect to any Interest Period:

(i)

during the period of 30 days prior to the next scheduled Debt Service Date, an amount equal to 110% of the Debt Service Amount to be paid by Buyan on such Debt Service Date;

(ii)

during the period of 31 days to 90 days prior to the next scheduled Debt Service Date, an amount equal to 100% of the Debt Service Amount to be paid by Buyan on such Debt Service Date. …”

I turn to consider the relevant legal principles.

The rule in Holme v Brunskill (1878) 3 QBD 495 Cotton LJ stated the applicable rule of law as follows at p505-506: -

“The cases as to discharge of a surety by an agreement made by the creditor, to give time to the principal debtor, are only an exemplification of the rule stated by Lord Loughborough in the case of Rees v Berrington (1): “It is the clearest and most evident equity not to carry on any transaction without the knowledge of him [the surety], who must necessarily, have a concern in every transaction with the principal debtor. You cannot keep him bound and transact his affairs (for they are as much his as your own) without consulting him”. The true rule in my opinion is, that if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and that if he has not consented to the alteration, although in cases where it is without inquiry evident that the alteration is insubstantial, or that it cannot be otherwise than beneficial to the surety, the surety may not be discharged; yet, that if it is not self-evident that the alteration is unsubstantial, or one which cannot be prejudicial to the surety, the Court will not, in an action against the surety, go into an inquiry as to the effect of the alteration, or allow the question, whether the surety is discharged or not, to be determined by the finding of a jury as to the materiality of the alteration or on the question whether it is to the prejudice of the surety, and will hold that in such as case the surety himself must be the sole judge whether or not he will consent to remaining liable notwithstanding the alteration, and that if he has not so consented, he will be discharged … The plaintiff, in support of his contention, that having regard to the finding of the jury, the surety was not discharged, relied on various dicta to the effect that any material change in the contract between the principals will not discharge the surety. Even if by these expressions the judges intended to state that to have the effect of releasing the surety the alteration must be material, it does not follow that they intended to lay down that no alteration would discharge the surety unless the jury in an action to enforce his liability, held it to be material, or to express any opinion at variance with the rule laid down by me. The case of Sanderson v Aston (2), was specially relied on by the plaintiff. But Martin, B., though he did not formally dissent from the decision of the majority of the Court, was not satisfied with the judgment; and if the decision is to be considered as based on the reason given by Pollock, B., that the Court was entitled to consider whether the alteration was material, it cannot, in our opinion, be sustained. ”

Thus the rule provides:-

(1)

the surety ought to be consulted about any agreement between the creditor and debtor with reference to the contract guaranteed.

(2)

in cases where it is without inquiry evident (a) that the alteration is insubstantial or (b) that the alteration cannot be otherwise than beneficial to the surety, the surety will not be discharged.

(3)

if it is not self-evident (a) that the alteration is insubstantial or (b) that the alteration is one which cannot be prejudicial to surety, the court will not, in an action against the surety, inquire as to the effect of the alteration or as to the materiality of the alteration or whether it is to the prejudice of the surety.

To hold the surety to his bargain, the creditor must show that the nature of the alteration can be beneficial to the surety only or that by its nature it cannot in any circumstances increase the surety’s risk, e.g. a reduction in the debtor’s debt or in the interest payable by the surety. The mere possibility of detriment is enough to bring about the discharge of the surety. (Ankar Pty Ltd v National Westminster Finance (Australia) Ltd (1987) 162 CLR 549 at 559, the High Court of Australia).

Unless the court comes to the conclusion that the alteration is insubstantial or cannot be prejudicial to the surety, the surety is discharged from liability. (Neill J in Coal Distributors Ltd v National Westminster Bank Ltd (4 February 1981, unreported).

The question whether an alteration is insubstantial or cannot be prejudicial to the surety is answered objectively, without reference to what the parties thought.

Cases where it was held that the surety was discharged by reason of variation of the contract between the creditor and the debtor include:-

(a)

Holme v Brunskill. (Contract of surety that a flock of sheep should be delivered up in good condition together with a farm as originally demised to the tenant; surrender of a seven acre field to the creditor and reduction in rent. It was held that it could not be said that the surrender of the seven acre field could not prejudice the surety – its loss might make a difference of 15 in the number of sheep which the farm would carry).

(b)

National Bank of Nigeria Ltd v Awolesi [1964] 1 WLR 1311, PC. (A guarantee was of the account as it existed at the date of the guarantee, and the parties did not contemplate the opening of a second account. It was held that by permitting the opening of a second account, the bank had permitted a substantial variation of the terms of the contract without the guarantor’s knowledge and to his detriment, with the result that the guarantor was discharged. “When the Bank allowed Taiwo to open the second account they were permitting the position of the respondent to be prejudiced as to his guarantee for, as happened thereafter, it was possible for Taiwo to make payments into the Bank without releasing the respondent from his liability under the guarantee. The opening of the new current account was an unauthorised departure from the terms of the contract of guarantee.” Per Lord Hodson at 1316 A-B).

(c)

Credit Suisse v Allerdale Borough Council [1995] 1 Lloyd’s Rep 315. (The rule was applied to a variation increasing the number of interest rests in the principal contract. Colman J held that such a variation was not insubstantial, and that the rule applied, notwithstanding that the variation could have been beneficial or prejudicial to the guarantor. He said at page 366: -

“In the present case the consequence of the consolidation agreement was to increase the number of interest rests. That was not insubstantial for it would have the consequence, depending on movements in interest rates, that the obligation of the Company in respect of interest was potentially greater than it would have been without consolidation. That was not inevitable. The effect might have been beneficial. What is quite certain, however, is that it would not inevitably have been. It follows that the variation was material … ”)

(d)

Guinness Mahon & Co Ltd v London Enterprise Investments Ltd [1995] 4 Bank LR 185, Stanley Burnton QC sitting as a deputy High Court judge. (A material increase in the amount of a demand loan facility was potentially prejudicial to the defendant guarantors who were as a result discharged).

(e)

Howard de Walden Estates Ltd v Pasta Place Ltd [1995] 22 EG 143. (The guarantors of a lease of a delicatessen were discharged by variations to the use provision in the lease permitting sales of alcohol).

(f)

Bank of Baroda v Patel [1996] 1 Lloyd’s Rep 391. (The plaintiff bank provided banking facilities to a company and was given a guarantee by the defendant. It was an integral and important part of the overall arrangement that ECGD cover should be provided in respect of foreign bill transactions. Potter J. held that the defendant’s position was the subject of prejudice or potential prejudice from the first occasion when the bank knowingly proceeded to provide finance for transactions which had no ECGD cover).

(g)

Lloyds TSB Bank plc v Shorney [2001] All ER (D) 277. (The husband entered into a guarantee for the liabilities of a company up to £150,000. The charge contained a clause (clause 21) which precluded the wife from enforcing any claim against the husband or the bank until all monies owed to the bank had been paid off. Subsequently the husband and the bank further increased the amounts for which he was liable under his guarantee. On default the bank obtained judgment against the husband for £238,000 and sought a charging order for the excess. The wife paid the £150,000 and sought to exercise her right to be subrogated to the bank’s charge. It was held that the bank was not entitled to rely on clause 21 since its conduct in increasing the husband’s liability had materially prejudiced the position of the wife as co-surety).

Cases where it was held that the surety was not discharged by reason of variation of the contract between the creditor and the debtor include:-

(a)

Egbert v National Crown Bank [1918] AC 903, 909-10, PC. (Guarantee of obligation to repay money subject to a condition that interest should not exceed 7 %; agreement to charge 8% statutorily invalid).

The rule in Holme v Brunskill is subject to contrary agreement between the parties and bank guarantee forms usually contain widely drafted clauses designed to avoid the application of the rule. Such clauses have, however, been construed strictly by the courts.

As a creditor has the right (by the law of contract) to accept a debtor’s wrongful repudiation of the contract guaranteed, the exercise of that right is not a material variation of the contract such as to discharge the guarantor’s liability (Moschi v Lep Air Services Ltd [1973] AC 331, HL).

Agreement by the creditor to give time to the debtor

A surety is discharged when the creditor, without the surety’s assent, by binding agreement, gives time to the debtor. By giving time to the debtor, the creditor deprives the surety of the right to use the name of the creditor to sue the debtor. If this right is suspended for an hour or a day this discharges the surety. (Polak v Everett (1876) 1 QBD 669 at 673-674). Cockburn C.J. in Swire v Redman (1876) 1 Q.B.D. 536 at 541 said:

“The relation of principal and surety gives to the surety certain rights. Amongst others the surety has a right at any time to apply to the creditor and pay him off, and then (on giving a proper indemnity for costs) to sue the principal in the creditor’s name. We are not aware of any instance in which a surety ever in practice exercised this right; certainly the cases in which a surety uses it must be very rare. Still the surety has this right. And if the creditor binds himself not to sue the principal debtor, for however short a time, he does interfere with the surety’s theoretical right to sue in his name during such period. It has been settled by decisions that there is an equity to say that such interference with the rights of the surety – in the immense majority of cases not damaging him to the extent even of a shilling – must operate to deprive the creditor of his right to recourse against the surety, though it may be for thousands of pounds.”

Time is only given if there is a binding agreement arrived at for good consideration. (Rouse v Bradford Banking Co Ltd [1894] AC 586 at 594, Lord Herschell L.C.).

It is immaterial what form the giving of time takes, so long as there is a binding agreement by the creditor to suspend his rights. Thus, agreeing to take payment by instalments, taking a bill or note payable on a future day, or obtaining judgment by consent with a stay of execution beyond the date when in the regular course judgment could have been obtained, discharges the surety. (McCardie J in Goldfarb v Bartlett and Kremer [1920] 1 KB 639 at 649 approving a passage to this effect in Rowlatt on Principal and Surety).

Release or surrender of securities

Subject to the terms of a guarantee, a guarantor has a right on paying the guaranteed debt to have all securities held by the creditor for that debt handed over to him by the creditor in the same state and condition as they were when they were received by the creditor.

In Watts v Shuttleworth (1860) 5H & N 235 at 247 – 248, the creditor had covenanted to insure mortgaged goods and failed to insure them. Pollock CB said: -

“… if the person guaranteed does any act injurious to the surety, or inconsistent with his rights, or if he omits to do any act which his duty enjoins him to do, and the omission proves injurious to the surety, the latter will be discharged … the rights of a surety depend rather on principles of equity than upon the actual contract.”

In Wulff v Jay (1872) LR7 QB 756 the creditor failed to register a mortgage as a bill of sale and failed to take possession of the mortgaged chattels which were then seized by the trustee in bankruptcy of the mortgagor. A guarantor for the debt owed by the bankrupt to the creditor and secured by the mortgage was discharged to the value of the mortgaged chattels. Cockburn C.J. said at 762-3: -

“… where a debt is secured by a surety, it is the business of the creditor, where he has security available for the payment and satisfaction of the debt, to do whatever is necessary to make that security properly available … Here, by registering the bill of sale, and by afterwards availing themselves of the power which they possessed to take possession, the plaintiffs might have secured the payment of the debt to themselves, or by protecting the securities and holding them in their hands, they could have made them over to the surety when the surety was willing, or was called on, to pay: but by omitting to do what was necessary in order to place themselves in that position, and by allowing bankruptcy to supervene so as to enable the trustee under the bankruptcy to take possession of these goods adversely, it is clear that they have placed the surety in a position very detrimental and prejudicial to the surety; and for that the surety ought to have, according to the general doctrine, a remedy.”

Hannen J. said at 764: -

“As a surety, on payment of the debt, is entitled to all the securities of the creditor, whether he is aware of their existence or not, even though they were given after the contract of suretyship, if the creditor who has had, or ought to have had, them in his full possession or power, loses them or permits them to get into the possession of the debtor or does not make them effectual by giving proper notice, the surety to the extent of such security will be discharged. ”

Watts v Shuttleworth and Wulff v Jay pre-dated Holme v Brunskill.

In Carter v White (1884) 25 Ch D 666 at 670, Cotton L.J. said: -

“The principle is this: that if there is a contract express or implied that the creditor should acquire or preserve any right against the debtor, and the creditor deprives himself of the right which he has stipulated to acquire, or does anything to release any right which he has, that discharges the surety; but where there is no such contract, and he only has a right to perfect what he has in his hand, which he does not do, that does not release the surety unless he can show that he has received some injury in consequence of the creditor’s conduct.”

In Smith v Wood [1929] 1 Ch 14 by memorandum of charge, twelve persons deposited the title deeds of their respective properties to secure payment to the defendant of sums due from a company whose overdraft he was guaranteeing. The defendant released the deeds of three houses to the extent of allowing a prior mortgage. It was held that the release of one property affected the right of any other depositor, whose property might be taken towards satisfaction of the company’s debt to the defendant, to have all the properties marshalled so as to cause the debt to fall rateably on the properties charged. The defendant’s act in handing over the deeds of the three houses had therefore brought about a substantial alteration in the contract connecting the parties inter se, and the properties of such of the plaintiffs as had not consented to the alteration were released from liability.

Lord Hanworth MR applied the rule in Holme v Brunskill and said (at page 23): -

“… inasmuch as these ten persons had inter se the right of marshalling and that there are now only nine of them left owing to the property of one of them being withdrawn, their rights inter se have been affected; it may be that they are very little affected, but it was for them to judge and for them to decide whether they would allow the alteration, and it is not for a Court or a jury to determine the materiality of the alteration. The result of the alteration was not really large in this case, but the contributing person is to be the sole judge of whether or not he will consent to remain liable notwithstanding the alteration. There was no such consent here, and it appears to me therefore that the learned Vice-Chancellor has come to a right conclusion, although with reluctance. ”

Sankey LJ said at page 26: -

“… if the surety is not consulted with reference to an alteration of the contract guaranteed, then, unless it is self-evident that the alteration is unsubstantial, the surety will be discharged.”

Where there is an agreement between the creditor and the debtor to alter the terms as to the provision of security in the contract guaranteed, unless the variation is insubstantial or cannot be prejudicial to the surety, the surety will be discharged.

Where the creditor’s dealings with the security constitute a breach of a condition of the contract of guarantee, the guarantor will be discharged.

The creditor’s failure to obtain the proper value of a security which he sells, reduces pro tanto the amount for which the guarantor is liable. (Skipton Building Society v Stott [2000] 2 All ER 779, CA).

Other irregular conduct on the part of the creditor

There is no general principle that “irregular” conduct on the part of the creditor, even if prejudicial to the interests of the surety, discharges the surety, though there are particular circumstances in which the surety may be discharged, examples of which are set out above. (Robert Goff LJ, Bank of India v Trans Continental Commodity Merchants Ltd [1983] 2 Lloyds’ Rep 298 at 302).

I turn to apply the above principles to the present case.

Article 7.2 of the DPS 1 Contract provided that as security for compliance with the obligations therein, the parties should enter into an assignment and security agreement in the form of Appendix 5 “attached hereto and made integral part hereof”. Appendix 5 contained the (unexecuted) Assignment and Security Agreement. The Assignment and Security Agreement dated 3 June 1996/Security Agreement 1 was executed before the DPS 1 Contract became effective on 18 June 1996. Thus for the purposes of the rule in Holme v Brunskill the contract guaranteed comprised the DPS 1 Contract and the Assignment and Security Agreement dated 3 June 1996.

The alterations to the contract guaranteed are found in the 1998 Rescheduling and the 1999 Rescheduling. The 1998 Rescheduling was contained in the 6 agreements dated 4 February 1998 referred to above. The 1999 Rescheduling was contained in the 5 agreements referred to above. The question whether an alteration is insubstantial or cannot be prejudicial to the surety is answered objectively. Unless the court comes to the conclusion that the variation is insubstantial or cannot be prejudicial to the surety, the surety is discharged from liability.

Although it is convenient to consider the defendant’s case as to subsequent discharge of the guarantee under four headings, when applying the rule in Holme v Brunskill it is necessary to have regard to the combined effect of the various alterations.

(1)

The Settlement and Release

There are a number of internal Marubeni documents which suggest that representatives of the defendant considered prior to the 1998 Rescheduling that Buyan had significant claims against MHK arising out of the DPS 1 Contract.

By way of example a Committee Paper dated 7 November 1997 stated: -

“There is a problem in that the knitting machines for the end process have not operated according to initial expectations. … We shipped 36 knitting machines made by the bankrupt Mitsuboshi Manufacturing which we had in stock. When it came to selecting the type of machine, the customer finally agreed but it seems that the selection process was in fact a difficult one in which, in order to obtain financing from us, our inventory problems were taken into account. In fact these Mitsuboshi Manufacturing knitting machines were designed for a special process called ‘inter-shear’ and were not suitable for the mass production of cashmere by way of shaped knitting that the customer needed. … ”

In a document dated 22 December 1997 it was stated: -

“Provisionally if there was no financial support for the project and application had been filed for issuance a letter of guarantee, it is considered that compensation would be paid to Buyan for losses sustained due to machine malfunction of the Mitsuboshi knitting machines. The losses set at US$4.9 million due to the decrease in production by 70,000 units in FY 97 through the machine malfunction of the Mitsuboshi machines; and through cancellation of 36 Mitsuboshi knitting machines the reshipment reached about US$2.8 million, bringing the estimated total to US$7.7 million. ”

Although points were raised as to the true translation of this passage, the broad sense is clear.

A guarantor can prima facie avail itself of any right of set-off possessed by the primary debtor against the creditor. Further the guarantor has its own independent right of set-off. (BOC Group plc v Centeon LLC and another [1999] 1 All ER (Comm) 53 at 67, Rix J). Civil Procedure Volume 1 2003 states at 24.2.6 under the heading ‘Effect of a set off or counterclaim’:

“The question which arises here is whether a defendant can rely upon a set-off or counterclaim as a “reason why the claim should be dealt with at trial” and thereby defeat a claim for summary judgment. The case law under the previous rules on this point was not coherent. Often the court refused to give summary judgment in such cases or granted summary judgment subject to a stay on enforcement pending trial of a counterclaim… in some exceptional cases the claimant obtained summary judgment which was enforceable immediately even though the defendant intended to raise a counterclaim … it is possible that, under the new rules, the court may grant summary judgment more frequently than hitherto and may impose a delay on enforcement more frequently than hitherto. … If a claim is otherwise suitable for summary disposal, the court may prefer to deal with a defence of set off by entering summary judgment on the claim expressing that judgment to be subject to the determination of the defendant’s cross claim or until further order, and stating that the summary judgment would not be enforceable until determination of the cross claim or until a further order was made.”

(See further The Supreme Court Practice 1999 note 14/4/14).

I accept Mr White’s submission that Article 11 of the DPS 1 Contract did not prevent Buyan from advancing a cross claim.

In his witness statement Mr Jargalsaikhan said: -

“Under the DPS Contract, delivery was also to be made to us of 36 pieces of machinery manufactured by … Mitsuboshi for the knitting of cashmere. … Whilst Mitsuboshi was a specialist Japanese Company who came to Ulaan Baatar to install the equipment and instruct our staff on how to use it, the equipment was wholly unsuitable for the processing of cashmere. As I am in the cashmere business, I felt that these pieces of equipment would not be appropriate for cashmere, although they would be appropriate for other less delicate fabrics. I indicated my concerns to Marubeni, but they insisted that the machines would be suitable. Marubeni then claimed that the machines could be modified so as to make them suitable for the knitting of cashmere. This proved not to be possible. I have since discovered that the 36 machines were stock which Marubeni had had for a long time and had been unable to sell to any other buyer. The 36 Mitsuboshi machines remain to this day in one of Buyan’s warehouses, idle and non operational.”

Some of Mr Jargalsaikhan’s answers in evidence may have been due to difficulties with interpretation. I formed the impression that Mr Jargalsaikhan was emphasising that he indicated his concerns to MHK that the machines would not be appropriate for cashmere prior to the DPS 1 Contract, but that MHK persuaded him that the machines would be suitable. I was struck by Mr Jargalsaikhan’s evidence to the effect that not a single cashmere jumper was produced using the Mitsuboshi machines.

Buyan could have pleaded its claim against MHK in relation to the DPS 1 Contract in a number of ways, for example misrepresentation, breach of contract and breach of collateral warranty.

I find that there were serious issues to be tried as between Buyan and MHK in relation to the DPS 1 Contract, which were compromised by Article 6 of the Settlement Agreement.

In my judgment the alteration contained in Article 6 of the Settlement Agreement (a release and discharge in extremely wide terms) was not insubstantial; further it was prejudicial to the defendant.

(2)

Rescheduling of Buyan’s payment obligations

The 1998 Rescheduling was contained in the 6 agreements dated 4 February 1998 referred to above, all of which were entered into without any consultation with the defendant. The 1999 Rescheduling was contained in the 5 agreements of about April 1999 referred to above, all of which were entered into without any consultation with the defendant.

I have set out above the relevant principles derived from the authorities as to agreements by the creditor to give time to the debtor. These principles in my view represent an application of the rule in Holme v Brunskill, in the particular context of giving time.

It is necessary to examine the terms of the 1998 and 1999 Reschedulings and apply the rule in Holme v Brunskill. Unless the court comes to the conclusion that the alterations are insubstantial or cannot be prejudicial to the surety, the surety is discharged from liability. The question whether an alteration is insubstantial or cannot be prejudicial to the surety is answered objectively.

The DPS 1 Contract provided that the purchase price was US$18,811,670. The first instalment of the price was to be paid within 60 days of the signature of the DPS 1 Contract, and the remaining amount was to be paid in 12 equal semi-annual instalments. The first of these was due on 19 October 1998.

The terms of the 1998 and 1999 Reschedulings are complex. Although I will refer to particular provisions of the Reschedulings, when applying the principle in Holme v Brunskill, the terms of the 1998 and 1999 Reschedulings should be looked at as a whole.

As to the 1998 Rescheduling, by the Loan Agreement MHK agreed to make available to Buyan US$3.5 million to be utilized by Buyan solely for the purpose of the second payment of interest due on 24 December 1997 together with deferred interest, the first instalment payment together with interest due on 18 October 1998 and the third instalment together with interest due on 18 October 1999, each payable by Buyan to MHK under the DPS 1 Contract. It should be noted that the second payment of interest due on 24 December 1997 was outstanding at the date of the Loan Agreement (of 4 February 1998). The Disbursement Schedule (Exhibit A to the Loan Agreement) provided for the first disbursement on 24 December 1997, the second on 18 October 1998 and the third on 18 October 1999. Buyan was obliged to repay MHK the first disbursement (US$953,869) on 18 April 2000, the second disbursement (US$2,093,895) on 18 April 1999 and the third disbursement (US$2,284,148) on 18 April 2000.

As to the 1999 Rescheduling, because of Buyan’s financial difficulties, Buyan requested MHK to amend the Loan Agreement dated 4 February 1998 and to borrow an amount from MHK not to exceed US$20 million for payment of debts incurred by Buyan to MHK under the terms of the DPS 1 Contract. All disbursements under the Amendment (of about April 1999) to the Loan Agreement (of 4 February 1998) were to be utilized by Buyan solely for the purpose of the relevant instalment payment together with interest payable on each Disbursement Date by Buyan to MHK under the DPS 1 Contract. The Disbursement Schedule (Exhibit A) to the Amendment to the Loan Agreement listed 11 disbursements of the loan of up to US$20 million between 6 March 1998 and 18 April 2003. Article 5.1 of the Loan Agreement was amended to provide for repayment dates between 18 October 2002 and 18 October 2007.

If the mechanics of a rescheduling involve a refinancing of debt, there will be elements of a roll-over, of making further advances and of giving time. Debt is often rescheduled on the “short-leash approach” – the amount of debt which is rescheduled is limited to a proportion of the amount of existing or imminent arrears. (See Project Finance, Subordinated Debt and State Loans, Philip Wood p160, in the context of Rescheduling of State Debt). This was the approach adopted in the Loan Agreement (1998 Rescheduling). The 1999 Rescheduling involved a more extensive refinancing. The leash had got longer. Buyan’s indebtedness to MHK (capital and interest) was not being reduced as contemplated in the DPS 1 Contract, but was extended by the 1998 Rescheduling and further extended by the 1999 Rescheduling.

Mr Joseph submitted that the potential benefit to the defendant under the terms of the 1998 Rescheduling was that Buyan’s indebtedness under the DPS 1 Contract would be reduced by US$3.5 million, and that the potential benefit to the defendant under the 1999 Rescheduling was that Buyan’s indebtedness under the same contract would be reduced by US$20 million and therefore extinguished. It is necessary however to look at both sides of the equation. Buyan’s indebtedness under the DPS 1 Contract would be reduced, but only so long as Buyan could afford to meet its extended obligations under the 1998 and 1999 Reschedulings. There is a marked difference between a borrower who pays off its borrowings in semi-annual instalments, and a borrower who reschedules its obligations.

In my judgment the alterations to the DPS 1 Contract referred to above (which alterations comprise part of the 1998 and 1999 Reschedulings) were not insubstantial and were prejudicial the defendant.

(3)

Alterations of security rights

The terms and effect of the Assignment and Security Agreement dated 3 June 1996 are explained above.

By the Trilateral Agreement between the Ministry of Finance, the Ministry of Trade and Industry and Buyan made in about April or May 1996, Buyan granted or purported to grant a security interest in favour of the Ministry of Finance in relation to the defendant’s obligations under the guarantee. The Ministry of Finance was given rights in relation to Buyan’s accounts in the commercial banks (clause 4.4). Further by clause 4.5 the Buildings etc listed in the Appendix to the Trilateral Agreement were “possessed by/placed under the control of” the Ministry of Finance as security for payment, in case Buyan failed to pay MHK the sums due under the DPS 1 Contract.

MHK rely on the following passage in The Modern Contract of Guarantee by O’Donovan and Phillips English Edition 2003: -

“Another example of an alteration which is clearly beneficial to the guarantor is a variation in the existing agreement by which the creditor takes an additional security from the principal. This is to the advantage of the guarantor because the guarantor is entitled to be subrogated to its additional security on satisfying the obligation under the guarantee.”

The alterations in the present case went far beyond the straightforward case contemplated by O’Donovan and Phillips of a creditor taking an additional security from the principal in relation to liabilities under the contract guaranteed. In particular (but without limitation): -

(1)

By Article 2.01(a) of Security Agreement 2 and Mortgage in order to secure performance of Buyan’s contractual obligations under the Loan Agreement, the Settlement Agreement, the DPS 1 Contract and Sales Contract 2, Buyan irrevocably granted, pledged and assigned to MHK and Marubeni a security interest with power of sale in the following: -

(i)

receivables;

(ii)

inventory and semi-processed articles; and

(iii)

equipment.

Equipment was defined as all present and hereafter acquired equipment wherever located, including, but not limited to the Products 1 and the Products 2 listed in Appendix 1, Schedules A and B. Thus Buyan granted or purported to grant to MHK and also Marubeni a security interest in relation to certain assets of Buyan, which were already the subject of the security interest granted or purportedly granted by Buyan to the defendant under the Trilateral Agreement.

(2)

The security interest granted by Article 2.01(a) of Security Agreement 2 and Mortgage did not just secure Buyan’s obligations under the DPS 1 Contract, but also secured Buyan’s obligations under the Loan Agreement, the Settlement Agreement and Sales Contract 2. Further the security interest granted was in favour of Marubeni in addition to MHK. A guarantor has a right on paying the guaranteed debt to have all securities held by the creditor for that debt (but not other debts) handed over to him by the creditor in the same state and condition as they were when they were received by the creditor. Further the Trilateral Agreement purported to grant the defendant a security interest exercisable prior to paying the guaranteed debt (see clause 4.5 “ … to pay the amount through seizing property”). Thus the defendant before and/or on paying the guaranteed debt would find itself in competition with MHK and Marubeni, for securities held by MHK for the guaranteed debt and for other debts, and for securities held by Marubeni for further debts.

In my judgment the alterations of security rights contained in the 1998 and 1999 Reschedulings were not insubstantial and were prejudicial to the defendant.

(4)

Alterations of the Collateral Account arrangements

The Required Balance in the Collateral Account at Bank of Tokyo-Mitsubishi Trust Company in New York (see the Assignment and Security Agreement dated 3 June 1996) was altered by the Amendment to Assignment and Security Agreement dated 3 June 1996 (in the 1998 Rescheduling) and by the Second Amendment to the Assignment and Security Agreement (in the 1999 Rescheduling). The percentage of the Debt Service Amount to be paid by Buyan on the scheduled Debt Service Dates was altered and the relevant periods of time were altered. The definition of “Contract” in the Assignment and Security Agreement dated 3 June 1996 was replaced with a new definition of “Contract” being collectively the DPS 1 Contract, the Loan Agreement and Sales Contract 2. Thus the expression “Debt Service Amount” now included all sums due to MHK and Marubeni under these three contracts. The result was that the Collateral Account was security not only for Buyan’s obligations to MHK under the DPS 1 Contract, but also for Buyan’s obligations to MHK and Marubeni under other contracts (not the subject of the guarantee).

I consider that the alterations of the Collateral Account arrangements should be regarded as forming part of the alterations of security rights (see (3) above). I would, however, if necessary hold that the alterations of the Collateral Account arrangements were not insubstantial and were potentially prejudicial to the defendant.

The combined effect of the various alterations

Although I have considered the defendant’s case as to subsequent discharge under four headings, when applying the rule in Holme v Brunskill it is necessary to have regard to the combined effect of the various alterations. In my judgment the alterations comprised in the 1998 Rescheduling and again in the 1999 Rescheduling, when taken together, were not insubstantial and were prejudicial to the defendant.

This conclusion should not come as a surprise to any person experienced in the law and practice of domestic or international finance. A standard form bank guarantee will typically contain a number of provisions designed in an attempt to avoid the application of the rule in Holme v Brunskill. By way of example only I refer to the Standard Form Bank Guarantee set out at page 548 and following in Andrews and Millett. Alterations such as those found in the 1998 and 1999 Reschedulings would almost inevitably lead to the discharge of a surety from liability, unless the surety consented to the same. MHK recognised this but chose not to consult the defendant. One example of this is found in the internal Marubeni note of the meeting on 30 October 1997.

It follows that the claim in this action fails.

I conclude by thanking all three counsel and the two teams of solicitors for the exemplary way in which this case has been conducted.