Экзамен зачет учебный год 2023 / The independence principle of letters of credit and demand guarantees

The N ature o f D em and Guarantees

sale contract is concluded. In such a case, the form of the guarantee is normally annexed to the contract. In other cases the wording of the guarantee is negotiated and agreed after conclusion of the sale contract. The seller then applies to his bank for the bank to arrange for the guarantee to be issued to the beneficiary. The seller will agree to pay the bank’s charges and to reimburse the bank for any sums paid under the requested guarantee. If the bank agrees to the request it will contact another bank in the buyer’s country and request that bank to issue a demand guarantee to the buyer. The instructing bank will promise to reimburse the issuing bank and will give a counter-guarantee to secure that promise. If the bank in the buyer’s country agrees with the request it will issue the demand guarantee to the buyer. If the issuing bank makes payment to the buyer under the demand guarantee it will be reimbursed by the instructing bank and the instructing bank will in turn be reimbursed by the seller. Thus, whereas in a letter ofcredit the chain of ultimate payment moves from the buyer to the seller, in a demand guarantee the movement of funds is in the opposite direction.

(Hi) Syndication

3.08Where an account party requires a demand guarantee in a very substantial amount, as where the account party has been awarded a very large construction or supply contract, usually by a government, banks may be reluctant to take the risk of issuing such a demand guarantee on their own. In such a case, banks may be more willing to spread the risk by coming together into a syndicate. The members of the syndicate would agree for one of the banks in the syn­ dicate to issue the demand guarantee in the full amount on terms that the syndicate will severally reimburse the issuing bank for any loss it may suffer as a result of issuing the guar­ antee. The obligation of each participating bank is normally proportional to its undertaking under the syndicate facility.19 If a valid demand is made under the demand guarantee, the issuing bank will make payment to the beneficiary and then demand reimbursement from the participating bank pro rata to the commitment of the participant. The account party is also under a reimbursement obligation. Depending on the arrangements, the account party’s reimbursement obligation may be owed to the issuing bank or directly to the participants for payments they have made to the issuing bank.20

C. Comparison with letters of credit

3.09There are important similarities between demand guarantees and letters of credit although there are differences between the two instruments.21

(i)Similarities

3.10The demand guarantee and the letter of credit share the same fundamental principle that the undertaking of the issuer is independent of the underlying contract between the benefi­ ciary and the account party. This means that if the beneficiary makes a demand for payment that complies with the requirement of the instrument the issuer must pay even though the account party complains about the performance or breach of the underlying contract. It is for this reason that the courts treat demand guarantees as the equivalent of irrevocable letters

19The reimbursement obligation of each participant is likely to be secured by a letter of credit or demand guarantee issued by the participant to the issuing bank.

20Under the arrangement an agent bank will normally be appointed to collect payments made by the account party and apply them to reimburse either the issuing bank or the participating banks pro rata.

21 See Charles Debattista, ‘Performance Bonds and Letters of Credit: a Cracked Mirror Image?’ (1997) JBL289.

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has performed the contract fully in accordance with its terms. These include transport docu­ ments, insurance documents, and a number of certificates certifying various matters such as the origin, quantity and quality of the goods. By contrast, the documents required under a demand guarantee are documents intended to give some indication that the seller has defaulted in his obligations under the sale contract. The type of document, as indicated above,25 may range from a statement by the buyer himself to a court judgment or arbitration award, depending on the perceived risks and the bargaining power of the parties at the time of the contract. Thus, whereas a large number of documents would normally be required under a letter ofcredit, comparatively few documents are usually required under a demand guarantee.

22e.g. MarubeniHongKongandSouth China Ltd v. Governmento fMongolia [2005] EWCA Civ 395; [2005]

1WLR 2497 at [23].

23See Chapters 5 to 9.

24See discussion in para 2.07.

25Para 3.01.

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The N ature o f D em an d Guarantees

3.14In the case of a letter ofcredit issued to support export trade the documents to be presented normally include documents of title such as bills of lading. These documents constitute security for the bank’s advances to the buyer. By contrast, since a demand guarantee secures the performance of the seller, the documents presented under it, such as a beneficiary’s statement of default, do not normally constitute security for the bank’s payment.26 This difference appears to suggest that a bank that pays under a demand guarantee is more

exposed than a bank that pays under a letter of credit in exchange for documents of title. However, this may not be of great significance in practice since a bank that agrees to issue a demand guarantee normally takes security from the instructing party in the form of a counter-guarantee or counter-indemnity in addition to a cash deposit, especially where the instructing party is not a bank.

3.15A further difference between a letter of credit transaction and a demand guarantee transac­ tion is that, in the case of a demand guarantee, a claim by the issuing bank for payment under the instructing bank’s counter-indemnity is different from a claim for reimbursement by a confirming bank under a letter ofcredit. In the case of a letter ofcredit, the issuing bank is the bank in the applicant’s country. The confirming bank, in the beneficiary’s country, makes payment to the beneficiary and forwards the documents to the issuing bank that in turn forwards them to the applicant. So, in a letter of credit, there is one set of documents passing up the chain. By contrast, in the case of a demand guarantee there are different documents to be presented under each contract in the chain.27 The beneficiary makes his demand in accordance with the terms of the demand guarantee. The issuing bank pays and makes its own demand under the terms of the instructing bank’s counter-indemnity. The instructing bank in turn makes its own demand under the terms of the account party’s counter-indemnity.

2.Functions and Types of Demand Guarantee

A.Functions

3.16A demand guarantee can perform a number of important functions. First, it is a security for the performance of the underlying contract. Secondly, unlike a true guarantee, it is an easily realizable form of security. Thirdly, it gives the beneficiary a provisional remedy. Fourthly, it can be used to secure performance under an unenforceable agreement. And, fifthly, it can be used as a method of payment, just like a letter of credit or as security for the buyer’s obliga­ tion to open a letter of credit by which the contract price is to be paid. It may be helpful to consider each of these functions briefly.

3.17A key function of a demand guarantee is to provide security to the beneficiary for the perfor­ mance by the account party ofhis obligations under the underlying transaction.28 A demand guarantee may be used to secure performance of a variety of contractual obligations.29 As already indicated, it is commonly used to secure the obligations of the seller under an

26See Potton Homes Ltd v. Coleman Contractors Ltd (1984) 28 BLR 19 at 28.

27GKN Contractors Ltdv. Lloyd’s Bank Pic (1985) 30 BLR 48 at 62.

28See RD Harbottle (Mercantile) Ltd v. NationalWeslminster Bank Ltd [1978] QB 146, 149.

29e.g. to secure the performance of a charter party by the owners: Maridive & Oil Services (SAP.) v. CAN Insurance Co (Europe) Ltd [2002 ] EWCA Civ 369; or to secure rental payments to a lessor: New OrleansBrass v. Whitney NationalBank, 818 So.2d 1057 (La. App. 4 Cir. 2002).

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lying contract is one which is unenforceable because the co-contracting party is a minor. In such a case, a suretyship guarantee to secure performance of the contract by the minor would also be unenforceable. However, a demand guarantee, which is independent of the

30See, e.g. the guarantees in Edward Owen Engineering Ltd v, Barclays Bank InternationalLtd [1978] 1 QB 159 and United Trading Corporation SA v.AlliedArab Bank Ltd [1985] 2 Lloyds Rep. 554.

31e.g. HCC InternationalInsurance Pic v. Conway [2006] All ER (D) 192 (Jul).

32e.g. IIG Capital LLC v. Van Der Merwe [2008] EWCA Civ 542.

33Siporex TradeSAv. BanqueIndosuez[l9S6\2L\oyd'sRep. 146,158,/>£T HirstJ. See also Esal(Commodities)

Ltdv. OCL [1985] 2 Lloyds Rep. 546, 549.

34See discussion in para 3.64 below.

35[1996] 2 Lloyd’s Rep. 524, 528.

36UzinterimpexJSC v. Standard Bank Pic [2008] EWCA Civ 819 at [20 \, per Moore--Bick L.J.

37The beneficiary’s liability to repay overpayments is discussed in Chapter 12.

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The N ature o f D em a n d Guarantees

underlying contract would be valid and enforceable.38 A more common example in commercial transactions is the issue of bid bonds to secure the obligation or promise of the bidder to enter into a binding contract in the period before negotiations are finalized and the contract concluded. Since the bidders promise is only a promise to enter into a contract (an agreement to agree) it is normally not enforceable but a bid bond given to secure performance of the promise is enforceable.39 The position may be different where the under­ lying contract is illegal.40

3.21Since a demand guarantee is the equivalent of cash, it may be used, like a letter of credit, as a method of payment of the contract price in international transactions.41 However, the use of demand guarantees for this purpose is not very common.42435So in some cases a demand guarantee may be used in international trade to secure the buyer’s obligation to open the letter of credit by which payment of the purchase price is to be made. In Siporex Trade SA v. Banque IndosuezN for example, the underlying contract was for the sale of two quantities of tallow. The contract was on terms that a named bank would issue a performance bond for the benefit of the seller for 10 per cent of the contract price. The actual payment of the purchase price was to be made by a confirmed irrevocable transferable credit. The letter of credit, opened on the instructions of the buyer, was not in conformity with the contract. For this reason the seller demanded payment under the performance bond. It was held that the seller was entitled to do so and was not obliged to prove actual loss.

3.22As indicated in Chapter 2, a standby letter of credit serves the same commercial purpose as a demand guarantee rather than a letter ofcredit. In this sense, a standby credit may be regarded as a form of demand guarantee. In some cases one instrument may be used even though the

contract calls for the other. In KvaernerJohn Brown Ltd v. M idland Bank PicN a requirement in the underlying contract for a ‘performance bond’ was satisfied by the provision of a standby credit’. Cresswell J. said that ‘[s]tandby credits issued by banks at the request of a seller or contractor in favour of the buyer or employer are sometimes used in lieu of firstdemand bonds in respect of major long term sales or construction contracts’. Similarly in

Oliver v. Dubai Bank Kenya Ltd45 a requirement in a share sale agreement for the provision o f‘a Guarantee . . . unconditionally guaranteeing the due payment to the Seller’ of the pur­ chase price was satisfied by the provision of a ‘standby letter of credit’ subject to UCP. However, it is not in every case that an obligation to provide a standby credit may be satisfied by the provision of a demand guarantee. There may be special circumstances, including the location of the parties, which may mean that a demand guarantee will not be suitable where a standby credit has been stipulated for.

cf. Yeoman Credit Ltd v. Latter [1961] 1 WLR 828, where, however, the instrument was an indemnity rather than a demand guarantee.

39See State Trading Corporation o fIndia v. Golodetz [1989] 2 Lloyd’s Rep. 277.

40On this point, see the discussion in Chapter 8.

41See, e.g. Sunderland Association Football Club Ltd v. Uruguay Montevideo FC [2001] 2 All ER (Comm) 828.

In Oliver v. Dubai Bank Kenya [2007] All ER (D) 135 (Sep), where payment of the purchase price under

a shaie transfer agreement was to be by an unconditional guarantee, a letter ofcredit provided by the buyer was accepted.

43[1986] 2 Lloyd’s Rep. 146.

44[1998] CLC 446.

45[2007] EWHC 2165 (Comm); [2007] All ER (D) 135 (Sep).

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46 Howe Richardson Scale Ltd v. Polimex-Cekop [1978] 1 I.loyd’s Rep. 161, advance payment of £25,000 on a contract price of£500,000.

47[2008] 2 Lloyd’s Rep. 456.

48The same applies in the shipbuilding industry. See, e.g. Gold CoastLtd v, Caja deAhorros delMediterraneo

[2003 ] 1 All ER (Comm) 142 and Rainy Sky SA v. Kookmin Bank [2010] EWCA Civ 582. 49 [2009] EWHC 2410 (Comm).

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The N ature o f D em and Guarantees

does not cover the account party’s liability to repay the advance payment in certain circum­ stances. In the recent case оf Rainy Sky SA v. Kookmin Bank50 six materially identical advance payment bonds were issued by a bank to secure certain obligations assumed by a shipbuild­ ing company (the builder) under six identical shipbuilding contracts with the beneficiary (the buyer). Each shipbuilding contract entitled the buyer to require the builder to refund the full amount of all advance payments in the event of the builder’s insolvency or the like. It is helpful to refer to one of the bonds. Paragraph 1 referred to the underlying contract. Paragraph 2 stated that pursuant to the terms of the underlying contract the beneficiary was entitled to repayment of pre-delivery instalments of the contract price upon your rejection of the Vessel in accordance with the terms of the Contract, your termination, cancellation or rescission of the Contract or a Total Loss of the Vessel’. Paragraph 2 of the bond reproduced in terms specific paragraphs of the shipbuilding contract. Paragraph 3 of the bond then stated that ‘[i]n consideration of your agreement to make the pre-delivery instalments under the Contract. . . we . . . undertake to pay to you . . . all such sums due to you under the Contract’ up to a specified maximum amount. Upon the builders insolvency the buyer demanded payment under the bond. The question was whether the builders obligation under the shipbuilding contract to refund advance payments in the event of the builders insolvency was covered by the terms of the bonds. The judge held that it was. The Court of Appeal, by a majority, held that it was not.

3.28Patten L.J., with whose judgment Thorpe L.J. agreed, with considerable trepidation’,501 said that the question was whether the words ‘all such sums due to you under the Contract’ in paragraph 3 refer back to pre-delivery instalments becoming payable in any circumstances under the contract or to their becoming repayable under the provisions referred to in paragraph 2. He noted that the judge adopted the first of these alternatives by construing such sums as a reference to the pre-delivery instalments mentioned in the first line o f para­ graph 3 so as to read the words in dispute as meaning ‘all (pre-delivery instalments) due to you under the Contract’. He said that the difficulty with this construction is that it robs paragraph 2 of any purpose or effect. He explained that

[i]f the purpose o f the bond was to provide a guarantee for the repayment o f the pre-delivery instalments regardless o f the circumstances in which they came to be repayable, paragraph 2 could have been omitted in its entirety. As it is, the obvious purpose o f this paragraph seems to me to be to give the addressee of the bond a clear statement o f the Builders obligations under the contract which are to be covered by the guarantee.52

He went on to say53 that although cover in the event of insolvency was, objectively speaking, desirable that is not enough in itself to justify a departure from what would otherwise be the natural and obvious construction of the bond. This case is a reminder that a beneficiary should not accept the terms of a demand guarantee unless they have been subjected to anxious scrutiny by his advisers.

(Hi) Bid or tenderguarantee

3.29The award of large construction or supply contracts is usually made following a tender procedure. When bids or tenders are invited for such projects the bidders are usually required

50[2010] EWCA Civ 582.

51Ibid., at [53].

52Ibid., at [49].

53Ibid., at [52].

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I. Introduction

to provide a bid or tender guarantee. The guarantee is normally for a percentage of the value of the project (usually up to five percent). The tender guarantee is usually payable on demand. The purpose of the guarantee is to ensure that anyone who submits a bid will not withdraw after the tender closing date and that the bidder will accept and sign the contract if awarded to him, be able to provide the performance guarantee required under the contract and be able to undertake the work. It is usually envisaged that the beneficiary will call on the tender guarantee if, for example, the bidder is awarded the contract but he fails to sign it or is unable to provide the performance guarantee required.

(iv) Retention guarantee

3. Uniform Rules

54 ICC No. 325.

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The N ature o f D em a n d Guarantees

into their demand guarantee if they wished. But very few adopted the URCG into their guarantees. The reason for this is probably because, to prevent abusive demands, the URCG provided that if a performance guarantee required only a statement of claim by the beneficiary the beneficiary must present either a court decision or an arbitral award justifying the claim, or the approval of the account party in writing of the claim and the amount to be paid. This requirement, though affording protection to the account party, failed to take sufficient account of the interests of the beneficiary who required a guarantee that was the equivalent of cash.

3.34Following the failure of the URCG, the ICC published the Uniform Rules for Demand Guarantees (URDG 458) in 1992.55 The URDG 458 applied to both the demand guarantee and the counter-guarantee. It abandoned the requirement of a court judgment or arbitral award. All that was required, in addition to any documents required by the terms of the guarantee itself, was a written statement by the beneficiary stating that the account party was in breach of the underlying contract and the respect in which the account party was in breach.56 The URDG struck a more reasonable balance between protection of the account party and allowing the beneficiary to have a security that is promptly and readily realizable. The account party’s interest was protected in that the beneficiary had to state that the account party was in breach and the respects in which he was in breach. A beneficiary could be guilty of fraud if he made such a statement with knowledge that it was false or without an honest belief that it was true.57 In such a case the account party could obtain an injunction restrain­ ing the beneficiary from receiving payment under the guarantee or freezing the proceeds of the guarantee pending the account party’s claim in relation to the fraud.58 At the same time, the beneficiary was satisfied since the issuer’s undertaking to pay was independent of the underlying contract and he did not have to wait for disputes under the underlying contract to be resolved before he could receive payment under the guarantee.

3.35The URDG 458 proved far more successful than the URCG. It was used by banks and busi­ nesses in various parts of the world. It has been adopted by the World Bank in its guarantee forms and has been endorsed by a number of leading industry associations. However, it has not been widely used in the UK.

3.36In 2007 the ICC launched a revision of the URDG 458. The revision was a joint project of the Commission on Banking Technique and Practice and the Commission on Commercial Law and Practice. The revised version, URDG 758, was adopted by the ICC Executive Board on 3 December 2009, published in February 2010 and came into effect on 1 July 2010. The publication includes, as appendices to the rules, suggested forms of demand guarantee and counter-guarantee under URDG 758 together with certain optional clauses. These appendices have not been approved by the commissions. The new rules are intended to be clearer, more precise, more comprehensive, more balanced, and more innovative.59 URDG 758 has been aligned in a number of respects with UCP 600. For example, it adopts the drafting style of UCP 600 by including provisions on definitions and interpretations.60

55ICC No. 458. See also the guide to the URDG 458 by Professor Roy Goode, ICC No. 510.

56Art. 20.

57See discussion of the fraud exception in Chapter 5.

58See discussion of injunctions in Chapter 10.

59See Introduction, 8-10.

60Arts 2 and 3.

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61Art. 20.a.

62See Art. 6.

63See discussions in Chapters 5, 7, and 8.

64The countries that have ratified the Convention are Belarus, El Salvador, and Panama and the countries

that have acceded to it are Ecuador, Gabon, Kuwait, Liberia, and Tunisia.

65See, Explanatory Note by UNCITRAL Secretariat, para 4.

66Art. 3.

67See Explanatory note by UNCITRAL Secretariat, para 45.

68Art. 19(1).

69Art. 1.

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