Article

US standbys and UK guarantees

by Roger Fayers

I have written in previous issues of DCInsight on the difficulties English courts have in determining the true nature of the obligations under English instruments of guarantee1 (see "Suretyship: guarantee or indemnity", April 2011 DCInsight, page 12 and "Bonds, contracts and the perils of poor draftsmanship", January 2012 DCInsight, page 21). Reading Jim Barnes' illuminating article "ISP98 standby forms and achieving 'independence'" in this year's January issue has driven me to reflect further on this topic and to confront what he has revealed to be uncomfortable questions: Why is determining the obligation under a standby so straightforward while under a guarantee it is so complex? What has prompted Longmore LJ in a recent court of appeal judgement in a guarantee case to exclaim "something surely has gone wrong"? And what has prompted Professor Jim Byrne, a distinguished US authority on standby law, to comment - bluntly but truly - that in coming to a decision in many of the English cases "the courts might as well flip a coin"2?

I can offer no rational answer to these criticisms. The best I can do is to try to give some explanation as to how such a situation has arisen and how it might be correcting itself.

An English judge once described the commercial client's ideal. He should be able to take his document to his lawyer and say: "Tell me what the law says this means and then I know what my agreement is and what I am bound to do."3 Whilst this was said in the context of explaining English principles of construction, it is a convenient starting point for a discussion on the difference that exists between the US standby and the English guarantee.

Briefly put, the response to such a question asked by the user of a standby from his lawyer in Chicago or New York would be clear and definite. But only an equivocal answer would likely be given by his lawyer in London to the user of a guarantee. Why so? There are, I think, two reasons for this, both of which have their origins in the differing systems that exist in the two countries.

US practice

In the US, the standby sits in what seems to be a near perfect melding of law and practice. The law exists in the form of a statutory code, in chapter 5 of the Uniform Commercial Code. Given this, bankers, regulators, businessmen and practitioners have agreed upon a form of document that will comply with the provisions of this code. As the article shows, there are eight model forms, or "off-the-peg" documents, the parties can choose from to fit their situation. There has been a concerted effort, in Jim Barnes' words, "to develop workable and appropriate texts for standbys and to improve the quality... of what customers ask banks to issue". If the parties depart from those forms, as they are free to do, then the matter may fall to be determined in accordance with the US common law.

English practice

The position in England is quite different. There is no statutory regime of guarantee law; it is essentially judge-made. Apart from recent moves in ICC towards the URDG, which parties can adopt, there exists no standardized form of guarantee. Any form of instrument the parties devise will be governed by common law principles. And herein lies the problem. The English common law principles of guarantee law have grown by the formation of precedents. Over the years, parties and their lawyers have devised clauses to vary these principles. As more and more cases on variously worded instruments have been decided, the law has become established.

This in turn has had two effects. The first is that these precedents, when finally established, have become rigid, and the second is that the number of these precedents has obliged judges to consider each of them in order to determine how near or how far the instrument before them differs from the instrument that was construed in each of the earlier cases. It is no surprise then that in the Wuhan case4, to which James Barnes refers, the judge at first instance found it necessary to consider no fewer than 20 authorities and deliver a judgment of 93 paragraphs.

In summary, whilst the system in the US has promoted simplicity and certainty, that in England has tended to lead in the opposite direction. It has, to use Longmore LJ's descriptive phrase, led to documentation resembling a "palimpsest". (I confess to readers that I had to scurry to the dictionary for its meaning, which is worth quoting: "A manuscript that has been written upon several times, often with remnants of earlier, imperfectly erased writing still visible".) As the Lord Justice added, "the commercial community deserves better." So, how are matters being corrected?

Recent changes

Jim Barnes refers to two recent decisions. Coincidentally, these decisions bring out two distinct aspects of the matter which it is easy to conflate. The Wuhan case, which involved a document confusingly containing clauses pointing in different directions, was concerned with the question of its independence or not from its underlying transaction; was it a "traditional" guarantee (and so in the nature a secondary obligation) or an "on demand" bond (and so in the nature of a primary obligation)? The judge at first instance had found the instrument was a traditional guarantee, but the court of appeal reversed this decision finding it to be an "on demand" bond.

Although he is too polite to say so, I think Jim Barnes is not that impressed with the shift in approach the appeal court made. But it has at least moved some way. Whilst at the end of the day everything must depend on the words actually used by the parties, the court said that "there is nevertheless a presumption that, if certain elements are present in the document, the document will be construed in one way or the other." These "certain elements" it identified as those set out in Paget's Law of Banking (11th ed.) under the heading "Contract of suretyship v demand guarantee".

Accordingly, if the instrument "(i) relates to an underlying transaction between parties in different jurisdictions, (ii) is issued by a bank, (iii) contains an undertaking to pay "on demand" (with or without the words "first" and/or "written") and (iv) does not contain clauses excluding or limiting the defences available to a guarantor, it will almost always be construed as a demand guarantee." The words "will almost always be" amount to a presumption.

But businessmen will always be businessmen, and documents containing conflicting provisions will likely still feature. This is the second aspect I mentioned: how will the courts approach the construction of such documents? Here both the Wuhan case and that of the Rainy Sky5 offer guidance.

What has emerged can, I think, be summarized: (a) courts should seek to achieve a consistency of approach so that all the parties know clearly where they stand; (b) in these types of instrument, courts should not treat the wording with the same reverence with which they would construe a statute, but rather should be guided by the general tenor of previous authority enunciated by past judges of great distinction; (c) if a particular provision is capable of two meanings, neither of which flouts common sense, then it is more appropriate to adopt the more, rather than the less, commercial construction; (d) if an experienced judge of the Commercial Court has reached the conclusion that a particular construction produces a surprising and uncommercial result, an appeal court should take account of that.

Independence

One final comment on Jim Barnes' article. The question of "independence", that is, the independence of the instrument from the underlying transaction, is all-important in the US. Unless it is independent, the instrument will not fall within chapter 5 of the UCC, and that is precisely why the model forms are drafted in the careful way they are and why they are adopted by the parties. No such helpful forms being available in England, instruments are what the parties make for themselves. Hence, ill-drafted documents, such as that in Rainy Sky, will need to be made sense of by the courts.

The question in this case was not one of independence; indeed, it was accepted that the bank had to pay something on demand; the issue was what precisely that something was. The resort to "extrinsic evidence" to which Jim Barnes refers, was not for the purpose of ascertaining (in English terms) the "demand" nature or not of the guarantee. Rather it was as a pointer to ascertaining the better business common sense of the one construction as opposed to the other.

Clearly, the more surprising and uncommercial the result, the more unlikely that the parties can have intended it. Accordingly, evidence (if indeed it is proper to call it evidence) that it would defy common commercial sense for the buyers to have agreed not to be able to make a call on the happening of the one event (the insolvency of the builder), where it would be most likely that they would need a first-class security, was an extremely relevant consideration.

What's to be done?

"Something must be done," said the court. But what? Legislation, even were it possible in a crowded legislative program, is not the answer. The law is there; what is required is the drafting of a standard simple instrument incorporating only those provisions needed for an undertaking to pay against the presentation of specified documents. A joint working party of the Confederation of British Industry and the British Bankers Association could readily produce such a form if only they would put their minds to it. In such a task, they should not be backward in looking to the ISP98 forms for guidance.

No US judge, Jim Barnes says, has had to agonize over whether a bank's undertaking is independent or not. However, unless something is done in England I fear this is just what English judges will continue to be faced with and English guarantees "will continue to confuse users and courts alike". n

Roger Fayers' email is r.fayers@ntlworld.com

1Using this word by itself, of course, begs the question; is the guarantee a "traditional" guarantee or is it an "on demand" guarantee?

2"Trends in Letter of Credit Practice", September 2012 Documentary Credit World, page 18.

3Lord Devlin, Samples of Lawmaking, page 56.

4Wuhan Guoyu Logistics Group v Emporiki Bank of Greece SA [2012] EWCA 1629.

5 Rainy Sky SA v Kookmin Bank [2011] UKSC 50

Cleaning counter-undertakings: another view

by Georges Affaki

I had the privilege of reading Jim Barnes' paper Cleaning Counter- Undertakings before its publication in the summer 2013 issue of DCInsight. In his article, Mr Barnes reviews the ICC rules and accompanying model forms concerning counter-undertakings, whether counter-guarantees or counter-standbys. He expresses his concern that some of the wording may lead to a liability of the issuer of the counter-undertaking that may exceed the terms of the commitment. He then proceeds to compare the ISP98 model forms with those of the URDG, expresses his opinion on the pr os and cons of each, and concludes by recommending a better drafting.

I can obviously but concur with Mr Barnes. Commercial contracts are enforced in accordance with their terms. The more precise the terms, the more certain their implementation. However, before reaching my conclusion, I would like to set matters in context.

If parties to a demand guarantee can avoid adding a counter-guarantee layer at all, I have no doubt that they will choose a simple and efficient directly issued guarantee structure. Counter-guarantees are more costly because they add the fees of the local guarantor. They increase legal uncertainty to the local guarantor because, unless otherwise agreed, the local guarantee is governed by the local guarantor's law while the counter-guarantee is governed by the counter-guarantor's. And, rightly or wrongly, counter-guarantees tend to raise a suspicion of collusion between the beneficiary and the local guarantor when a demand for payment comes in the context of a dispute.

Fact of life

That said, counter-guarantees are a fact of life. They are issued whenever the beneficiary is unwilling to accept the foreign guarantor's undertaking and prefers that of a local bank acceptable to it. In that case, the applicant's bank will instruct its correspondent in the beneficiary's country to issue its own guarantee in favour of the beneficiary. In doing so, the counter-guarantor will commit to hold the guarantor harmless and fully indemnify it for any payment it may have to make under its guarantee. Hence, the term "under our responsibility" that counter-guarantees usually include in their opening paragraph.

As an astute lawyer, Mr Barnes picks up that point. What does "under our responsibility" mean, he asks? Is it a blank check that the counter-guarantor is giving the guarantor that could lead to payment even when the applicant's instructions are not strictly followed?

Where the URDG 758 apply, the answer is obviously no. The model counter-guarantee form printed at page 38 of the English version of the URDG does not stop at the "under our responsibility" sentence. After quoting the terms of the guarantee that the guarantor is instructed to issue, the counter-guarantee continues to indicate the conditions for any demand for payment by the guarantor and closes by incorporating the URDG in the counter-guarantee itself. The result is that the guarantor is only entitled to payment when it presents a "complying demand" (as defined in URDG article 2) that meets the specific terms of the counter-guarantee and the URDG including, in particular, articles 14 and 15.

Those are hardly the terms of a blank check. In any event, article 12 and, if necessary, international standard demand guarantee practice, which is part of the URDG, would bar any absurd claim by the guarantor purporting to draw under the counter-guarantee after its expiry, as suggested by Mr Barnes. The same would occur under ISP98.

Feedback

So far, ICC has not had feedback from guarantee users as to the increased risk that including "under our responsibility" in the counter-guarantee may add. To the contrary, banks insisted in 2009 on adding those terms into the model counter-guarantee form even though, as Mr Barnes correctly points out, they are unnecessary and find no basis in the URDG.

Going forward, the ICC Task Force on Guarantees is continuously monitoring the use of URDG and listing areas for improvement in the next revision. Jim Barnes' remarks deserve to go into that list, as does his suggestion that no guarantor acting upon the instructions of a counter-guarantor should misrepresent to the beneficiary that it is acting on behalf of the applicant.

The safest and simplest solution is obviously to use the model guarantee and counter-guarantee forms appended to the URDG 758 publication.

Dr Georges Affaki, Global Coordinator for Corporate Banking, CIB Legal, at BNP Paribas, was Vice-Chairman of the ICC Banking Commission and Honorary Chairman of the ICC Task Force on Guarantees. He is co-author (with Sir Roy Goode) of Guide to ICC Uniform Rules for Demand Guarantees, ICC Publ. 702. His email is georges. affaki@bnpparibas.com