Documentary Credit World

Prior History: CAMA (Luoyang) Aviation Protective Equipment Co. v. UBAF (Hong Kong) Limited [2018] (Supreme Court Civil Retrial No. 1216) [P.R. China], abstracted in May 2021 DCW at 12. In this previous case, Instructing Party and Transferee of Subcontract Agreement sued Beneficiary, Local Guarantor, Supplier, and Sub-Supplier and requested court to prohibit Counter Guarantor from honoring Local Guarantor ’s claim due to independent guarantee fraud. The trial court dismissed the action. On appeal, the Supreme People’s Court of P.R. China reversed the decision of trial court and ordered Counter Guarantor to terminate payment to Local Guarantor under the counter advance payment guarantee, but make payment under the counter performance guarantee, and dismissed all other claims by Appellants.

Topics: Independent Bank Guarantee; Injunction; URDG758; Fraud; Advance Payment Guarantee; Counter Advance Payment Guarantee; Good Faith; Double Fraud; Discrepancy; Jurisdiction; Evidence

Type of Lawsuit: Instructing Party and Transferee of Subcontract Agreement sued Beneficiary, Local Guarantor, Supplier and Sub-Supplier and requested court to prohibit Counter Guarantor from honoring Local Guarantor ’s claim due to independent guarantee fraud. On appeal, the Supreme People’s Court of P.R. China reversed the trial court decision and ordered Counter Guarantor to terminate payment to Local Guarantor under the counter advance payment guarantee for having committed guarantee fraud and not acting in “good faith”. Local Guarantor petitioned for rehearing from the Supreme People’s Court of P.R. China.

Parties:                

Rehearing Applicant/Defendant/Appellee/Local Guarantor– UBAF (Hong Kong) Limited, Hong Kong

Rehearing Respondent/Plaintiff/Appellant/Instructing  Party– CAMA (Luoyang) Aviation Protective Equipment Co., P.R. China

Rehearing Respondent/Plaintiff/Appellant/Transferee of Subcontract Agreement– Luoyang Aviation Engineering Construction Co., P.R. China

Rehearing Respondent/Appellee/Defendant/Beneficiary/Contractor– Korea Hyundai Engineering and Construction Co., Korea

Rehearing Respondent/Appellee/Defendant/Applicant/Supplier– Qatar Hyojong Industrial Co., Qatar

Rehearing Respondent/Appellee/Defendant/Applicant/Sub-Supplier– Luoyang Aviation Construction (Qatar) Co., P.R. China

Rehearing Respondent₁/Counter  Guarantor– Bank of China, Henan Branch, P.R. China

Underlying Transaction: Supply and assembly services of steel pipe piles.

Bank Guarantees: Counter performance guarantee and counter advance payment guarantee, each for USD 5,980,833.40. Performance guarantee and advance payment guarantee, each for USD 5,980,833.40. All four instruments were issued subject to URDG758.

Decision: The Supreme People’s Court of P.R. China dismissed the claims by Rehearing Applicant/Local  Guarantor, citing Article 200 (i), (ii) and (vi) and 204(i) of The Civil Procedure Law of the People’s Republic of China and Article 395 (ii) of The Judicial Interpretation of the Application of the Supreme People’s Court.

Rationale: A demand cannot be deemed as valid if made to Counter Guarantor ’s Head Office instead of Counter Guarantor (Henan Branch) who is an independent civil entity in accordance with PRC law.

When Beneficiary knowingly conceals that it does not have the right to request payment and makes presentation to induce issuer of the guarantee to make payment erroneously, such abuse is independent guarantee fraud.

By presenting a fraudulent demand to Counter Guarantor on its own without taking Beneficiary’s fraud as a prerequisite (double fraud), Guarantor has committed independent guarantee fraud.

Legal Analysis of  Supreme People’s Court:

1. Factual Evidence: Local Guarantor claimed that they had presented a complying demand to Counter Guarantor on 23 December 2011. Unlike the previous two demands made to Counter Guarantor, this third demand was presented to Counter Guarantor ’s Head Office instead of Counter Guarantor ’s Henan Branch. The Supreme People’s Court analyzed:

“An independent guarantee is a commitment issued by a bank or non-bank financial institution to the beneficiary in writing, agreeing to pay a specific amount or make payment within the maximum amount of the guarantee when the beneficiary requests payment and presents documents that meet the requirements of the guarantee. The basic operating principle is a payment first system wherein the beneficiary gets payment from the issuer based on stipulated documents, after which the beneficiary and debtor separately settle the underlying debtor- creditor relationship. An independent guarantee has the documentary nature whereby the issuer is obliged to make payment against complying documents, which is the legal characteristic of complying presentation.”

The court further stated that such matter had clearly been established in the original judgment, and Counter Guarantor had not acknowledged that the third demand by Guarantor to Counter Guarantor ’s Head Office constituted a valid presentation during the Supreme People’s Court’s hearing. Therefore, the court decided that Local Guarantor ’s assertion could not be accepted as the facts in the original judgment were indisputable.

2. Applicable Law: Local Guarantor argued that the original judgment mistakenly applied three different laws: (1) Article 12(5)₂  and Article 20₃  of the “PRC Independent Guarantee Provisions “; (2) Article 14(3)₄  of the “PRC Independent Guarantee Provisions”; and (3) Article 68₅  of the “Opinions of the Supreme People’s Court on Several Issues Concerning Implementation (Trial)”.

(a) Article 12 (5) and Article 20 of the “PRC Independent Guarantee Provisions”.
Local Guarantor claimed that abuse of its right to demand payment requires subjective intent of
deception which it maintained was absent in this case. Instead, it sought repayment of the amount it
had paid in good faith under the advance payment guarantee.

Local Guarantor further argued that in a counter guarantee transaction, fraud could only be conducted through collusion between beneficiary and guarantor. Therefore, Local Guarantor considered that, in the absence of any evidence of fraudulent collusion and failing to meet the standard of “beyond reasonable doubt” required by Article 20 of “PRC Independent Guarantee Provisions”, there was erroneous application of laws in the original judgment which determined that Local Guarantor had committed fraud.

Referencing Article 12 (5), Article 20 and Article 14 (3) of the “PRC Independent Guarantee Provisions“, the Supreme People’s Court rejected Local Guarantor ’s arguments:

“Based on the principles of good faith and non-abuse of rights, the judicial interpretation prudently determines the only exception to the principle of independence for beneficiary’s fraud in Article 12, and provides the rules of the temporary stop payment order in Article 14 and final stop payment judgment in Article 20, requiring that when entering a judgment suspending the issuer ’s payment and terminating the issuer ’s payment obligations, the fraudulent actions the court relies upon must meet the standards of high possibility and beyond reasonable doubt respectively. Article 12(5) related to this case is a general cover-all clause for obvious abuse of payment rights, that is, the beneficiary knowingly conceals the fact that they do not have the right to request payment, but still issues and presents documents, such as payment demand and default statement, that appear to be complied with the terms and conditions of the guarantee, to induce the issuer to make payments erroneously. Therefore, such abuse of the right to request payment is considered guarantee fraud.”

The Supreme People’s Court further emphasized the facts revealed in the original hearing regarding the demands by Local Guarantor under the counter advance payment guarantee. That is, on 15 December 2011, Local Guarantor demanded from Counter Guarantor stating that they had received a complying demand under the advance payment guarantee. On the contrary, the court found this a false statement at that time since Local Guarantor sent a refusal advice on 14 December (the day before) to the presenting bank listing the discrepancies and Local Guarantor did not actually receive Beneficiary’s complying demand until 19 December 2011.

The Supreme People’s Court therefore decided that Local Guarantor ’s action constituted guarantee fraud. It concluded:

“The court considers that the nature of an independent guarantee is a payment commitment based on the condition of complying presentation. This attribute determines that the issuer ’s payment obligation is conditional, provided that the beneficiary requests payment and presents documents that meet the requirements of the guarantee, that is, complying presentation. The payment obligation of the issuer only arises when the conditions for presentation are met, and therefore, documents are the only basis for determining whether the issuer can make payment.”

The Supreme People’s Court decided that Local Guarantor ’s action constituted independent guarantee fraud and the original hearing had factual and legal basis for its decision:

“In this case, without receiving a complying demand from Beneficiary, on the one hand, [Local] Guarantor refused to pay the ‘Advance Payment Guarantee’ to Beneficiary due to discrepancies and, on the other hand, concealed facts, violated the integrity of commercial banks, and falsely presented [its] demand that appeared to comply with the terms and conditions of the Counter Advance Payment Guarantee, such action is in line with Article 12 (5) of the ‘PRC Independent Guarantee Provisions’, which states that ‘The Beneficiary … knowingly abuses its right to demand payment when it has no such right.’”

(b) Article 14 (3) of the “PRC Independent Guarantee Provisions”.

Local Guarantor argued that “Beneficiary’s fraudulent action must be conducted first before a guarantor bank can commit fraud. In the absence of evidence of fraudulent collusion, the payment by [Local Guarantor] to Beneficiary under the Advance Payment Guarantee in accordance with the decision of Hong Kong SAR High Court (No. HCA 175/2012)  constituted payment in good faith under Article 14 (3) of ‘PRC Independent Guarantee Provisions’”. Therefore, Local Guarantor argued that it was incorrect for the original judgment to deny its right to get payment under the Counter Advance Payment Guarantee.

In the original judgment, the court held that Article 14 (3) of the “PRC Independent Guarantee Provisions” referred to the situation where there existed two guarantees, namely a guarantee and a counter guarantee in the case of an indirect guarantee transaction. The court considered that even if the beneficiary of the guarantee conducted a fraudulent action, as long as the issuer of the guarantee did not participate in the fraud and was unaware of the fraudulent facts and made payment in good faith, the issuer of the guarantee should have the right to demand payment from the Counter Guarantor under the Counter Guarantee, and the People’s Court shall not stop payment on the grounds that the local beneficiary committed fraud. Therefore, according to the court, “Article 14 (3) refers to a payment made by the issuer of the guarantee without knowledge of the beneficiary’s fraudulent action. If the issuer of the guarantee commits fraud before making payment or has knowledge of the fraud and still makes payment, it does not constitute a payment in good faith. ” The court concluded that the situation in this case was that Local Guarantor itself had conducted fraudulent action and therefore could not demand ‘payment in good faith’.

The Supreme People’s Court stated that because the issuer of the Local Guarantee under the counter guarantee transaction also enjoyed the right of a “beneficiary”, it had the right to demand payment from the Counter Guarantor. The court considered it a recovery right which must meet two requirements: “The beneficiary has the right to demand from the guarantor under an independent guarantee, and the guarantor has the right to recover payment from the counter guarantor.”

The Supreme People’s Court further concluded:

“Correspondingly, there should also be two scenarios of fraud in counter guarantee transactions: The first scenario is where the guarantor pays the beneficiary when knowingly being aware of the beneficiary’s fraud, and then demands payment from the counter guarantor under the counter guarantee. Such scenario is called ‘double fraud’; the second scenario is where the guarantor independently makes fraudulent demand from the counter guarantor in their own role as the ‘beneficiary’ of the counter guarantee, without taking beneficiary’s fraud as a prerequisite. This situation should be governed by the general provisions of independent guarantee fraud, and is not subject to the requirement of ‘double fraud’”.

The Supreme People’s Court acknowledged that fraud in the counter guarantee was more common in practice in the first scenario, but the court considered that Local Guarantor ’s demand in this case belonged to the second scenario. Consequently, the Supreme People’s Court did not consider the understanding and application of the relevant provisions of “PRC Independent Guarantee Provisions” in the original judgment improper as Local Guarantor itself committed fraud and there was no need to take Beneficiary’s fraud as a prerequisite.

The court also denied Local Guarantor ’s argument that there was issue of “similar cases with different judgments” by referring to the court’s other decisions for the reason that those cases cited by Local Guarantor are different from the scenario in this case.

(c)  Article 68 of the “Opinions of the Supreme People’s Court on Several Issues Concerning Implementation (Trial)”.

Local Guarantor stated that according to the previous views of the Supreme People’s Court and the opinions of several authoritative experts in Chinese civil law academia, independent guarantees should also apply the standard in Article 68 of the “Opinions of the Supreme People’s Court on Several Issues Concerning Implementation (Trial)” in determining fraud. Local Guarantor argued that it was unable to determine under any circumstances that it had subjective malice or intent to deceive Counter Guarantor or others when demanding payment on 15 December 2011, nor was there any false intention expressed by Counter Guarantor due to “fraudulent action”. Local Guarantor submitted expert opinions to support its position that the original judgment should apply Article 68.

The Supreme People’s Court did not support such assertion for lacking legal basis and being inconsistent with legal principles. The court considered the “PRC Independent Guarantee Provisions” (which came into effect 1 December 2016) to be a judicial interpretation specifically formulated for independent guarantee issues. The Supreme People’s Court further concluded: “According to the principle that special law is superior to general law, independent guarantee fraud is different from the concept of ‘fraud’ under traditional civil law. The ‘PRC Independent Guarantee Provisions’ has provided special provisions for the determination of independent guarantee fraud, which should be applied in priority over other judicial interpretations. ”

3. New Evidence for Rehearing:  Local Guarantor submitted the following new evidence for the rehearing:

1) Local Guarantor ’s SWIFT demand made to Counter Guarantor ’s Head Office on 23 December
2011;

2) The hearing record of final civil judgment No. 880 of the Supreme People’s Court on 3
September 2019 proving that Counter Guarantor was not entitled to refuse the third demand
(which was not recognized in the first trial);

3) The email message sent by lawyers from Stephenson Harwood Hong Kong Law Firm to Local Guarantor on 15 December 2011 regarding re-presentation of the demand to Counter Guarantor;

4) Four legal experts’ opinions, testifying that Local Guarantor ’s demand on 15 December 2011 did not constitute a fraudulent demand;

5) The guiding case of the civil retrial judgment No. 134₆  of the Supreme People’s Court [2017] indicating that “double fraud” examination standards should apply to counter guarantee fraudulent demand determination.

The Supreme People’s Court did not consider the evidence submitted by Local Guarantor sufficient for rehearing because the alleged “new” evidence did not meet the following two requirements to initiate a rehearing:

Firstly, the evidence must comply with the general provisions of the law for civil evidence, which can prove the facts of the case with authenticity, relevance, and legality. However, the court did not consider that the alleged “new” evidence could prove the facts of the case and was not civil evidence because the opinions were the legal opinions of the experts, the Civil Judgment No. 134 of the Supreme Court of Justice (2017) was a comparative case of legal application, and the hearing record final civil judgment No. 880 on 3 September 2019 were the litigation materials formed in this case.

Secondly, the rehearing based on new evidence should be sufficient to overturn the basic facts determined by the original judgment. The court found that the content recorded in a message sent by Local Guarantor on 23 December 2011 had been determined in the original judgment, and the content of the email message sent by lawyers from Stephenson Harwood Hong Kong Law Firm to Guarantor on 15 December 2011 regarding re-presentation of the demand to Counter Guarantor could not overturn the basic facts of the original judgment regarding Guarantor ’s fraudulent demand.

Comments by Jun  XU:

1. Double Fraud and Good Faith: The Supreme People’s Court’s decisions regarding “double fraud” by both guarantor and beneficiary and “independent fraud” by guarantor are reasonable and consistent with standard international banking practice in the guarantee business.

As noted in the previous case summary, this case is thought to be the first case heard by the Supreme People’s Court based on the PRC Independent Guarantee Provisions deciding that a guarantor committed counter guarantee fraud and did not make payment in good faith. However, the decision of the case actually reflects the long-standing positions of the Supreme People’s Court in determining whether or not banks have acted in good faith in trade finance transactions. That is, banks’ misconduct will be a critical factor for determining fraud as regards independent undertakings. For example, in a past LC case, the court concluded that a negotiating bank’s conduct was not in good faith because “it should have had a constructive knowledge of [the] fraudulent activity as a professional bank and because it made discount payments under the letters of credit without carefully reviewing the documents submitted by the foreign suppliers, according to its Silent Confirmation Agreement signed with each foreign supplier.”₇

2. Branches in the Same Country: In this case, Local Guarantor presented demands to Counter Guarantor twice (on 9 December 2011 and 15 December 2011) and was refused payment due to discrepancies and court injunction order respectively. On 23 December 2011, Local Guarantor demanded directly from Counter Guarantor ’s Head Office via SWIFT, stating that Counter Guarantor (Henan Branch) refused to honor its complying presentation due to court’s injunction order.

Counter Guarantor and its Head Office are both located in China. It is obvious that, by making presentation to Counter Guarantor ’s Head Office, Local Guarantor considered that Counter Guarantor and its Head Office were the same bank as they were in the same country.

However, URDG 758 Article 2 states that: “Counter-guarantor means the party issuing a counter- guarantee …” and “Guarantor means the party issuing a guarantee …”.

URDG 758 Article 14(a) stipulates: “A presentation shall be made to the guarantor: i. at the place of issue, or such other place as is specified in the guarantee … ”.

URDG 758 Article 3(b) provides the interpretation: “Except where the context otherwise requires, a guarantee includes a counter-guarantee and any amendment to either, a guarantor includes a counter-guarantor … ”.

In this case, the issuer of the counter guarantee is a bank branch instead of its Head Office, and as the counter guarantee requires the demand to be made to Counter Guarantor and does not indicate that the demand may also be made to its Head Office, it is an invalid presentation by Local Guarantor in claiming from Counter Guarantor ’s Head Office.

URDG758 also addresses the issues of governing law and jurisdiction regarding counter
guarantees and counter guarantors. URDG758 Article 34(b) states: “Unless otherwise provided in the
counter-guarantee, its governing law shall be that of the location of the counter-guarantor ’s branch
or office that issued the counter-guarantee.”

URDG758 Article 35(b) states: “Unless otherwise provided in the counter-guarantee, any dispute between the counter-guarantor and the guarantor relating to the counter-guarantee shall be settled exclusively by the competent court of the country of the location of the counter-guarantor ’s branch or office that issued the counter-guarantee.”

Therefore, it is justified for the Supreme People’s Court in its decision to determine that:

“Although [Counter Guarantor] Head Office and its branches are the same legal entity, each branch is an independent civil entity in accordance with the law and can engage in civil activities in its own name. The issuer of the counter advance payment guarantee in this case is [Counter Guarantor, Henan Branch], and [Counter Guarantor] Head Office is not a party to the guarantee. The demand was sent by [Local Guarantor] to [Counter Guarantor] Head Office on December 23, 2011, the effect of which cannot naturally be equivalent to be made to [Counter Guarantor], and therefore does not constitute a valid demand.”

URDG758 does not address the matter of a guarantor ’s branch or head office in the same country; instead, it only interprets branches of a guarantor in different countries, as provided in URDG758 Article 3(a) “Branches of a guarantor in different countries are considered to be separate entities.” Unlike ISP98, URDG758 adopts the same approach regarding branches in different countries as in UCP600.₈

ISP98 Rule 2.02 (Obligation of Different Branches, Agencies, or Other Offices) states: “For the purposes of these Rules, an issuer ’s branch, agency, or other office acting or undertaking to act under a standby in a capacity other than as issuer is obligated in that capacity only and shall be treated as a different person.” ISP98 does not distinguish the concept of “different countries”, which means that even if in the same country, different branches of a standby issuer will be considered different persons. Furthermore, as explained in The Official Commentary on ISP98₉  and ISP98 & UCP500 Compared₁₀  regarding ISP98 Rule 2.02, based upon the “capacity-oriented” approach, such rule provides clearer guidance in practice and may reduce disputes in situations similar to this case.

* Jun Xu is Director Senior Manager at Bank of China, Jiangsu Branch, China. She is Vice Chair of ICC Banking Commission Steering Committee, member of ICC Banking Commission Guarantee Task Force, Co-leader of ICC SCF Rules Drafting Team, member of Payment and Infrastructure Committee Cross-border Payment Interoperability and Extension Taskforce of BIS, Chair of ICC China Banking Committee Translation Expert Group, member of GSCFF and ICC China Banking Committee Forfaiting and Factoring Expert Group, ICC DOCDEX expert, Distinguished Expert Committee of Nanjing University Free Trade Zone Comprehensive Research Institute, undergraduate industry professor (part-time) of Nanjing University of Finance & Economics, Off-campus Master ’s Supervisor of Southeast University. She is also a DCW Editorial Advisory Board member.

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