Article

Factual Summary: To secure its obligations under three sub-contracts for a project with the Libyan government, the Turkish bank issued its performance bond totalling US$ 1.13 million at the request of the Chinese bank based upon its counter guarantee on behalf of its principal. The guarantor declined to issue an advance payment bond, however.

The sub-contractor provided a workforce in Libya, but was not able to perform because the contractor did not advance the requisite funds (in part because advance payment bonds could not be issued) and the workcamp was eventually shut down by the Libyan government.

In March 1985, the beneficiary/contractor demanded payment from the guarantor under the performance bonds, and the guarantor so notified the counter-guarantor. Six days after the demand, the principal notified the guarantor by telex that the demand was unreasonable. The telex asserted that the non-performance was the fault of the beneficiary. The beneficiary indicated that it would be willing to delay payment of the bonds while negotiations between it and the principal proceeded.

In a follow-up telex, the principal again asserted its position to the guarantor and noted that the beneficiary's request for payment was "unreasonable, abusive, fraudulent, and unlawful." This telex was copied to the counter guarantor which asked the guarantor to investigate the matter carefully. The principal again wrote the guarantor in June and asserted that all breaches of the underlying contract were the beneficiary's fault. The counter guarantor notified the guarantor that it had no reason to disagree with the principal's views and would not support any decision to pay out under the performance bonds.

The guarantor then obtained an opinion from its legal department which stated that its obligations on the performance bonds were separate from any dispute on the underlying contract. As such, the guarantor should pay out on the performance bonds and would be entitled to payment under the counter-guarantees. In addition, the guarantor received a letter from the beneficiary which related its side of the story, namely that the principal was in breach and many difficulties in its own performance were due to the Libyan government's failure to make payments under the contract. Accordingly, the guarantor paid on the performance bonds and demanded that the counter guarantor pay on the counter-guarantees. The counter guarantor refused and the applicant brought suit.

At trial, the court found that the facts as presented and known by the guarantor did not give rise to a "clear and obvious" indication of fraud. As such, payment on the performance bonds was proper and the guarantor was entitled to payment under the counter-guarantees.

Legal Analysis:

1. Performance Guarantees: Similar to LCs: The court first noted that the law for the performance guarantees in this case was the same as that for letters of credit.

2. Fraud: Accordingly, the court examined whether the fraud exception relieved the guarantor of its obligations under the performance guarantees, thereby relieving the counter guarantor of its obligations under the counter-guarantees.

The counter guarantor argued that the guarantor knew that the issuance of the advanced payment bonds was a condition precedent to the beneficiary's obligations to advance any funds to the principal, which, in turn was a condition of the principal's performance. By not issuing the advanced payment bonds, the counter guarantor argued that the guarantor had evaluated the beneficiary's financial capabilities and knew that it would not be able to provide the principal with any advanced fees. As such, the guarantor should have known that the beneficiary would be in breach of the underlying contract and any demands under the performance bonds alleging principal breach would have to be fraudulent. The court rejected this argument, first noting that the trial court found, as a matter of fact, that the guarantor did not have any knowledge of the terms of the underlying contract. Additionally, the guarantor's subsequent guarantee of a loan to the beneficiary belied the counter guarantor's argument that the guarantor knew the beneficiary was in dire financial straits and would be unable to advance fees to the sub-contractor. Further, the guarantor had offered to issue the advanced payment guarantees under its standard terms, but the parties could not come to an agreement.

The court next concluded that all of the evidence supplied to the guarantor by the principal and beneficiary, at best, was suspicious and indicated "the possibility of sharp practice, but [was] without anything remotely approaching true evidence of fraud or anything which makes fraud obvious or clear to the bank."

©1998 INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.