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1.1 What is a demand guarantee?

1 A demand guarantee (also called independent, autonomous or first demand guarantee) is an irrevocable undertaking issued by the guarantor upon the instructions of the applicant to pay the beneficiary any sum that may be demanded by that beneficiary up to a maximum amount determined in the guarantee, upon presentation of a demand complying with the terms of the guarantee.

2 The term demand guarantee in other languages:

- in Arabic: khitab dhamann (moustaq’l)

- in Chinese (Mandarin (in Pinyin)): du li dan bao

- in Danish: anfordringsgaranti

- in Dutch: onafhankelijke garantie

- in French: garantie indépendante (or autonome)

- in German: garantie (auf erstes Anfordern)

- in Hebrew: arvut autonomit (or arvut atzmait)

- in Italian: garanzia autonoma

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- in Norwegian: selvstendig garanti

- in Russian: bankovskaya garantiya3

- in Spanish: garantía independiente

- in Swedish: självständig garanti

- in Turkish: müstakil teminat

1.2 Types of guarantees

3 Demand guarantees are issued every day in every sector, country, industry and trade for an infinite range of payment, performance or non-performance (abstention) obligations. In short, any obligation can be secured by the issue of a demand guarantee. The most common categories of demand guarantees include:

- Tender guarantees (also called bid bonds) cover the obligation of a tenderer (bidder) not to withdraw its tender (bid) until the adjudication of the contract and, if awarded the contract, to sign the contract according to the terms of the offer and to procure the issue of any other guarantee required in the contract, which is generally a performance guarantee. Tender guarantees are typically issued for an amount equal to 2-5% of the value of the tender. In some cases, where the procurement terms so require, the amount of a tender guarantee is not correlated to the tender amount and the guarantee is therefore issued for a flat amount.

- Performance guarantees cover the obligation of a party to deliver the performance promised in the contract. They are sometimes conceived to balance the buyer’s obligation to procure the issue of a documentary credit assuring that the seller or contractor is paid. This is done by offering an assurance to the buyer that it will be paid the guaranteed amount in case of non-conforming delivery of the goods, works or services that form the object of the contract. Performance guarantees are typically issued for an amount equal to 5-10% of the value of the underlying contract.

- Advance payment guarantees cover the obligation of a debtor to reimburse, possibly with interest, any amount paid in advance for the delivery of goods, equipment, services or works if that delivery is not in accordance with the terms of the contract. Advance payment guarantees are issued for the amount of the paid advance, although they often contain a reduction clause that leads to the reduction of the guarantee amount upon determined dates or events generally linked to the performance of the contract.

- Retention money guarantees allow contractors or sellers to receive the full amount due as partial or full payment for their delivery instead of the purchaser retaining part of that amount (usually 5-10%) until full performance is procured or following the lapse of an agreed period thereafter. In corporate acquisition finance, retention money guarantees

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are commonplace. They allow payment by the purchaser of the full price amount instead of withholding a part of that amount to secure the accuracy of the representations and warranties made by the seller as to the purchased company’s net worth, its compliance with its regulatory, environmental and accounting obligations or any other legal liability that may arise in the future as a result of pre-acquisition activity.

- Warranty guarantees cover the supplier’s or contractor’s obligation to maintain the equipment, goods, works or services delivered in a state corresponding to the agreed contract specifications during an agreed period. Warranty guarantees are typically issued for an amount equal to 5% of the value of the contract.

- Customs guarantees are issued to the customs authority to cover any duty or liability that may become payable when imported goods or equipment that would be exempt from duty if re-exported within a specified time are not in fact re-exported within that time.

- Payment guarantees cover payment obligations relating to (i) the price of furnished goods or services, in which case this type of guarantee can be regarded as an alternative to more costly documentary credits; (ii) the reimbursement of a facility; (iii) the payment of a receivable such as accounts payable by a distributor, including cases where that receivable is embodied in a promissory note drawn on the account debtor; (iv) the payment of capital contributions by partners to a limited partnership or a joint venture; (v) the payment of decommissioning costs, for example of oil refineries, nuclear power plants and other hazardous activities; or (vi) the payment of rents under a lease or any other payable.

- Credit enhancement guarantees allow a better-rated financial institution to undertake to pay securities holders should the lesser- rated securities issuer default. This enhances the credit rating of the issuing entity and impacts positively on the interest rate that it is expected to pay the holders.

- Parent company guarantees cover the performance or payment obligations of the guarantor’s subsidiaries or affiliates. Likewise, banks are sometimes required to issue guarantees in favour of their foreign subsidiaries to avoid having to transfer funds as capital to meet local banking regulatory requirements.

- Reinsurance guarantees are used by reinsurers to spread the insured risks among several insurers, by arranging for demand guarantees to be issued in favour of the insurer instead of having to deposit funds against their coverage obligation.

- Risk participations, which are conceptually similar to reinsurance guarantees, allow banks and other financial institutions or entities to issue a demand guarantee in favour of the lender, thus sharing the borrower’s default risk without having a relationship with the borrower. As opposed to funded participations, risk participations are put in place

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where the credit to the borrower does not require the lender to fund it immediately, as in the case of documentary credits. Depending on the particular case, risk participations could be structured and drafted as demand guarantees.

- Guarantees issued by multilateral financial institutions cover the payment risk of borrowers from developing economies with a view to encouraging lenders from developed economies to engage in local financing with a view to fostering growth in the local economy and transferring credit know-how to local banks. One example of this is the successful Global Trade Finance Programme, managed by the World Bank, where guarantees issued in favour of banks confirming documentary credits cover up to 100% of the payment risk of issuing banks from developing economies in relation to short-term trade exchanges. Without the World Bank guarantee, few of the global trade finance banks would have accepted the payment risk on the selected issuing banks.

- Sub-contract guarantees enable the main contractor to procure the issue of a demand guarantee that assures the sub-contractors the payment of sums due to them under the sub-contract in the event that the main contractor defaults on any payment due. Reversing the flow, sub- contractors can also be required to procure the issue of performance, warranty or advance payment guarantees in favour of the main contractor to secure the performance of their obligations under the sub-contract. Sometimes, the main contractor can choose to transfer the sub-contract guarantees to the project owner instead of reissuing new guarantees in favour of the owner. Guarantors, especially banks, are generally cautious when the guarantee transfer request is not accompanied by a transfer to the same transferee of the transferor’s rights and obligations arising from the underlying relationship.

- Court guarantees (judicatum solvi or appeal bonds) are procured by one or both litigants to guarantee the payment of money ordered in the judgment, the case and attorney costs or, in the case of arbitration, the arbitrators’ fees. Litigation-related guarantees also include guarantees securing the payment of amounts or the performance of obligations agreed in a settlement ending the dispute.

The above list is not exhaustive. Demand guarantees can cover any obligation, whether contractual, statutory, regulatory or court-ordered, in any sector of industry or trade, involving two, three (direct guarantee), four (indirect guarantee) or multiple parties (syndicated or consortial guarantee), in all domestic and international settings.

4 While it is generally accepted that demand guarantees are a creature of international trade developed in support of turn-key construction contracts as a substitute for cash deposits required by hard-bargaining State-owned beneficiaries, they are at least as developed in domestic exchanges as well. In the United States, standby letters of credit – the conceptual equivalent of demand guarantees – issued in domestic transactions exceed in value those issued in

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international transactions. It is precisely in the extreme adaptability of demand guarantees to every conceivable situation that their immense success lies⁴.

1.3 No proof of breach

5 Unless the guarantee requires the beneficiary to present a document substantiating the breach, the beneficiary is entitled to demand payment without asserting, let alone establishing or proving, that the applicant is in breach of its obligations or the quantum of loss caused by that breach⁵. However, this does not mean that the beneficiary can cash the guarantee and keep its amount where the applicant has committed no breach. A guarantee is not a discount voucher on the contract price. The fact that the beneficiary has presented a demand for payment implies that a breach has actually occurred and that the claimed amount corresponds to the loss suffered as a result of that breach. It is simply the case that, by choosing to issue a demand guarantee, the parties agree that in the first instance any demand that is not manifestly fraudulent is to be paid by the guarantor on a due presentation, leaving questions as to the existence of grounds for the demand to be resolved between the parties to the underlying contract themselves. If it is subsequently established that no breach has occurred, the applicant (after having reimbursed the guarantor) can claim repayment from the beneficiary of the amount unduly paid. Such a claim has to be made pursuant to the underlying relationship, without the guarantor being compelled to take part in it, because the guarantor is not a party to that relationship.

1.4 Fraud

6 Generally, and depending on the applicable law, it is only where the applicant is able to establish, before the payment of the guarantee, that the demand for payment is manifestly fraudulent that the guarantor should withhold payment. Courts in various jurisdictions are very stringent – as they should be – in assessing the fraud standard. Generally, they allow a defence of fraud only in the case of an established forgery in the presented documents or the absence beyond doubt of any right for the beneficiary to demand payment. Examples where the fraud or unfair demand defence was upheld by courts include:

- Cases where the risk covered by the guarantee has clearly not materialised. Such is the case, for instance, in cases where the parties agree that the guarantee covers the payment that would be ordered by the court at the end of a trial but where the parties settle their case and the claim is withdrawn so that no judgment is rendered.

- Cases where the beneficiary certifies in writing that the applicant has performed its obligation in conformity with the contract, simultaneously

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claiming payment from the guarantor for non-conforming performance.

- Cases where the fulfilment by the applicant of its obligation covered by the guarantee has been prevented by the wilful misconduct of the beneficiary. In one case, following the breakdown of diplomatic relationships between their countries, the beneficiary revoked the work permit of the foreign contractor – a national of the belligerent country – without stating any particular breach, expelling its staff from the country where the works were being performed, and then called the guarantee for non-performance of the works⁶.

Article 19 of the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit (1995) contains a comprehensive restatement of the fraud exception in demand guarantees. (For more information on the UN Convention, see paragraph 586.)

1.5 Documents

7 In addition to the demand, the guarantee may require as a condition of its payment the presentation of one or more documents, including, for instance, a statement indicating in what respect the applicant is in breach of its underlying contract obligations, an engineer’s certificate, a surveyor’s report, a court judgment whether final or subject to appeal, an arbitral award, etc. If any of these documents are not presented within the guarantee’s validity period, the demand is incomplete and payment should be refused. The guarantor should examine all presented documents required by the guarantee diligently and in accordance with professional standards. The URDG 758 provide a step-by-step approach to presenting and examining presentations to assess their conformity with the terms of the guarantee.

1.6 Non-documentary conditions

8 Some guarantees provide for their entry into effect, variation of amount, expiry or payment in the form of non-documentary conditions, i.e. conditions whose occurrence cannot be determined by the presentation of documents to the guarantor. In such cases, the fulfilment of these conditions should be determinable by the guarantor from its own records (e.g. by verifying the receipt of an advance payment on a deposit account opened in the guarantor’s books) or as a result of an act within the sphere of the guarantor’s normal operations (e.g. consulting a publicly quoted index or interest rate). Otherwise, these conditions could well create a link with the underlying transaction that may convert the demand guarantee into an accessory suretyship. For that reason, non-documentary conditions should be avoided in demand guarantees. Where the URDG 758 apply, non-documentary conditions are deemed not to exist (see URDG article 7).

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1.7 Independence of guarantee

9 The essential characteristic of a demand guarantee is its twofold independence. First, a demand guarantee is independent of (i.e. completely separate from) the underlying relationship between the applicant and the beneficiary that prompted the issue of the guarantee (segment 1 in Diagram1) or, indeed, any relationship between the applicant and the beneficiary. Second, a demand guarantee is also independent of the instruction relationship pursuant to which the applicant requested the guarantor to issue the guarantee in favour of the beneficiary (segment 2).

10 The corollary of this independence is twofold:

- A demand guarantee is subject only to its terms, whether such terms are expressly stipulated in that guarantee or incorporated by reference. For instance, an arbitration clause provided in the underlying contract does not bind the guarantor and the beneficiary under the guarantee, unless the guarantee provides specific terms to this effect, such as: “Clause [the arbitration clause] stipulated in [title, reference number and date of the underlying contract] is deemed to be incorporated in this guarantee and accordingly forms an integral part thereof”. By the same token, the guarantor cannot be expected to vary the amount of its guarantee so as to reflect the state of the performance of the underlying relationship, unless a variation of amount clause is expressly stipulated in the guarantee.

- No defence arising under the underlying transaction (termination, set- off, force majeure, a commercial dispute between the applicant and the beneficiary, etc.) or the applicant-guarantor relationship (bankruptcy of the applicant, breach of the duty to pay the guarantor’s charges, etc.) can be asserted by the guarantor to avoid the payment of the guarantee or to adjust the amount payable under the guarantee to that of the actual loss of the beneficiary. The guarantor is only empowered to examine the beneficiary’s demand and determine whether it conforms on its face to the terms of the guarantee. Once it has so determined, the guarantor should pay without delay the amount claimed under the guarantee, unless a manifest fraud is established before payment is made.

11 A demand guarantee is thus different from a suretyship, an indemnity and a documentary credit.

1.8 Demand guarantees distinguished from suretyships

12 A suretyship guarantee (also called an accessory guarantee, a suretyship or simply a guarantee) is an undertaking by the surety (i.e. the issuer of the guarantee) to pay sums due from the applicant by way of debt or damages (as opposed to the guarantor’s own primary obligation under a demand guarantee). It is payable on actual default and the measure of the surety’s liability is that of the applicant debtor. This entitles the surety to assert all defences to the guaranteed debt that are available to the applicant and only

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to pay the amount that the beneficiary establishes as being owed by the applicant under the underlying relationship.

13 In practice, there is some confusion between independent guarantees and accessory guarantees. This is doubtlessly exacerbated by the use of the English term “guarantee”, which generically covers both. Some courts have been prone to consider that a reference in the guarantee to the underlying transaction is an indication that the guarantee is accessory. This is wrong. On the contrary, it is important that the guarantee identifies this transaction in order to establish the underlying relationship to which the guarantee relates (see URDG article 8(d)). Neither should the mere description of the guarantee as a demand guarantee or as a suretyship guarantee be determinative. Whether a guarantee is an independent guarantee or a suretyship, the nature of the guarantee is to be determined by its terms as a whole. Terms that express the guarantor’s duty to pay independent of default – for example, “regardless of objection by the applicant [or the counter- guarantor in the case of an indirect guarantee]”, “without proof of default or loss” or words to this effect – are indicative of a demand guarantee. By contrast, where the duty to pay is stated to be dependent on proof of default by the applicant or is to be limited to the loss suffered by the beneficiary as a result of the applicant’s breach, the guarantee will be a suretyship guarantee. Considerable difficulty can arise where terms of both types are used in the same guarantee, as where the guarantee is stated to be payable on demand and this is followed by words requiring evidence of default as a condition for payment. Such combinations should be avoided. A reference in the guarantee to the URDG combined with the use of the URDG model forms is the safest way to ensure that a guarantee is recognised as an independent guarantee.

14 The following examples illustrate the difference between a suretyship and an independent guarantee. A has entered into a construction contract with B. At A’s request, G Bank issues a guarantee in favour of B which provides: “in the event of A defaulting in the performance of its obligations under the above mentioned contract we will pay you the amount of your loss up to a maximum of €10 million”. This is a suretyship guarantee under which the guarantor’s liability is dependent on the default of the applicant and is limited to the loss suffered by the beneficiary. It is not an independent guarantee.

15 In the next example, the facts are as in the previous example except that the guarantee does not refer to default but simply states: “we will pay you on first written demand the amount of any loss you may suffer in connection with the above mentioned contract up to a maximum of €10 million”. This is not a demand guarantee but a contract of indemnity under which the undertaking is to pay any loss suffered by the beneficiary up to a maximum amount (for more on this, see paragraph 18).

16 In the third example, the facts vary again. Here, the guarantee provides: “we undertake to pay you on demand the amount specified in such demand up to a maximum of €10 million”. This is a true demand guarantee, since the

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obligation to pay is dependent solely on the presentation of a complying demand and the amount or maximum amount of that obligation is to be ascertained solely on the basis of the demand and the terms of the guarantee.

17 The term suretyship in other languages:

- in Arabic: kafala

- in Chinese: (Mandarin (Pinyin)): bao zheng

- in Danish: kaution

- in Dutch: borgtocht

- in French: cautionnement

- in German: bürgshaft

- in Italian: fideiussione

- in Norwegian: selvskyldnergaranti

- in Russian: poruchitelstvo

- in Spanish: fianza

- in Swedish: borgensgaranti

- in Turkish: kefalet

1.9 Demand guarantees distinguished from indemnities

18 Under English law, an indemnity shares some of the characteristics of a demand guarantee in that, in contrast to a suretyship guarantee, it is a primary liability not dependent on another party’s default. However, it differs from a demand guarantee in that it is not an undertaking to pay a specified sum or maximum sum but simply an undertaking to hold another party harmless against loss, the amount of which therefore has to be ascertained. Under Swiss and French law, porte-forts are conceptually similar to indemnities and, as such, are different from independent guarantees.

1.10 Demand guarantees distinguished from documentary credits

19 A documentary credit is first and foremost a means of payment. It thus differs functionally from a demand guarantee. A demand for payment under a documentary credit is indeed a “normal” event that the parties expect to happen when the beneficiary performs its obligations under the underlying transaction. The tendering of the documents specified in the documentary credit represents the due performance of the beneficiary’s obligations. By contrast, a demand for payment under a demand guarantee is an exceptional event that is not expected to occur if the applicant performs its obligations. The presentation of a demand for payment under a guarantee necessarily implies that a default has occurred, although no proof of such default is required.

20 Documentary credits also differ structurally from demand guarantees. Where the beneficiary of a documentary credit requires an undertaking supplementary to the issuer’s, a confirming bank will issue its own confirmation in favour of the beneficiary, which will then enjoy two separate

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and direct undertakings: the issuer’s and the confirmer’s (see Diagram 2 below). The beneficiary of a demand guarantee will typically only have the benefit of one undertaking: the guarantor’s. This does not change in the case of an indirect guarantee, where the counter-guarantor’s undertaking is issued to the guarantor and not to the beneficiary (see Diagram 3).

21 Documentary credits nonetheless share some characteristics with demand guarantees: both are independent from the underlying transaction and both are subject to their own terms. This renders many established principles in the law and practice of documentary credits equally applicable to demand guarantees.

1.11 Demand guarantees distinguished from standby letters of credit

22 Standby letters of credit were developed in the United States in the 19th century as a result of a statutory prohibition on national banks against issue of guarantees – the accessory type – which were considered to be too hazardous7. Banks resorted to using documentary credits but ascribed to them a default function: instead of paying the letter of credit upon proper performance of the obligation, it is the non-performance that triggers the beneficiary’s demand. Accordingly, a standby letter of credit is functionally equivalent to a demand guarantee, but differs from it by using the form and structure of a documentary credit as displayed in Diagram 2 above.

23 Standby letters of credit have been an immense success in the United States and remain so to this day, even after the repeal of the statutory prohibition

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and the express authorisation by the Office of the Comptroller of the Currency for national banks to issue, starting in 1996,⁸ independent undertakings and, starting in 2008, under certain conditions, accessory undertakings too⁹. As a particular variety of standby letters of credit, direct-pay standbys are structured to be paid at maturity with no need for a demand to be presented by the beneficiary, let alone for a default to be stated. They are used in particular as a credit enhancement device for sub-investment grade securities issued by municipalities in the United States.

1.12 Multi-party guarantees; syndicated guarantees

24 Guarantees issued in favour of two or more beneficiaries by two or more syndicated guarantors – or for the account of two or more applicants – are perfectly legitimate and are issued regularly. Multiple beneficiaries or multiple applicants are often the result of those parties acting together in a consortium, a partnership or a joint-venture that is not incorporated as a legal entity. Likewise, guarantees for important amounts are frequently syndicated, generally through risk participations, as they do not involve upfront funding.

25 Experience shows that, unless the rights and obligations arising under each party’s role under a guarantee are vested in one party acting as an agent or trustee for the benefit of the other parties, disputes may arise as to who owes a duty and to whom it is due. For example, if a guarantee is issued by a syndicate of ten banks, to which bank should a presentation be made? And which bank is to examine such a presentation? And which bank’s decision as to the conformity of the presentation is to prevail in case of divergence? In the case of an extend or pay demand, which bank should decide whether to extend or to pay? Similarly, in the case of multiple applicants, to which applicant does the guarantor owe an information duty? From which applicant should the guarantor accept amendment instructions? If a statement is required from the beneficiary in support of a demand and the guarantee is issued in favour of multiple beneficiaries, which beneficiary is to sign the statement? Identifying a single party to accomplish the relevant duty for the benefit of the class is an elementary precaution that parties to a guarantee involving a multi-party structure should consider.

26 If, instead of a syndication, the structure involves a participation agreement whereby one guarantor issues the guarantee or counter-guarantee and shares the risk among multiple parties, the guarantee is not strictly a multi-party guarantee, as there is only one guarantor that receives all the rights and duties ascribed to it under the guarantee. The participants are not privy to the relationship that the guarantor has with the applicant(s) or beneficiary(ies).

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1.13 Two-party guarantees

27 Two-party guarantees are issued for the guarantor’s own account or at the request of the beneficiary itself. For example, a company may issue a guarantee covering its own liability to a lending bank under a loan agreement or a contract for the supply of goods or services. The advantage to the beneficiary of such a guarantee is that the guarantor’s obligations under the underlying contract are reinforced by an independent payment undertaking. In principle, this undertaking has to be fulfilled even where the applicant would have a defence against a claim made under the contract itself, so that the beneficiary’s right to payment is insulated from the rest of the contract. Another frequent case where two-party guarantees are used is where the head office of a company issues a guarantee covering the liability of its branch vis-à-vis its creditors. In the case of banks, bank regulators may require a bank branch in their jurisdiction to have a minimum capital. The issue by the head office of a demand guarantee obviates the need for transferring the required additional regulatory capital to the branch. Two-party guarantees are also issued at the request of the beneficiary itself. This is the case where an exporter requests its bank to issue a guarantee covering the payment of the price of goods payable by the importer. The exporter then has the dual role of applicant and beneficiary.

1.14 Guarantees not issued in connection with an underlying contract

28 Guarantees may be issued to cover obligations in connection with an underlying relationship that arises as a matter of law or court order as opposed to a contract. An example of this is a customs guarantee issued to the customs to cover any duty that may become payable when imported goods that would be exempt from duty if re-exported within a specified time are not in fact re-exported within that time.

1.15 What is a counter-guarantee?

29 The need for an indirect guarantee structure is best illustrated by an export contract in which an exporter undertakes to deliver certain goods to an importer according to the agreed terms for an agreed price. While a demand guarantee issued by a guarantor located in the exporter’s country hedges the importer against commercial risks (e.g. the exporter’s breach of contract or its insolvency), it falls short of providing an adequate protection against political and cross-border litigation risks. Indeed, although issued on demand, such a guarantee is still vulnerable to possible embargoes and exchange controls imposed in the exporter/guarantor country. Likewise, it does not spare the importer the costs and contingencies of initiating legal proceedings before the courts of the foreign jurisdiction where the guarantor and the exporter are domiciled to obtain payment under the guarantee or the contract. This often leads the importer to ask the exporter to arrange for a guarantee to be issued by a guarantor located in the importer’s country. A counter-guarantee is then

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issued to that guarantor by another guarantor – henceforth referred to as the counter-guarantor – with which it has a correspondent relationship. This counter-guarantor, acting upon the exporter’s instructions, asks the local guarantor to issue its guarantee in favour of the beneficiary and undertakes to pay the amount of the counter-guarantee if the guarantor presents a demand that conforms to the terms of the counter-guarantee.

30 The term counter-guarantee in other languages:

- in Arabic: dhamann moukabel

- in Danish: kontragaranti

- in Dutch: contragarantie

- in French: contregarantie

- in German: rückgarantie

- in Italian: controgaranzia

- in Spanish: contragarantía

- in Swedish: motgaranti (the same term is also used in Norwegian)

- in Turkish: kontrgaranti

1.16 Structure of a counter-guarantee

31 Setting forth an indirect guarantee structure requires the applicant to ask a party (the “counter-guarantor”) (through the application in segment 2), whose creditworthiness is acceptable to the guarantor, to request that guarantor to issue its own guarantee in favour of the beneficiary (guarantee in segment 4). The counter-guarantor counter-guarantees the guarantor (counter-guarantee in segment 3) by irrevocably undertaking to pay any sum that may be claimed by the guarantor up to a maximum amount determined

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in the counter-guarantee. Such payment is to be made upon the presentation of a demand in conformity with the terms of the counter-guarantee.

1.17 Independence of a counter-guarantee

32 A counter-guarantee is independent from the guarantee (segment 4 in Diagram 3), the underlying relationship (segment 1) and the application (segment 2). The consequences of the independence of the counter- guarantee are as follows:

(i) Each undertaking is subject only to its own terms, which do not have to mirror each other. Thus:

- An accessory suretyship can be counter-guaranteed by an independent counter-guarantee.

- A guarantee may be governed by a law different from that governing the counter-guarantee and attribute jurisdiction to a different court (this is indeed the default rule in URDG 758 articles 34 and 35 – see paragraphs 34.5 and 35.5 in Chapter 4).

- Recourse to arbitration may also be stipulated in the guarantee, although disputes arising under a counter-guarantee may remain within a national court’s competence, either as a result of an express jurisdiction clause in the counter-guarantee or in the absence of any jurisdiction clause.

(ii) The expiry of the guarantee does not automatically lead to the expiry of the counter-guarantee. In fact, stipulating identical expiry dates or events in both the guarantee and the counter-guarantee should be avoided in order to allow a guarantor that has received a demand on the last day of the guarantee’s validity the time to examine the conformity of that demand and to prepare and present its own demand under the counter-guarantee.

(iii) The variation by reduction or increase of the amount of the guarantee by application of a variation of amount clause in that guarantee does not lead to a proportional variation in the amount of the counter- guarantee, unless a corresponding variation clause is also provided in the counter-guarantee. This could possibly take the form of a reference in both the guarantee and the counter-guarantee to the same index whose variation triggers that of the guarantee and counter-guarantee amount¹⁰.

(iv) The guarantor does not have to establish the actual payment of its guarantee before being entitled to present a demand for payment under the counter-guarantee, unless the counter-guarantee so requires.

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(v) The beneficiary’s fraud under the guarantee does not, in itself, vitiate the guarantor’s rights under the counter-guarantee. Therefore, unless it is established before the payment of the counter-guarantee that the guarantor has aided and abetted the beneficiary in its fraud, or that it could not have ignored it given the circumstances of the case,¹¹ a counter- guarantor is bound to honour the guarantor’s conforming demand.

1.18 Is there a claim available to the beneficiary against the counter-guarantor?

33 As Diagram 3 above shows, there is no direct link between the counter- guarantor and the beneficiary. The counter-guarantor requests the guarantor to issue its own demand guarantee in favour of the beneficiary, whereupon the counter-guarantee covers the guarantor against the financial consequences of carrying out the counter-guarantor’s instructions whether in terms of payment to the beneficiary, imposition of stamp duties or taxes on the guarantor or otherwise. The consequence is that the beneficiary cannot make a presentation to the counter-guarantor or claim payment directly from the counter-guarantor, even where the guarantor wrongfully dishonours its undertaking under the guarantee. Absent a direct contractual commitment, the counter-guarantor owes no duty to the beneficiary, whether of payment, fiduciary or otherwise. However, where the applicable law so permits, the beneficiary may be entitled to claim damages from the counter-guarantor if the counter-guarantor’s conduct gives rise to a tortious liability vis-à-vis the beneficiary. This can be inferred from the decision of the French Court of Cassation, Commercial Section, 30 March 2010, Eurocopter v. Banque Melli Iran, No. 09-12.701, reviewed below in paragraphs 629 et seq.

1.19 Is there a claim available to the applicant against the guarantor, and reciprocally, in an indirect guarantee?

34 The above holds true when examining a possible claim by the applicant against the guarantor in an indirect guarantee. The absence of a contractual relationship between the applicant and the guarantor, because of the interposition of the counter-guarantor, sets aside any direct claim that could be made either:

- by the guarantor against the applicant for payment in the event of a wrongful dishonour by the counter-guarantor of a complying demand under the counter-guarantee; or

- by the applicant against the guarantor because of the non-performance by the guarantor of the duties owed to the counter-guarantor under the counter-guarantee, such as an information duty in the event of a demand, variation of amount or termination.

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35 Once again, however, where the applicable law so permits, the applicant could avail itself of a direct claim against the guarantor in an indirect guarantee in one of the following three situations:

- a claim in tort, where the guarantor’s conduct has caused a prejudice to the applicant;

- a claim as subrogee, typically where the applicant has paid the counter- guarantor and steps into the counter-guarantor’s shoes in availing itself of all claims available to the counter-guarantor against the guarantor arising under the counter-guarantee (depending on the legal system, a claim in subrogation under an independent undertaking can be based on the general law of obligations, a specific statutory provision or the principles of equity); or

- a claim in restitution for unjust enrichment.

36 In all three cases, the applicant must have paid the counter-guarantor so that it can claim a prejudice that would underlie a claim for tortious liability against the guarantor or a claim qua subrogee to the rights of the counter- guarantor against the guarantor. The applicant’s claim in tort against the guarantor in an indirect guarantee is illustrated in the case that led to the decision of the French Court of Cassation, Commercial Section, 30 March 2010, Eurocopter v. Banque Melli Iran, No. 09-12.701, reviewed below in paragraph 629 et seq.

37 The same applies where the guarantor in an indirect guarantee has paid the beneficiary upon presentation of a complying demand but has been denied reimbursement by the counter-guarantor. If permitted under the applicable law, this guarantor can avail itself of a direct claim as subrogee against the applicant by using the claims available to the paid beneficiary against the applicant arising under the underlying relationship.

PROLOGUE

The Road to URDG 758

1 Why the URDG?

38 The URDG are the culmination of four stages in demand guarantee practice spanning some 40 years:

(1) in the beginning, the absence of internationally accepted standard terms for demand guarantees;

(2) at the second stage, the failure of an attempt to impose on the market the Uniform Rules for Contract Guarantees (URCG) because they did not meet the market’s expectations;

(3) at the third stage, the drafting of the URDG 458 as an answer to the market’s demand for a guarantee that offers a fair compromise between all parties’ interests and concerns; and

(4) finally, after 15 years of applying the URDG 458, the launch in 2007 of an ambitious revision that led, two and a half years later, to the adoption of the URDG 758 on 3 December 2010.

1.1 In the beginning… a void

39 Bankers and traders engaged in international trade and project finance in the 1970s will remember the negotiation course in cross-border guarantees. There were no uniform rules, standardised practice or any internationally harmonised model guarantee forms. Demand guarantees had to be negotiated and drafted from scratch for each new contract or, worse, adhered to because the party with the stronger bargaining power – generally the beneficiary – so required. Negotiating the terms of demand guarantees and counter-guarantees was all the more difficult amid seemingly irreconcilable interests of beneficiaries, guarantors and applicants.

40 The beneficiary (traditionally the buyer¹²) wished to be secured against the applicant (the seller) not fulfilling its obligations in respect of the underlying relationship. For example, in a construction contract awarded through an open bid process, those obligations typically include signing the contract and procuring the issue of a performance guarantee once the contractor is awarded the contract. The applicant then has to perform the contract and deliver the works at the agreed time and with the agreed specifications, ensure their maintenance if so agreed and reimburse any advance paid by the owner where the works are not performed in accordance with the contract. Beneficiaries – often state administrations in developing countries

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– primarily wanted to avoid responsibility for “white elephant” economic failures. These are often the result of gigantic, ill-prepared projects agreed too hastily between newly independent states and unscrupulous contractors. Most of these projects are now ruins overgrown by jungle. As a result, beneficiaries tried to obtain, wherever possible, a cash-equivalent security that enabled them to immediately satisfy their claim without having to first establish the applicant’s breach before costly arbitral tribunals or foreign courts.

41 The applicant seldom agreed that it was liable for the breach that the beneficiary alleged and almost never that the amount demanded under the guarantee fairly represented the loss directly caused by its breach. In addition, a number of demands for payment in the early 1980s that were allegedly politically motivated rendered applicants wary of guarantees payable upon a beneficiary’s simple demand. Little consolation could be found in the prospect of initiating a post-payment recovery before the courts of the beneficiary’s home country, which were often suspected of national bias. Thus, in an attempt to limit the risk of fraudulent demands, applicants preferred (i) not to see the guarantee paid until the beneficiary had first proven the actual breach and (ii) to be able to challenge such a breach.

42 The guarantor and the counter-guarantor are not parties to the underlying relationship between the applicant and the beneficiary and, where the guarantor and counter-guarantor are banks, should not be expected to know its content. Therefore, they endeavoured to avoid situations where they might be required to examine the commercial contract to determine whether the applicant and the beneficiary had performed their respective duties. Guarantors and counter-guarantors looked to have their undertakings worded in a way that (i) rendered their guarantee or counter-guarantee clear and unambiguous and (ii) essentially insulated them from any issue arising from the underlying relationship.

43 As might be expected, guarantee and counter-guarantee texts were biased and influenced by the specific cultural and national law environment of the party that had the strongest bargaining power. More often than not, this party was a State-owned beneficiary. The result was lengthy negotiations, conducted in an adversarial context, resulting in imprecise drafting with frequent litigation and costs of expert evidence as an inevitable corollary.

44 In a buyer-oriented market, the only acceptable alternative to guarantees was a cash deposit in the amount that the buyer estimated sufficient to offset the seller’s performance risk. Because such a solution gravely burdened the seller’s cash flow, an alternative that would offer an equivalent security to the beneficiary had to be found. That alternative could only consist of having a third party with acceptable financial means undertake to pay a pre-determined amount upon the buyer’s demand. Hence the birth of demand guarantees. The market needed a set of uniform terms for such guarantees that would spare considerable negotiating time and effort, even if they had to be adapted in specific situations.

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1.2 The URCG

45 Inspired by the success of the UCP, exporters and their bankers, joining forces through their representatives at ICC, decided in 1968 to draft a set of rules for guarantees that would apply uniformly in all jurisdictions. This gave birth on 20 June 1978 to the Uniform Rules for Contract Guarantees (URCG) (ICC Pub. No. 325). They were followed, four years later, by The Model Forms for Issuing Contract Guarantees (ICC Pub. No. 406) to be used in conjunction with the URCG if the parties so wished.

46 Regrettably, the URCG were drafted to provide an answer only to the concerns of applicants (called “principals” in the rules) but not to those of the beneficiaries or guarantors. The disparity between the expectations of a buyers’ market regarding a cash-equivalent instrument and the URCG was particularly obvious in article 9, which provides:

“If a guarantee does not specify the documentation to be produced in support of a claim or merely specifies only a statement of claim by the beneficiary, the beneficiary must submit:

(a) in the case of a tender guarantee, his declaration that the principal’s tender has been accepted and that the principal has then either failed to sign the contract or has failed to submit a performance guarantee as provided for in the tender, and his declaration of agreement, addressed to the principal, to have any dispute on any claim by the principal for payment to him by the beneficiary of all or part of the amount paid under the guarantee settled by a judicial or arbitral tribunal as specified or otherwise agreed upon, by arbitration in accordance with the Rules of the ICC Court of Arbitration or with the UN Arbitration Rules, at the option of the principal;

(b) in the case of a performance guarantee or of a repayment guarantee, either a court decision or an arbitral award justifying the claim, or the approval of the principal in writing to the claim and the amount to be paid”.

47 While the requirements under the URCG were technically documentary in character, so that production of a judgment or arbitral award would arguably suffice even if given without jurisdiction, the requirement to obtain such a judgment or award meant that guarantees covered by the URCG were in practice almost indistinguishable from suretyship guarantees.

48 Initially conceived in an effort to limit the risk of unfair demands, the requirement for the beneficiary to justify its claim by proving its right to claim payment and the amount of that payment, in practice, excluded from the scope of the rules the category of guarantees that was the most widely used in international trade: demand guarantees.

49 The URCG suffered from other congenital deficiencies as well. First, they provided no specific provisions for counter-guarantees, nor did they purport to regulate them by analogy to guarantees. They simply ignored them. Second,

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by simultaneously affirming the independence of a URCG guarantee (article 3) and conditioning its payment upon proof of default (articles 2 and 9), the URCG made it impossible to determine with certainty whether a URCG guarantee was an independent undertaking or an accessory one. Hence, the URCG failed to achieve the very purpose for which they were presumably drafted, namely to provide a uniform understanding of the nature of the guarantee that would enable the parties to deal with it in full knowledge of its effects. Unsurprisingly, the URCG never received market acceptance. The modest application that they received in the few years following their adoption rapidly dwindled to almost nothing. The ICC Banking Commission no longer lists these rules among its publications and offers no support for their use in its DOCDEX dispute resolution service or elsewhere¹³.

1.3 The URDG 458

50 ICC drew the necessary lessons from the URCG’s failure. A working group composed of delegates from both the Banking Commission and the International Commercial Practice Commission (later renamed the Commercial Law and Practice Commission) was constituted and worked for a decade (1981-1991) to give shape to the URDG. Avoiding the repetition of the fundamental conceptual error behind the URCG, it set as a target that the next rules should be built upon a fair balance of the legitimate interests of all parties involved in a demand guarantee.

51 Hundreds of pages of comments were received from international organisations and ICC national committees, including those representing traditional beneficiary strongholds¹⁴. All were duly reviewed and, where appropriate, incorporated into the 11 drafts successively produced. Each draft was submitted to both the Banking Commission and the International Commercial Practice Commission and amply discussed. Ultimately, this transnational endeavour gave birth to the URDG, adopted by the ICC Executive Council on 20 December 1991. They entered into force in April 1992. Two years later, the ICC Model Forms for Issuing Demand Guarantees were completed and released (ICC Pub. No. 503), offering five ready-to-use model URDG guarantee and counter-guarantee forms.

The compromise achieved by the URDG 458 between the conflicting interests at stake can be summarised as follows:

(1) Beneficiary to state, but not prove, the breach

52 Although legally independent from the underlying relationship, a demand guarantee is not a negotiable instrument whose payment can be claimed by any holder irrespective of whether it holds an interest in the underlying relationship. But the proof by the beneficiary of the applicant’s breach and of the extent of its actual loss is postponed until after the payment of the

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guarantee. This is the application of the general principle, now universally recognised in demand guarantees, of “pay first, argue later”¹⁵. In order to present a complying demand for payment under the URDG, beneficiaries are expected to indicate (but not to justify, establish or prove) in general terms the respect in which the applicant is in breach. The parties are nonetheless at liberty to vary even the requirement of that minimum statement, either by excluding it from the guarantee or by strengthening it by requiring additional documents in support of the demand, such as an engineer or surveyor’s report, a decision of a dispute adjudication board, an arbitral award, etc.

(2) Applicant to renounce defences derived from underlying relationship

53 By choosing to instruct a guarantor to issue a URDG guarantee (as opposed to an accessory suretyship), applicants renounce all defences derived from their underlying relationship with the beneficiary. Such defences include the termination or nullity of that relationship, as well as the beneficiary’s breach of its obligation vis-à-vis the applicant under that relationship. Unless the applicant agrees otherwise with the beneficiary (and ensures that such agreement is recorded in the guarantee), it can only expect the beneficiary, when presenting a demand for payment, to indicate the respect in which the applicant is in breach of its obligations. Beneficiaries are under no obligation to establish that the amount claimed under the guarantee is actually due under the underlying relationship. An applicant that believes that a demand is unfair can claim reimbursement from the beneficiary after the guarantee is paid. However, this claim is outside the scope of the URDG.

(3) Guarantor’s independent and documentary role

54 Guarantors and counter-guarantors are assured that their undertakings will only be subject to their own terms. Indeed, the URDG unambiguously affirm (1) the independent nature of the guarantee and counter-guarantee and (2) the documentary nature of these undertakings. This insulates both guarantees and counter-guarantees from the underlying relationship and confines guarantors and counter-guarantors to a document checking role. They do not have to assess the accuracy or honesty of the beneficiary’s statement of breach nor do they have to determine any disputed question of fact or law. The experience of the UCP over eight decades proves that, where the conditions of an undertaking are expressed only in terms of presentation of documents (availability for presentation, reduction of amount, expiry, payment, termination, etc.), the independence of such an undertaking cannot be challenged¹⁶.

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55 URDG 458’s success. By offering balanced rules and codifying the market’s existing practices within that spirit, the URDG 458 seduced bankers and users of all sectors and countries. Their clear drafting style, conciseness, practical approach and simplicity of use (including the phrase “subject to URDG” in the guarantee or counter-guarantee sufficed to secure their application) saved considerable negotiating and drafting time and effort by offering the parties shortened guarantees of an indisputably independent nature. Lawmakers have taken the URDG as a model for statutes on demand guarantees (e.g. the Organisation for the Harmonization of Business Law in Africa (OHADA) Uniform Act on Secured Transactions of 1997 and the new Uniform Act on Secured Transactions of 2010), bank regulators have recommended their use by their national banks (e.g. the Central Bank of Iran’s circular letter of April 2004), international organisations have endorsed them (e.g. the UN Commission on International Trade Law) or adopted them in their demand guarantee forms (e.g. the World Bank and the International Federation of Consulting Engineers) and several leading banks have selected the URDG as a template.

2 A brief history of the revision

56 On 26 April 2007, during the meeting of the ICC Banking Commission in Singapore, the ICC Task Force on Guarantees¹⁷presented the case for the revision of the URDG 458. It was argued that the URDG – like any set of ICC rules – needed to reflect the current state of market practice and aspirations that had evolved since the adoption of the URDG 458 in 1991. Articles 2(d),7(a), 10, 17, 20, 21, 25 and 26 of the URDG 458 were singled out as having prompted many queries for clarification of scope or terms. In addition, numerous URDG seminars conducted around the world had provided comprehensive comments, experiences and feedback on the rules, as well as suggestions for drafting improvements. Furthermore, the recently completed revision of UCP 600 (2006) had introduced a new drafting style and experience that would arguably benefit a revised version of the URDG. This was all the more so in the light of the continuing requests of small and medium-sized banks and businesses to align both the drafting style of URDG and the solutions they provided to those of the UCP to the extent they were not specifically linked to the payment function of documentary credits. This was understandable. In a world where documentary credits and guarantees are – in our opinion rightly – perceived as sharing a common independent and documentary nature and are used for similar purposes in support of trade finance, it is difficult to justify as dramatic a divergence as the one that existed between the UCP 500/600 and the URDG 458. Differences included the lack of specific rules in the URDG concerning non-documentary conditions, transfers of guarantees, rejection process and preclusion. Finally, the URDG 458 contained certain standards, such as “reasonable time” and “reasonable care”, whose assessment depended on the particular circumstances of the case at hand and, as such, were regarded as being too unpredictable.

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57 Consensus was reached as to the objective of the revision, namely to produce a new set of rules that are:

- more comprehensive, by covering areas of guarantee practice that are not covered by the URDG 458. Examples include: non-documentary conditions, amendments, notices of rejection, a possible preclusion rule, partial and multiple demands, language of the documents accompanying a demand and the expiry of a guarantee that provides no expiry terms.

- more specific, by providing precise solutions for each of the issues addressed in the rules, including the standards for the examination of a presentation, and a specific section that compiles all the definitions spread out across the first version of the URDG (458).

- clearer in their drafting of rules that were reported in the past as being unclear or having given rise to a misinterpretation. Examples cited in the business case for the revision include the interaction between articles 20(a)(i) and (ii) and between articles 10 and 21, the application of the URDG to counter-guarantees and what constitutes “writing” in paper and electronic documents.

2.1 The revision process

58 Building on the revision process of the UCP 600, a two-tier structure was put in place: a drafting group comprising a small number of experts to be chosen by the Task Force on Guarantees from among its members and other ICC members with the relevant expertise and a larger consulting group consisting of the members of the Task Force to whom observers could be added as necessary.

59 The revision started immediately upon the approval of the business case and was conducted under the joint aegis of the ICC Banking Commission and the Commission on Commercial Law and Practice. Five comprehensive drafts were produced between 19 February 2008, the date of the first draft, and 10 October 2009, the date of the fifth and final draft submitted for adoption. Each draft was circulated for review and comments among all ICC national committees. International and professional organisations that showed interest in the process were also invited to express their comments. Over 600 sets of comments from a total of 52 countries were thoroughly examined by the Drafting Group. Regular progress reports were presented to meetings of the various sponsoring ICC commissions and were extensively debated with the participants. This method ensures that the revision takes full account of the views received from a broad cross-section of concerned parties.

60 The resulting URDG 758 were adopted by the ICC Executive Board in New Delhi on 3 December 2009, following their endorsement by the members of the two sponsoring commissions. They came into force on 1 July 2010 and apply to any demand guarantee or counter-guarantee where they are incorporated by reference in the text of the guarantee.

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61 As will be explained in detail in Chapters 3 and 4 of this Guide, the new URDG 758 endorse and build on the balance that the URDG 458 had struck between the legitimate expectations of the parties. They also contain a number of new rules and changes to existing rules. The table below lists the main similarities and differences between the URDG 758 and the URDG 458.

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