Books

Chapter 1

Demand guarantees and counter guarantees in a nutshell

What is a demand guarantee?

Diagram 1: Direct Guarantee

1. A demand guarantee (also called an 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. Once issued, the guarantee has the force of a contract or other legally binding engagement. Demand guarantees are issued to cover a broad array of obligations, whether non-monetary ones, such as delivery or construction obligations, or payment guarantees covering loan reimbursement obligations or the payment of goods or services. The issue of a guarantee sets up a number of relationships described later in this chapter.

[Page24:]

2. The term demand guarantee in other languages:

• in Arabic: khitab dhamann mustaq’l

• in Chinese (Mandarin): 独立担保 or du li dan bao (in Pinyin)

• 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

• in Norwegian: selvstendig garanti

• in Russian: bankovskaya garantiya¹

• in Spanish: garantía independiente

• in Swedish: självständig garanti

• in Turkish: müstakil teminat

Types of guarantee

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, such as non-compete or non-disclosure obligations. In short, any obligation can be secured by the issue of a demand guarantee. The classification of a demand guarantee is not relevant to its content, signifying only the purpose for which it is issued. The most common types of demand guarantee 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 accordingly issued for a flat amount.

• Performance guarantees cover the obligation of a party to deliver the performance promised in the contract. They are sometimes issued 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.

[Page25:]

• 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, works or services 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 guaranteed amount upon determined dates or events generally linked to the performance of the contract.

• Deferred payment guarantees are the converse of advance payment guarantees. They are issued to cover payment obligations in which the beneficiary, typically the seller, has agreed to give credit to the applicant, typically the buyer, for example by agreeing to payment by instalment.

• 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 are commonplace. They allow payment by the purchaser of the full price amount instead of withholding part of the 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 goods, equipment, 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 in practice not 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 credit facility or an overdraft; (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 in the case of oil refineries, nuclear power plants or 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

[Page26:]

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.

• Own-account guarantees are guarantees issued on behalf of a foreign branch of the guarantor, which is treated as a separate entity from the issuer (see URDG article 3(a)). They fulfil much the same function as parent company guarantees.

• 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. In contrast to funded participations, risk participations are put in place 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 in order to foster growth in the local economy and transfer 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

[Page27:]

accompanied by the transfer to the same transferee of the transferor’s rights and obligations arising from the underlying relationship.

• Court guarantees (also called judicatum solvi, security for costs or appeal bonds) are procured by one or both litigants to guarantee the payment of money ordered in a judgment or arbitral award, as well as any associated costs or fees. Applicants, often the defendants (or counter-defendants), are thus assured that, if they are awarded a monetary remedy or their costs, they will be able to recover them. Litigation-related guarantees also include guarantees securing the payment of amounts or the performance of obligations agreed in a settlement ending a 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 guarantees), four (indirect guarantees) or multiple parties (syndicated or consortial guarantees), in all domestic and international settings.

Why are demand guarantees used?

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 international transactions. The immense success of demand guarantees lies precisely in their extreme adaptability to every conceivable situation.² Though a majority of demand guarantees are issued to secure non-monetary obligations, payment guarantees are also utilized as a cheaper alternative to documentary credits.

Legal nature of demand guarantees

5. A demand guarantee is a form of payment undertaking requiring payment against specified documents and, where the URDG apply, a written statement of breach.

[Page28:]

A demand guarantee possesses the same legal characteristics as a documentary credit despite serving a different function (see paragraph 18 below).

6. Unless the guarantee requires the beneficiary to present a document substantiating the breach, the beneficiary is entitled to demand payment without establishing or proving that the applicant is in breach of its obligations or the quantum of loss caused by that breach.³ Indeed, the beneficiary need not even assert a breach unless the guarantee so requires or the URDG apply. 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. If it is subsequently established that no breach has occurred, the applicant can (after reimbursing the guarantor) 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, because it is not a party to that relationship.

Fraud and other defences

7. Demand guarantees are sometimes described as near-cash instruments, signifying the importance attached to the ability of beneficiaries to rely on issuers fulfilling their undertakings to pay promptly on first written demand and presentation of any other specified documents. It is therefore only in exceptional circumstances that courts will grant an injunction to prevent a beneficiary from making a demand or a guarantor from making payment where a complying demand has been made. In extreme cases, however, the courts will intervene to protect the applicant for the credit from a demand that is unjustified or for which there is some other defence. These cases are discussed in Chapter 5. Where an injunction is sought against a guarantor, it is not for the guarantor either to dispute or to agree to the injunction. The appropriate response is to adopt a neutral position, abiding by whatever the court decides. Nevertheless, a guarantor notified of a court order preventing payment should inform the beneficiary of the court order without delay and transmit to the beneficiary a copy of the court order (see International Standard Demand Guarantee Practice for URDG 758 (ISDGP) paragraph 211).

[Page29:]

Documents

8. A demand guarantee is triggered by a written demand and, where the URDG apply, a statement of breach, which can be quite brief and general (see paragraph 337). Not infrequently the guarantee will call for the presentation of other documents, such as an engineer’s certificate, a surveyor’s report, a document authenticating the signature of the presenter or indicating the presenter’s authority to make the presentation, a certificate of analysis of shipped goods, a document by a third party certifying a delay in the shipment of goods, or even a court judgment, whether final or subject to appeal, or an arbitral award, although a requirement to present a judgment or award substantially converts the guarantee into a suretyship guarantee.⁴ If any of these documents are not presented within the guarantee’s validity period, the demand is incomplete and payment should be refused (see URDG article 14(b)). The guarantor should examine all presented documents required by the guarantee diligently and in accordance with professional standards. Articles 14 to 24 of URDG 758 provide a step-by-step approach for presenting and examining presentations to assess their conformity with the terms of the guarantee.

Non-documentary conditions

9. 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 URDG 758 apply, non-documentary conditions are deemed not to exist (see URDG article 7 and ISDGP paragraph 140). For more on non-documentary conditions, see paragraph 386.

Independence of guarantees

10. 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 Diagram 1) or, indeed, any relationship between the applicant and the beneficiary. Second, a demand guarantee

[Page30:]

is independent of the relationship between the applicant and the guarantor (segment 2 in Diagram 1).

11. The corollary of this independence is twofold:

• A demand guarantee is subject only to its terms, whether such terms are expressly stipulated in the 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.

• In the absence of fraud or other vitiating factors set out in Chapter 5, no defence arising under the underlying transaction (e.g. termination, set- off, force majeure, a commercial dispute between the applicant and the beneficiary, etc.) or the applicant-guarantor relationship (e.g. 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 to the knowledge of the guarantor before payment is made.

• Similarly, it is irrelevant to the guarantor’s duty to pay on presentation of the requisite documents that the beneficiary of the guarantee claiming payment is itself in breach of its obligations under the underlying contract. Of course, this assumes that there is no contrary provision in the guarantee based on documents, as opposed to external facts. However, where the guarantee provides, for example, that payment will not be made if the failure to perform the underlying contract is caused by force majeure, this provision is covered not by article 26, which concerns situations in which the guarantor’s ability to deal with presentation or payment is affected by force majeure, but by article 7, under which it is to be ignored as a non-documentary condition. The same applies to a provision to the effect that the guarantee is to continue in force until the beneficiary has released the guarantor.

12. Reflecting the independence principle, it is not usual for an issuing bank to ask for a copy of the underlying contract. Nevertheless, some banks do so in order to verify that they are dealing with an actual transaction rather than a money- laundering scheme.

[Page31:]

13. For the reasons set out below, a demand guarantee is different from a suretyship, an indemnity or a documentary credit, although some demand guarantees also incorporate indemnities (see paragraph 18 below).

Demand guarantees as distinguished from suretyships

14. A suretyship guarantee (also called an accessory guarantee, a suretyship, a “see to it” guarantee – where the guarantor’s duty is to see to it that the principal debtor performs – 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 if the applicant defaults in payment or other performance. So, whereas in the case of a demand guarantee the issuer is the first port of call for payment, in the case of a suretyship guarantee it is the guarantor who is primarily liable, and the measure of the surety’s liability is that of the applicant debtor. This entitles the surety to assert all those defences to the guaranteed debt that are available to the applicant and to only pay the amount that the beneficiary establishes as being owed by the applicant under the underlying relationship.

15. 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 the transaction in order to distinguish it from other transactions covered by the guarantee (see URDG article 8(d)). Neither should the mere description of the guarantee as a demand guarantee or as a suretyship guarantee be determinative.

16. Whether a guarantee is an independent guarantee or a suretyship guarantee is determined by its terms as a whole. Terms that express the guarantor’s duty as being to pay independent of default – for example, “regardless of objection by the [applicant or counter-guarantor]” or “without proof of default or loss” or words to this effect – are indicative of a demand guarantee. The situation is the same where the guarantee requires presentation of specified documents in addition to the written demand. However, problems arise where a guarantee combines phrases demonstrating the independence of the guarantee from the underlying transaction with phrases referring to default or limiting the guarantor’s liability to loss suffered by the beneficiary. In such cases, the court has to determine whether, overall, the guarantee is a demand guarantee or a suretyship guarantee. It is therefore important to avoid such phrases. 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 recognized as an independent guarantee.

17. The following examples illustrate the distinction between these two types of guarantees. In each case A has entered into a construction contract with B.

[Page32:]

Example 1: At A’s request, G Bank issues a guarantee in favour of B stating: “In the event of A defaulting in the performance of its obligations under the above- mentioned contract we will pay you the sum of £10 million.” This is a suretyship guarantee under which the guarantor’s liability is dependent on the default of the applicant.

Example 2: At A’s request, G bank issues a guarantee in favour of B stating: “We guarantee unconditionally and not as surety that we will pay you on written demand the sum of £10 million or the amount of your loss on the contract, whichever is less.” The first sentence is indicative of a demand guarantee but is qualified by the second, which requires the amount of the loss to be determined and limits G Bank’s liability for that loss. The guarantee is therefore a suretyship guarantee.

Example 3: At A’s request, G bank issues a guarantee in favour of B stating:

“We will pay you the sum of £10 million absolutely and unconditionally, and not merely as surety, on your first written demand. Payment will be made forthwith on presentation of a certificate by the contract architects stating that the applicant has failed to complete the contract works within the period specified in the contract.” In this case, the payment undertaking is conditioned only on the presentation of documents, as provided by article 15(a) of the URDG, rather than on an actual default. The guarantee is therefore a demand guarantee.

Demand guarantees as 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 dependent on another party’s default. However, it differs from a demand guarantee in that it is an undertaking to pay a specified or maximum sum on presentation of a demand and other specified documents, whereas an indemnity is 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. The only provision relating to indemnities in the URDG is article 31, which provides for indemnity against obligations and responsibilities imposed by foreign laws and usages. However, some counter-guarantees add indemnities, which might in certain cases cover losses suffered by the guarantor over and above the amount paid under the guarantee (see paragraph 31 below).

19. The term suretyship in other languages:

• in Arabic: kafala

• in Chinese (Mandarin): 保证 or bao zheng (in Pinyin)

• in Danish: kaution

• in Dutch: borgtocht

• in French: cautionnement

• in German: bürgshaft

[Page33:]

• in Italian: fideiussione

• in Norwegian: selvskyldnergaranti

• in Russian: poruchitelstvo

• in Spanish: fianza

• in Swedish: borgensgaranti

• in Turkish: kefalet

Demand guarantees as distinguished from documentary credits

20. Although they serve different functions, demand guarantees and documentary credits possess the same legal characteristics. Both are abstract payment undertakings that take effect upon issue without the need to meet any of the ordinary conditions of a contract, such as offer and acceptance, consideration, reliance or cause. Both are autonomous in that they are independent of the underlying transaction, which means that the issuer has to pay against conforming documents, regardless of whether there has been proper performance of the underlying contract by the beneficiary (in the case of a documentary credit) or a breach of the underlying contract (in the case of a demand guarantee). Both are documentary in character, which means that the issuer is only required to examine the documents presented, without enquiring into the facts. Finally, in both cases, the issuer acts as principal vis-à-vis the beneficiary, not as an agent for the applicant for the credit or guarantee. There the similarities end.

21. 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 demand guarantee necessarily implies that a default has occurred, although no proof of such default is required. In fact, in the absence of fraud or other vitiating factors, the guarantor must pay even if there has been no default.

22. Documentary credits also differ structurally from demand guarantees. Where the beneficiary of a documentary credit requires an undertaking supplementary to the issuer’s undertaking, a confirming bank will issue its own confirmation in favour of the beneficiary, which will then enjoy two separate and direct undertakings: the issuers and the confirmer’s (see Diagram 2). 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).

[Page34:]

23. Documentary credits and demand guarantees nonetheless share the same legal characteristics.

Diagram 2: Confirmed Documentary Credit

Demand guarantees as distinguished from standby letters of credit

24. Standby letters of credit were developed in the United States in the 19th century as a result of a statutory prohibition on national banks to issue accessory guarantees, which were considered to be too hazardous.⁵ Banks therefore resorted to using documentary credits but assigned them a default function: instead of paying the letter of credit upon proper performance of the obligation, it is the non- performance of the obligation that triggers the beneficiary’s demand. Accordingly, with the exception of a direct pay standby letter of credit, 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. By contrast, in a direct pay standby letter of credit (which is really a contradiction in terms), the issuer is meant to be the first port of call for payment, since the credit is 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 established. Direct pay standby

[Page35:]

letters of credit are used, in particular, as a credit enhancement device for sub- investment grade securities issued by municipalities in the United States.

25. 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 and the express authorization of the Office of the Comptroller of the Currency (OCC) for national banks to issue independent undertakings (starting in 1996)⁶6 and, under certain conditions, accessory undertakings (starting in 2008).⁷ Federal courts in the United States give effect to demand guarantees and counter-guarantees as being functionally equivalent to international letters of credit, and thus subject to letter of credit law, particularly article 5 of the New York Uniform Commercial Code.

As these courts have correctly held, this is because letters of credit and demand guarantees share the principle that they are independent of the underlying relationship between the applicant and the beneficiary.⁸

Multi-party guarantees; syndicated guarantees

26. 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.

27. 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 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 duties for the benefit of the class is an elementary precaution that parties

[Page36:]

to a guarantee involving a multi-party structure should consider. For more on this, see paragraph 36 of the ISDGP.

28. If, instead of a syndicate, 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 to which all the rights and duties are ascribed under the guarantee. In such cases, the other participants are not privy to the relationship that the guarantor has with the applicant(s) or beneficiary(ies).

Two-party guarantees

29. Two-party guarantees are issued for the guarantor’s own account or at the request of the beneficiary itself. While it is possible for a company to 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, it is more frequent to see two-party guarantees used where the head office of a company issues a guarantee covering the liability of its overseas branch vis-à-vis its creditors (see URDG article 3(a), under which a foreign branch is considered a separate entity). The beneficiary can then look to the head office for payment as well as to the branch. 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 to transfer 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. The resulting situation is functionally equivalent to “silent” confirmations of documentary credits, where a bank confirms a credit upon the request of the beneficiary rather than the request of the issuing bank.

Guarantees not issued in connection with an underlying contract

30. Guarantees may be issued to cover obligations in connection with an underlying relationship that arises as a matter of law or as a result of a 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 in practice not re-exported within that time.

What is a counter-guarantee?

31. The need for an indirect guaranteed 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-

[Page37:]

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 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. Not infrequently a counter-guarantee also includes an indemnity against any loss suffered or liability incurred by the guarantor by entering into the guaranteed transaction. This indemnity confers on the guarantor additional protection where it suffers loss or incurs a liability in excess of the amount of the guarantee, for example because of any additional burdens imposed by local law. As Bertrams has pointed out,⁹ even without the counter-guarantee, the request to the local bank to issue the guarantee would entail a commitment to reimburse the issuer as an incident of the mandate generated by the request. The effect of the counter-guarantee is to crystallize the duty of reimbursement that would otherwise be imposed on the guarantor.

32. 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

[Page38:]

Structure of a counter-guarantee

Diagram 3: Indirect Guarantee

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

Independence of a counter-guarantee

34. 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:

• Each undertaking is subject only to its own terms. Thus:

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

[Page39:]

– a guarantee may be governed by a law different from that governing the counter-guarantee and may confer jurisdiction on a different court (this is the default rule in URDG articles 34 and 35, see paragraphs 1131 and 1132 in Part II);

– 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.

• 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.

• The 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 included in the counter-guarantee. This could potentially take the form of a reference in both the guarantee and the counter- guarantee to the same index, whose variation triggers the variation of the guarantee and counter-guarantee amount.¹⁰

• 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.

• 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.

[Page40:]

Can the beneficiary make a claim against the counter-guarantor?

35. 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. See also Eurocopter v. Banque Melli Iran, No. 09-12.701, which addressed the question of a demand held to be abusive because it was motivated by the beneficiary’s attempt to extract from the guarantor an increase in the amount of the guarantee.

Can the applicant make a claim against the guarantor, and vice versa, under an indirect guarantee?

36. The above holds true when examining a possible claim by the applicant against the guarantor under 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.

37. Once again, however, where the applicable law so permits, the applicant could avail itself of a direct claim against the guarantor under 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

[Page41:]

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.

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 under 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, which is discussed in paragraph 35.

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.

[Page42:]

---

---