Books

Chapter 2

The road to URDG 758

Why the URDG?

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

• The first stage was characterized by the absence of internationally accepted standard terms for demand guarantees.

• In the second stage, an attempt to impose the Uniform Rules for Contract Guarantees (URCG) on the market failed because they did not meet the market’s expectations. One of the reasons for this was that the requirement to produce a judgment or arbitral award in support of a claim almost amounted to a requirement to demonstrate default.

• In the third stage, URDG 458 were drafted in response to the market’s demand for a guarantee that offered a fair compromise between the interests and concerns of all the relevant parties.

• Finally, after 15 years of applying URDG 458, an ambitious revision was launched in 2007. This led, two and a half years later, to the adoption of URDG 758 on 3 December 2009.

In the beginning … a void

39. Bankers and traders engaged in international trade and project finance in the 1970s will remember the negotiation process for cross-border guarantees. There were no uniform rules, standardized practices or internationally harmonized 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 greater bargaining power – generally the beneficiary – so required. Negotiating the terms of demand guarantees and counter-guarantees was all the more difficult amid the 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

[Page43:]

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 – 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 alleged by the beneficiary, 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. Guarantors and counter-guarantors therefore 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 greatest bargaining power. More often than not, this party was a state- owned beneficiary. This led to lengthy negotiations, conducted in an adversarial context and resulting in imprecise drafting, with frequent litigation and costly 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

[Page44:]

found. That alternative could only consist of having a third party with acceptable financial means undertake to pay a predetermined 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.

The URCG

45. Inspired by the success of the Uniform Customs and Practice for Documentary Credits (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 led to the adoption of the Uniform Rules for Contract Guarantees (URCG) (ICC Pub. No. 325) on 20 June 1978. The URCG were followed, four years later, by the Model Forms for Issuing Contract Guarantees (ICC Pub. No. 406), which were to be used in conjunction with the URCG if the parties so wished.

46. Regrettably, the URCG were drafted to respond only to the concerns of applicants (called “principals” in the rules) but not to those of beneficiaries or guarantors. The disparity between the URCG and the expectations of a buyers’ market regarding a cash-equivalent instrument 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.

[Page45:]

49. The URCG also suffered from other congenital deficiencies. First, they contained no specific provisions on counter-guarantees, nor did they purport to regulate them by analogy to guarantees. They simply ignored them. Second, 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 had presumably been 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 achieved 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 elsewhere.¹³

URDG 458

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

51. Hundreds of pages of comments were received from international organizations and ICC national committees, including those representing traditional beneficiary strongholds.¹⁴ All were duly reviewed and, where appropriate, incorporated into the 11 drafts that were 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 Uniform Rules for Demand Guarantees (URDG), which were adopted by the ICC Executive Council on 20 December 1991. The URDG 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 URDG 458 between the conflicting interests at stake can be summarized as follows:

[Page46:]

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. However, 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 guarantee. This is the application of the general principle, now universally recognized 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 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’s or surveyor’s report, a decision of a dispute adjudication board, an arbitral award, etc.

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 falls outside the scope of the URDG.

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 (i) the independent nature of the guarantee and counter-guarantee and (ii) the documentary nature of these undertakings. This insulates both guarantees and counter-guarantees from the underlying relationship and confines guarantors and

[Page47:]

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 the presentation of documents (availability for presentation, reduction of amount, expiry, payment, termination, etc.), the independence of such an undertaking cannot be challenged.¹⁶

URDG 458’s success

55. By offering balanced rules and codifying the market’s existing practices within that spirit, 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 time and effort on negotiating and drafting 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 Uniform Act on Secured Transactions (1997 and 2010) of the Organization for the Harmonization of Business Law in Africa (OHADA)), bank regulators have recommended their use by their national banks (e.g. the Central Bank of Iran’s circular of April 2004), international organizations 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.

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 Guarantees¹⁷ presented the case for the revision of 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 URDG 458 in 1991. Articles 2(d), 7(a), 10, 17, 20, 21, 25 and 26 of 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

[Page48:]

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 relevant in the light of the continuing requests of small and medium- sized banks and businesses to align both the drafting style of and solutions provided by the URDG 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 UCP 500/600 and URDG 458. Differences included the lack of specific rules in the URDG concerning non-documentary conditions, transfers of guarantees, the rejection process and preclusion. Finally, 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.

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

• more comprehensive, by covering areas of guarantee practice not covered by URDG 458, such as 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 compiling 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 included the interaction between articles 20(a)(i) and (ii) and between articles 10 and 21, the application of the URDG to counter-guarantees and the definition of “writing” in paper and electronic documents.

The revision process

58. Building on the revision process of UCP 600, a two-tier structure was put in place: (1) a drafting group comprising a small number of experts who were to be chosen by the Task Force on Guarantees from among its members and other ICC members with relevant expertise and (2) 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

[Page49:]

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 organizations that showed interest in the process were also invited to submit 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 ensured that the revision took 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.

61. As will be explained in detail in Chapter 4 and Part II of this Guide, the new URDG 758 endorse and build on the balance that 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 URDG 758 and URDG 458.

URDG 758 and URDG 458 compared

[Page50:]

[Page51:]

[Page52:]

[Page53 :]

[Page54:]

---

---