Article

by Pradeep Taneja

On 25 October 2006, over 250 members of the ICC Banking Commission representing more than 50 countries assembled in Paris. In the meeting, more than 3½ years of intensive effort to revise UCP 500 resulted in approval of UCP 600 by a unanimous vote of 91-0.

"Excellence in preparation, excellence in execution and excellence in result", remarked Dieter Kiefer, the outgoing Chairman of the Commission. But the meeting was not over. The next item on the agenda was a presentation by Dr Georges Affaki, Chair of the Task Force on Guarantees, who was to discuss the most recent work of the task force and seek the Commission's approval to begin work on the revision of ICC's Uniform Rules on Demand Guarantees (URDG), ICC Publication No. 458.

The question was not whether the URDG needed to be revised. Member after member, representing a spectrum of countries, agreed that there was a genuine case for the revision of the rules, to standardize and harmonize international demand guarantee practice and the techniques that have evolved over time.

After intensive debate, the task force was "given a mandate to seek a mandate" to start the revision process. And thus the URDG revision process began, an historic opportunity, not only to promote and propagate widespread acceptance and usage of the URDG worldwide, but also to establish "international standard demand guarantee practice", to align the URDG with UCP 600 and, where appropriate, to seek inspiration from the relevant provisions of ISP98 and the UN Convention on Independent Guarantees and Standby Letters of Credit.

History

The constitution of the Task Force on Guarantees in 2003 contributed to a growing awareness of the advantages of the URDG. The adoption of the URDG by the Federation of International Consulting Engineers (FIDIC) in their guarantee templates, and later by the World Bank, had also a significant impact in increasing the number of URDG guarantees and counter-guarantees.

In many countries, national lawmakers took the URDG as a model for independent guarantee statutes. For example, The Uniform Securities Act, as adopted by the 15 African states belonging to OHADA (Organisation for the Harmonisation of Commercial Law in Africa) provides that the demand for payment under a guarantee must not only state that the principal has breached, but also in what respect the principal has breached his contractual obligations towards the beneficiary, a provision based on URDG article 20.

Referral or application of URDG as trade usage by some courts, even though the disputed guarantees were not even issued subject to URDG, lent credence and credibility to the rules and gained further acceptance for them by banks, principals and beneficiaries.

Islamic banking

In my own country, Bahrain, a three-day training programme on the URDG has become almost a regular feature at the Bahrain Institute of Banking and Finance (BIBF). In the Trade Finance Department of my own bank, Al Salam Bank, all of our counter-guarantees in favour of foreign correspondents have been issued subject to URDG. The Head of Sharia Compliance in the bank, Shaikh Osama Bahar, subscribes to the view that there is nothing in the URDG that, directly or indirectly, is in conflict with the provisions of Sharia principles. We believe this should be the approach by other Islamic banks in the region as well.

Indeed, URDG can be applied to guarantees issued by Islamic banks, since most Islamic bank guarantees are akin to those of the conventional ones insofar as they are both non-funded and fee-based transactions, i.e., they do not involve payment of interest or Riba, the Islamic term for interest. The practices are similar except to the extent that the underlying transaction and purpose of guarantee are vital for an Islamic Bank, which should neither be for a purpose expressly prohibited by Sharia, e.g., for speculative activity or a transaction dealing with import/export of goods or documents covering illegal activities forbidden by Islam, nor for a purpose of seeking an interest-based loan.

Islamic banking discourages abuse of the instruments of a guarantee or documentary credits and advocates fairness, upholding the tenets of equity for all parties concerned. It discourages "unfair calls" on guarantees, a principle no different from that embodied in article 20 of URDG 458, calling for a beneficiary's statement of default to protect the principal and to deter the beneficiary from making an unfair call.

The AAOIFI (Accounting and Auditing Organisation for Islamic Financial Institutions) standard 8.6, relating to third- party guarantees, stresses the principle of independence and autonomy of the "promise" (i.e., guarantee) from the "contract", a principle articulated in sub-article 2 (b) of URDG 458 and article 4 of UCP 600, whereby guarantees or credits are separate transactions from the contracts on which these might be based.

Guarantee practice in Middle East

The ICC Bahrain Trade Finance Forum is supported by the Bankers' Society of Bahrain in an effort to dispel the mistaken belief of some international bankers that there are issues relating to expiry provisions in GCC/Middle Eastern practices. Contrary to the belief that there are mandatory laws in most Middle Eastern countries requiring that beneficiaries, including ministries and government organizations, demand that the guarantees in their favour be issued on open-ended basis, i.e., without an expiry date or an expiry event, the fact is there are no such legal requirements.

Under the Commercial Law of Bahrain and as per the opinions we have received from some banks in GCC countries, a guarantee cannot be called after its expiry. Moreover, the return of the guarantee by the beneficiary is tantamount to its termination. However, if a beneficiary of a guarantee approaches the issuing bank to extend the validity of the guarantee or, as an alternative, to pay, the issuing bank is obliged to "extend or pay", provided the beneficiary has approached the issuer within the validity of the guarantee, i.e., prior to the guarantee's expiry date or expiry event. In this regard, the laws are no different than the relevant provisions of URDG.

Issues for the revision

There have been suggestions as to what should be or is likely to be revised in the URDG. At this stage, we cannot be sure of what will be in the final text, but the following points are being considered.

As demand guarantees are primarily documentary in nature, the new URDG is expected to take into account the fact that apart from a demand accompanied by a statement of default, guarantees under the current practice also require, inter alia, copies of the documents of the kind covered by UCP 600, e.g., copies of unpaid invoices and bills of lading. Accordingly, there is likely to be some provision in the new URDG specifying a standard for examination of documents.

As both demand guarantees and letters of credit are similar in nature, it is natural that the governing ICC rules should offer similar solutions. Therefore, this revision should take advantage of this singular opportunity to align the URDG with UCP 600 by the introduction of new terms and new separate articles on definitions and interpretations. It should also aim to achieve what UCP 600 could not, i.e., lend credence to the existing "customs and practice" by an explicit recognition and acknowledgement that the issuers of guarantees or counter-guarantees are not necessarily banks. Issuers can also be "parties", such as insurance companies, corporates or other bodies and persons. Accordingly, terms such as "issuing bank" may need to be replaced with others such as "guarantor", "counter-guarantor", etc. Furthermore, to simplify and align URDG with other ICC rules, the word "principal" may be replaced with word "applicant".

While the URDG 458 provide for guarantees issued either on a direct or an indirect basis, in today's practice cross-border guarantees are often routed through the issuer's correspondents in the country of the beneficiary, to be advised after authenticating the guarantee. Accordingly, an article on advising the guarantee, along with a definition of the advising party and the second advising party, is likely to be required in the new URDG, along the lines of similar language in UCP 600.

It will also be necessary to bring clarity and precision to the rules by removing imprecise phrases such as "reasonable care" in articles 9 and 15 and "on their face" in article 9, terms that are linked to examination of documents to ascertain whether or not they are in conformity with the guarantee terms. Likewise, the term "reasonable time", now appearing in article 10 to describe the period within which the guarantor must decide whether to pay or refuse the demand, should be removed and replaced with a definite number of days, as is the case with UCP 600. However, the new URDG may prescribe a lesser number of days than the maximum of five banking days allowed in UCP 600 to accept or refuse documents, since it takes fewer days to examine a URDG demand.

Apart from these changes, it is my view that the drafters of new URDG owe it to the world of guarantees to demonstrate how the URDG can include transferability and assignment of beneficial interests in a guarantee to cover an assortment of current alternate techniques of asset-based lending, which include those arising from guarantees covering international trade receivables, based on the "assignment" of proceeds, which is essentially a "transfer" of the beneficiary's right to the proceeds.

Accordingly, the scope of the existing article 4 on assignment could be broadened to encompass transferable L/Cs with a reference to the "applicable law" on assignment of this right of the beneficiary.

Other issues

In view of other developments during the 15 years since URDG came into effect, its disclaimer articles may need to be updated and revised, particularly in view of new provisions in UCP 600. For example, article 11 on effectiveness of documents could be expanded to include the description, quantity, weight, quality, value or existence, etc., of the goods, services or other performances represented by any document. Article 12, the UCP equivalent of the disclaimer article on translation and transmission, needs to be revised and aligned with article 35 of UCP 600. Article 13 dealing with Force Majeure should include "acts of terrorism" as one of the acts covered, in line with article 36 of UCP 600. Similarly, the existing article 15 should be revised to bring it into conformity with UCP 600's article 37 for disclaimers concerning acts of an instructed party.

Conclusion

To repeat: this revision offers an historic opportunity for the ICC Banking Commission and for trade finance bankers, not only to promote use of the URDG, but also to standardize and harmonize international standard demand guarantee practice and to bring these rules in line with other ICC rules that have been widely accepted by the marketplace. I echo the words of my colleague Dr Andrea Hauptmann in the October-December 2007 issue of DCInsight: "One day, the URDG will be the standard for guarantee practice as UCP are now for L/Cs."

Pradeep Taneja is a member of the ICC Banking Commission and of the URDG Drafting Group. He is the Chairman of the ICC Bahrain Trade Finance Forum and Vice President, Head of Trade Finance Services at the Al Salam Bank in Manama, Bahrain. The views expressed herein are his own.

His e-mail is pradeep_taneja@yahoo.co.in