Article

by Sarah Younger

In May 2010, a full-day seminar was held in Tel Aviv on the subject of the URDG 758. No less than 250 people listened avidly to the words of Dr Georges Affaki, the Chairman of the ICC Drafting Group on the URDG 758.

Among those present were bankers from all the Israeli banks and lawyers from firms with international trade departments, but the majority present were representatives of big corporations and middle-market businesses which, in their trading operations, open international guarantees.

It must be acknowledged that URDG 458 have not been successful in Israel, and most of the guarantees issued by the Israeli banks have been subject to the laws of the State agreed between the exporter and importer. Standby L/Cs were generally subject to the UCP.

Reasons for non-acceptance

Why were URDG 458 not accepted in Israel? Following are some reasons:

1. No small number of guarantees were required to be opened for closed projects and in large amounts. These were issued with the wording agreed in advance by the lawyers on behalf of both parties. It was unusual for these texts to be subject to URDG;

2. The Israeli banks did not, to say the least, like, the provisions of article 20 of URDG 458 providing in sub-article 20 (a) that "Any demand for payment under the guarantee shall be in writing and shall (in addition to such other documents as may be specified in the guarantee) be supported by a written statement (whether in the demand itself or in a separate document or documents accompanying the demand and referred to in it) stating:

i. That the principal is in breach of his obligation( s) under the underlying contract( s) or, in the case of a tender guarantee, the tender conditions, and

ii. The respect in which the principal is in breach."

The reluctance of the banks to incorporate article 20 arose from their desire to make it easier for beneficiaries of guarantees to present a demand suitably complying with the text of the demand as provided for in the guarantee, without the necessity of a further declaration as required under URDG 458 (even if article 20 of URDG 458 stated expressly that it was possible to exclude it in the guarantee);

3. The banks' lack of detailed knowledge of the rules and their benefits; and

4. Lack of awareness by lawyers, representatives of the trading companies of the existence of the rules and of their benefits to parties to guarantees.

Change of attitude

The new version of the URDG caused a significant change in the banks' attitude. The main reason stems from the intense involvement of practitioners in the process of revising URDG 458.

Representatives of all the Israeli banks that participated in the local Israeli National Committee of the ICC studied together the drafts issued by the Drafting Group. Each article and its meaning was analyzed by members, both in view of benefits to their customers and the ease with which banks could issue the guarantees. As the result of this involvement there was a greater recognition that the benefits of the URDG exceeded the drawbacks. Upon reading the final text, a large majority of the members declared they would recommend to their customers that guarantees should be subject to the new rules.

The benefits

Bankers in Israel saw a range of benefits in the new rules:

- Many people dealing with guarantees in the banks also deal with documentary credits. The changes in the structure of UCP 600, which coincide with certain changes in URDG 758, significantly eased the process of learning the subject and applying daily working procedures;

- There is no necessity to repeat in the text of the guarantee the principles and provisions of URDG 758. Focusing on the essentials and important details of the specific transaction without drowning in a sea of verbosity were appealing to issuing banks;

- URDG 758 contain a specific reference to counter-guarantees;

- There is a distinction between demands for payment and for extension or payment;

- There is a specific time limit for the examination of requested documents;

- The Rules clearly resolve the problem of the governing law. It is preferable to base international transactions on standard rules acceptable throughout the world, than on the laws of a state which are not known in depth by one of the parties;

- Regularization of guarantees without a validity date and, more importantly, without an expiry event, both from the aspect of collateral held by the bank for an unlimited period and from that of the applicant - the one who requests the issue of the guarantee;

- The reference to force majeure is very important as a response to the problem of banks being closed as the result of natural disasters, acts of terrorism, etc.; and

- The standardization of guarantee texts simplifies the issuance of all kinds of guarantees.

URDG 758 and Basel II

In addition to the fact that practitioners understand the benefits of using the Rules, Basel II has imposed a greater necessity for the receipt of independent and irrevocable guarantees, in particular if a bank relies upon them as collateral for a credit. URDG 758 ensure that guarantees subject to them will be direct, explicit, clear, irrevocable and independent. The provisions of Basel II provide that such guarantees can be taken into account when calculating capital requirements, so long as banking institutions comply with specific operational threshold conditions in connection with procedural management of risks related to the protection of these credits.

With the validity of guarantees subject to these uniform rules, a bank has the right, as the beneficiary of the guarantee, to receive all payments from the guarantor without being required to take legal steps against another party.

In order to comply with the Israeli Basel II requirements, Israeli banks are allowed to rely on certain collateral posted by a counter party or third party to reduce their credit exposure to the counter party, provided guarantees and credit derivatives are binding on all parties and legally enforceable in all relevant jurisdictions. According to Bank of Israel (the Israeli Central Bank), these requirements also apply to bank guarantees received as collateral by banks from foreign banks. This requirement does not seem practical (or consistent with market practice), as it requires banks to receive legal opinions when there are foreign bank guarantees. In light of the above, Israeli banks are considering utilizing bank guarantees for Basel II purposes without requiring legal opinions if the guarantees are subject to the rules of ICC (URDG 758 or UCP 600).

Summary

No doubt it will take time for the use of URDG to equal that of the UCP, but it is clear that an important step has been taken towards their adoption worldwide. In order to achieve this, it is necessary to provide extensive education, not only for banks engaged in the field, but also for their customers and the lawyers assisting them. This will involve arranging meetings before large audiences, as well as individual explanations to each customer requesting the opening of a guarantee. I am optimistic that, in time, URDG 758 will be accepted in all regions.

Sarah Younger is the Head of International Trade and Payments at Bank Leumi Le-Israel. She is also the Chair of the ICC-Israeli Banking Committee. Her e-mail is sarahy@bll.co.il