Article

by Kim Sindberg

Approaches to standby letters of credit (standbys) and guarantees differ in different parts of the world. People perceive things differently, and that has an impact on how practice evolves. Take for example the Americas where standbys are generally used when issuing a guarantee undertaking. In Europe, however, (and for that matter in other parts of the world) guarantees serve the same purpose.
It is said that the counter-guarantee originated in the Middle East1, and the standby was invented in the US because US banks - at a certain point in time - were not allowed to issue guarantees2.

It may not seem fruitful to have too many rules dealing with instruments that are intended to cover similar transactions, e.g., URDG 758 (for demand guarantees), UCP 600 (for documentary credits - which include standbys), ISP98 (for standbys) or, for that matter, "no rules", i.e., local law. Add to these the forms used for these instruments, which also differ considerably: letter of guarantee, SWIFT MT760, SWIFT MT700, SWIFT MT799 or the good old telex.

The question is whether it makes a difference what these instruments are called. Can a guarantee always be used in lieu of a standby and vice versa?

Rules versus structure

When considering the differences between two instruments, the rules used are important. They define the basis for the transaction, the obligation of the parties and reflect the structure of the transaction.

The traditional guarantee is used when a guarantor issues an undertaking vis-àvis a beneficiary. If the beneficiary would like to obtain an undertaking from its own bank, this is solved by using a counter-guarantee.

This means that the beneficiary of the guarantee receives a guarantee issued by a bank (guarantor), even though it is originally issued by the applicant's bank (counter-guarantor). The counter-guarantee indemnifies the guarantor in the event a complying demand is made (by the beneficiary) under the guarantee. The counter-guarantee and the guarantee are two separate guarantees, independent of one another.

In similar circumstances, the standby is generally confirmed by a confirming party. The ISP98 rules state that the "issuer" includes a "confirmer" as if the confirmer was a separate issuer and its confirmation was a separate standby issued for the account of the issuer"3.

Rules versus no rules

Guarantees

In 2010, a new version of the URDG, URDG 758, came into force. Those are ICC's Uniform Rules for Demand Guarantees. Even though rules designed for demand guarantees have existed since 1992, there are still a substantial number of guarantees issued without reference to any rules. There are also examples of a counter-guarantee and a guarantee being issued subject to different rules.

Standby

Practically every standby is issued subject to rules, either ISP98 (International Standby Practices) or UCP 600. The latter is designed to facilitate commercial documentary credits and may not always be suitable for standbys, whereas the first is made specifically for standbys.

Comment:

It is a clear advantage to have a standby/guarantee issued subject either to ICC/IIBLP rules than to no rules at all. Although there may be provisions in the rules that are not always desirable, it is still easier to navigate when one knows which rules apply. Being subject only to local law means that the outcome of a potential dispute will be far from a given.

Points of entry/ availability

Guarantees

A guarantee is only "available" with the guarantor. The beneficiary has one point of entry and must make a demand to the guarantor on or before the expiry of the guarantee.

The beneficiary cannot present a demand to a counter-guarantor, and a complying demand to the guarantor does not obligate a counter-guarantor.

Standby

A standby may include a "confirming party" which, (depending on the wording in the standby), allows the beneficiary to present either to the confirmer or the issuer. In a worst case scenario where the confirmer goes bankrupt, the beneficiary may present to the issuer. It should also be noted that a complying presentation to a confirmer also obligates the issuer.

Comment:

From the perspective of the beneficiary, this is an advantage for the standby over the guarantee. When the beneficiary has done its "duty" under a standby, i.e., made a complying presentation to the confirmer, then both the issuer and the confirmer are obligated. The same is not true for guarantees; a complying demand to the guarantor only obligates the guarantor.

Expiry dates and places

Guarantees

Since the counter-guarantee and the guarantee are two separate guarantees, each guarantee includes its own expiry date and place. These are normally "adjusted", so that it is expected that the guarantor will have sufficient time to make a demand under the counter-guarantee when a demand is made under the guarantee. However, there is the risk that this may not be possible.

Standby

Since there is only one standby, there is only one expiry. If there is a confirmer, then the presentation must be made to the confirmer or, if the standby permits, also to the issuer. In this , a complying presentation to the issuer will also obligate the confirmer. A complying presentation to the confirmer always obligates the issuer.

Comment:

A confirmer knows that the issuer is obligated when a complying presentation is made under a standby.

The same is not true for a guarantor that has issued a guarantee on the basis of a counter guarantee, as the guarantor must make a complying demand to the counter-guarantor. This raises the risk of not being able to present a complying demand.

It should be added that when a complying presentation under a standby is made to the confirmer, then the risk of documents being lost in transit lies with the issuer. The same is not true for guarantees. However, this may be solved by allowing for demands via electronic means (e.g., SWIFT).

Protection

Guarantees

It is not clear whether a guarantor that is not being reimbursed by the counter-guarantor due, for example, to an injunction against the counter-guarantor, is protected by URDG 758. According to the Guide to ICC Uniform Rules for Demand Guarantees - URDG 758, in similar circumstances, there would be a possibility to sue the applicant.

Standby

Under a standby, when a confirmer pays out on the basis of the nomination granted by the issuer, the confirmer is "protected" by the applicable rules. This is the case when a court injunction is filed against the issuer. It should be noted that this is the generally understood practice, but courts may rule differently based on local law.

Comment:

This is a legal issue, and it may be hard to foresee the outcome of an actual case. However it appears that the standby offers more protection in cases like this.

Law and jurisdiction

Guarantees

For demand guarantees, the applicable law and jurisdiction is the place of the counter-guarantor for the counter-guarantee and the place of the guarantor for the guarantee. There can result in a "mismatch" between the law and jurisdiction of the two instruments, possibly creating a dilemma in the event of a dispute.

Standby

There is a general understanding that the law and jurisdiction of a standby is the place where the standby is available.

Comment:

The rule for guarantees is stated clearly in URDG 758. However, it can be a messy situation with two guarantees covering the same transaction but subject to two different laws/jurisdictions.

In other words, there is only one instrument, but two parties (issuer and confirmer) are obligated under it.

As such, ISP98 includes a more sophisticated gallery of characters than URDG 758. A standby may nominate a person to carry out certain duties, e.g., confirm4 the standby, while the rules for guarantees do not include this option. For guarantees, it is only possible to add an "advising party", whose sole role is to advise the guarantee and not to assume any kind of "undertaking" under it5. If an undertaking by another party is required, then a counter-guarantee is necessary.

The differences

The above-mentioned differences in structure make a guarantee - by nature - different from a standby. The following is not a test of whether one set of rules (e.g., URDG 758) is better or worse than another set of rules (e.g., ISP98), but rather a comparison of the structural differences in demand guarantees versus standbys. The assumptions at the end of this article are based on the situation in which the beneficiary's bank has obligated itself to the beneficiary:

Conclusion

The standby is a more sophisticated instrument than a traditional guarantee. In some cases, this does not matter, for example where the guarantor and the beneficiary live in the same country. In others, for example in cross-border transactions where the beneficiary requires an undertaking by its own bank, this can mean the difference between being paid or not!

The demand guarantee is a reliable instrument that has been around for many years, and seems to be working well. However, when making a facts-based analysis it is hard to reach any conclusion other that the standby has significant advantages, at least in the situation where the beneficiary requires an undertaking from its own bank.

The differences between the two instruments, some of which are considerable, may well justify the use of two different sets of rules.

Kim Sindberg is Vice President and Technical Trade
Finance Adviser at Nordea.
His e-mail address is kim.sindberg@nordea.com

1 See e.g. LCUpdate, "IIBLP Budget Letter Released!", September 2011.

2 See Guide to ICC Uniform Rules for Demand Guarantees URDG 758 (by Dr. Georges Affaki and Professor Sir Roy Goode) Chapter 1,11.

3 ISP98, Rule 1.11c.

4 Id., Rule 2.04.