Article

Factual Summary: Beneficiary sold equipment and materials for a cashmere processing plant in Mongolia under a deferred payment contract for US$18,511,670. Disputes between the Seller and Buyer resulted in several reschedulings of the payment obligations of the Buyer. Following non payment of most of the rescheduled amounts, Seller demanded payment of US$13,796,556 plus interest under the undertaking issued by the Finance Ministry of Mongolia, reproduced below. Issuer refused to pay on the grounds that the reschedulings materially changed the underlying obligation with the effect of discharging its obligations under its undertaking. The claimant Beneficiary sought to eliminate that defense by characterizing the undertaking as "independent".

Legal Analysis:

The English Court of Appeal held that the undertaking issued by the Finance Ministry of Mongolia, reproduced below, was not an independent undertaking. The court emphasized that the Issuer was not a bank and held that only bank undertakings to pay on demand enjoy a presumption of independence, such that they are enforceable as first demand guarantees or performance bonds that are analogous to letters of credit. The court then determined that neither the text of the undertaking nor any other factor overcame the presumption of non-independence of the non-bank undertaking in this case.

For procedural reasons the court did not consider any other grounds for treating the undertaking as unaffected by reschedulings of the underlying payment obligations.

Comment by James G. BARNES:

1. Determining which undertakings qualify as independent and which do not can be difficult, particularly if there is no clear statutory or case law definition of independence.

2. US law provides a clear framework for identifying undertakings that qualify as independent. The Restatement Third, Suretyship and Guaranty, broadly defines guarantee and suretyship relationships and expressly excludes letters of credit from the definition. The Uniform Commercial Code defines letters of credit, essentially as undertakings to pay against the presentation of documents, so as to exclude from suretyship law commercial letters of credit, standby letters of credit, and independent guarantees, notably undertakings issued subject to UCP500, ISP98, and URDG, as well as Article 5 of the UCC itself. A feature of the law and practice applicable to such undertakings is that nondocumentary conditions, if any are included in the undertaking, must be disregarded. A consequence of this interpretive rule, as well as the statutory definition of "letter of credit", is that an undertaking containing nondocumentary conditions that are essential to the undertaking may not qualify as a letter of credit, in which case they would not be excluded from the definition of suretyship. Fortunately, the divide between independent and non-independent undertakings is not frequently tested in the US, and US case law applying UCC Article 5 in this regard is generally good.

3. Outside the US there is much more testing of the divide between independent and non-independent undertakings both in practice and in the courts. There is more inclination to draft undertakings that are intended to be independent and then to add recitals and waivers appropriate for suretyship undertakings but not for independent undertakings. There is an understandable desire on the part of courts, and the banking industry generally, to enforce bank undertakings to pay without regard to the facts of performance or default in the underlying transaction. Accordingly, there is considerable case law outside the US treating bank undertakings as independent that are riddled with nondocumentary conditions and otherwise in a form that would not be issued by a US bank. In this case, the English court rather struggled to decide that the undertaking before it was not independent, because, had it been issued by a bank, it might have qualified under English case law precedent as independent, even though it is indefinite as to the form and substance of the demand required to be presented, its duration and amount are expressed only in terms of a defaulted underlying obligation, and it does not incorporate rules that might signify its independence and provide for disregard of nondocumentary conditions.

4. US law recognizes that ordinary guarantors may effectively waive defenses otherwise available to a secondary obligor, notably by providing in the guarantee that the beneficiary may change the underlying obligation, or release collateral, or otherwise agree to pay as if a primary obligor. It appears that English law is similar, but for procedural reasons the Court of Appeal did not address the possibility that this particular undertaking should be unaffected by a rescheduling of the underlying debt even though it did not qualify as independent.

TEXTUAL APPENDIX

The following text appeared in the report of the decision:

To: Marubeni Hong Kong Ltd

In consideration of your entering into the deferred payment sales contract No 258500 (hereinafter called the 'agreement') with Buyan Holding Co Ltd, a corporation duly organised and existing under the laws of Mongolia, with its principal office at I-40000-68-4 Ulaanbaatar, Mongolia (hereinafter called the 'buyer') for sales and purchase of a textile plant the contract price of which is United States dollars eighteen million eight hundred eleven thousand six hundred seventy (US$18,811,670), the undersigned Ministry of Finance of Mongolia unconditionally pledges to pay to you upon your simple demand all amounts payable under the agreement if not paid when the same becomes due (whether at stated maturity, by acceleration or otherwise) and further pledges the full and timely performance and observance by the buyer of all the terms and conditions of the agreement. Further Ministry of Finance undertakes to hold indemnify and hold you harmless from and against any cost and damage which may be incurred by or asserted against you in connection with any obligations of the buyer to pay any amount under the agreement when the same becomes due and payable (whether at stated maturity, by acceleration or otherwise) or to perform or observe any term or condition of the agreement, or in connection with any invalidity or unenforceability of or impossibility of performance of any such obligations of the buyer.

This covenant shall come to force from the date of implementation of this agreement and remain in full force and effect until all amounts due to you by the buyer under the agreement have been paid in full and all the terms and conditions of the agreement have been fully performed and observed by the buyer.

The Ministry of Finance hereby waives any right to require you to proceed against the buyer or against any security received from the buyer or any third party or to pursue any other remedy available to you.

All disputes related to this pledge shall correlate in accordance with the jurisdiction courts of England.

*James G. BARNES practices law with Baker & McKenzie in Chicago, Illinois.

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