Article

Factual Summary: To effect payment, Seller/ Principal caused bank (Guarantor) to issue an independent guarantee in favor of Buyer/Beneficiary in a format required in an appendix to the sale contract. By its terms, Guarantor undertook to pay with interest within three days after Buyer/ Beneficiary presented a notice of cancellation or a statement on or before 30 February1 that Seller/ Principal had failed to perform its contractual obligations or that Buyer/Beneficiary had reason to believe that it would fail.

1. The original Chinese text stated "30 Feb." which is obviously a typographical error.

Seller/Principal failed its obligation in the underlying contract due to delayed delivery. Subsequently, Buyer/Beneficiary and Seller/Principal reached agreements concerning the delayed delivery, and Guarantor and Buyer/Beneficiary agreed to extend the validity of the guarantee. On the new deadline, Buyer/Beneficiary notified Guarantor that there was a breach of the underlying sale agreement and demanded payment plus interest under the guarantee. Guarantor dishonored.

Buyer/Beneficiary then sued Guarantor for wrongful dishonor and sued Seller/Principal for expectation damages for its breach of the sale agreement. The trial court found for Buyer/ Beneficiary, in part based on the theory of demand guarantee, but it refused to award expectation damages because Seller/Principal had compensated Buyer/Beneficiary, which had been agreed and accepted by Buyer/Beneficiary. On appeal, affirmed.

Legal Analysis:

1. Independent Guarantee; Application of URDG458: The PRC Supreme Court concluded that ICC Uniform Rules for Demand Guarantee (URDG458) should apply to the dispute and should be deemed to be international custom. Since the documentary requirement of demand guarantee had been met, Guarantor had the duty to pay, or otherwise it was liable for breach of contractual obligation. In holding so, the court stated that:

"[t]he Banker's letter of guarantee issued by Guarantor to Beneficiary [was] a demand guarantee, and the undertaking [was] legally effective ... Beneficiary ha[d] met the documentary requirements of the guarantee by presenting, before its expiry, the written notification to the effect that the technical feasibility of the production line couldn't be affirmed. According to international practices, Guarantor should fulfill its obligation to pay under the guarantee."

More specifically and clearly, the Supreme Court stated that:

"[t]he ICC Uniform Rules for Demand Guarantees should apply to the dispute for reference as international practices. Under URDG, the duty of a Guarantor under a Guarantee [was] to pay the sum or sums on the presentation of a written demand for payment and other documents specified in the Guarantee which appear[ed] on their face to be in accordance with the terms of the Guarantee. Before the expiry of the guarantee, Beneficiary presented document specified in the Guarantee which appear[ed] on their face to be in accordance with the terms of the Guarantee, and Guarantor raised no objection ... The documentary requirement of demand guarantee ha[d] been met. Therefore, Guarantor should pay, or otherwise [was] liable for breach of contractual obligation."

2. Independence: Guarantor issued a demand guarantee, which was independent of the sale agreement. Guarantor should make payment unconditionally under the guarantee.

Without mentioning the independent nature of demand guarantee, the trial court had ruled that:

"[s]eller should refund US$848,750 plus stated interest ten days after the decision takes effect. If Seller fail[ed] to do so, Guarantor should refund the said amount plus interest."

In reviewing the above decision, the Supreme Court stated that:

"[t]he Guarantor issued a demand guarantee, which [was] generally separate from the sale agreement ... Guarantor should pay unconditionally the amount under the guarantee in the first place. The original judgment as ... [was] based on the conditional guarantee, which [was] contradictory to unconditional undertaking under demand guarantee. Whereas Buyer/ Appellee did not appeal against the original judgment in respect of Guarantor's unconditional undertaking, which mean[t] Appellee ha[d] accepted it, the judgment [was] therefore affirmed."

3. Jurisdiction; Consolidating Hearing: The court has jurisdiction over any dispute arising from a sale agreement which is performed in the jurisdiction. Buyer/Beneficiary was entitled to sue Guarantor solely. Furthermore, according to Chinese law, nothing prohibited the consolidation of the hearings concerning the underlying transaction and the guarantee dispute. In addition, the guarantee was one of the appendixes to the sale agreement, and therefore, it was appropriate to consolidate the hearing of two disputes.

In holding so, the Supreme Court stated that:

"[i]t was agreed upon in the sale agreement that the production line is to be installed, experimented and adjusted in Liyang, Jiangsu Province, China, which justifie[d] Jiangsu High Court's jurisdiction over any dispute arising from the sale agreement on the basis that Jiangsu [was] the place of performance.... and Beneficiary [was] entitled to bring a single litigation against Guarantor. According to Chinese law, nothing prohibit[ed] consolidation hearing of disputes over the underlying transaction and over the guarantee. Furthermore, the agreed sample letter of guarantee was included as one of the appendixes to the sale agreement. It [was] appropriate for the trial court to consolidate the hearing of two disputes when Beneficiary sued Guarantor for failure in fulfilling its obligation towards Beneficiary at the same time it sued Seller. Guarantor raised no objection to jurisdiction within the period specified by the trial court for it to file its statement of defense, which meant Guarantor ha[d] accepted jurisdiction of the trial court in accordance with PRC Civil Procedure Law."

Comments by JIN SAIBO:

1. By ruling that the agreement was a demand guarantee that was independent of the underlying transaction, PRC Supreme Court applied directly the Uniform Rules for Demand Guarantees (hereinafter "URDG458", ICC Publication No.458) but offered no reason for the choice of law, though there was no explicit provision concerning applicable law(s) or international practice(s) in the guarantee. The Supreme Court did not mention other relevant international rules concerning independent or demand guarantees, such as ISP98 and United Nations Convention on Independent Guarantees and Stand-by Letters of Credit. Disappointingly, as to what rules were referred to as "international treaties" and "international practices" stipulated in Article 142, PRC General Principles of the Civil Law (1982), the Supreme Court failed to provide the reason for applying URDG458 or its consideration in doing so. The Supreme Court was offered a precious opportunity to clarify the rule of applicable law concerning foreign-related independent undertaking disputes, but to our surprise, it failed to grasp it. On the other hand, Chinese courts will apply law(s) or follow international practice(s) that are explicitly stated in guarantees.

2. In the field of demand guarantee, this is a case of first impression for Four Civil Division of PRC Supreme Court, as well as for any Chinese court, which lack practical experience in handling demand guarantee disputes. The case will be remembered by virtue of its historical significance and it will change the way that all Chinese courts decide similar disputes. The trial court reached its judgment that the Guarantor was JOINTLY AND SEVERALLY liable for the payment by applying the accessory guarantee doctrine to the guarantee in dispute which was an independent guarantee in nature. While affirming the trial judgment, PRC Supreme Court surprisingly left the mistake uncorrected in its opinion and failed to take advantage of the chance. The Supreme Court should have conducted a deeper analysis for the major features justifying a guarantee as INDEPENDENCE. It is greatly regrettable that the Supreme Court gave up the opportunity.

3. Furthermore, the opinion of the Supreme Court failed to give any reason for dismissing the issue raised by the Appellee - since URDG458 was applied to the dispute, both Articles 27 (Governing Law) and 28 (Jurisdiction) should be applied, in which case the governing law should be Italian law rather than Chinese law, and an Italian court rather than a Chinese court should have jurisdiction over the guarantee dispute. Both the trial court and the Supreme Court failed to respond to this telling argument raised by the Appellee.

[JS/FJ/ny]

* Jin Saibo is partner of Commerce & Finance Law Offices, jinsaibo@tongshang.com. Assisted by Feng Jing. Niu Yue, J.D. Candidate 2012, George Mason University School of Law, assisted in the edits.

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