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Note: When Oswal Chemicals & Fertilizer Ltd (Buyer) ordered 40,000 tons phosphorite grit from Anhui Import and Export Co., Ltd (Seller), Buyer required Seller's performance to be secured by a guarantee. Accordingly, Seller applied to the Bank of China (Counter Guarantor) which issued its Counter Guarantee in favor of the State Bank of India (Local Bank), instructing it to issue a local undertaking in favor of Buyer as the Local Beneficiary. The Local Guarantee required Buyer to present a statement that Seller was in breach of the contract. Subsequently, Buyer demanded payment under the Local Guarantee on the ground that Seller was in breach of the contract. Consequently, Local Bank demanded payment under the Counter Guarantee from Counter Guarantor, which demanded reimbursement from Seller.

Claiming that Buyer's claim on the Local Guarantee was inconsistent with the fact that Seller had fulfilled its obligation under the contract, Seller sued Buyer for making a fraudulent demand and sought a declaratory judgment from the court to prevent Counter Guarantor from making the payment. The District People's Court of He Fei-STIP, Judge Liu Jing ruled in favor of Seller, ordering both the Local Bank and Counter Guarantor not to pay Buyer.

The Judge reasoned that the court had jurisdiction over this dispute because it was the court of the place of tort under the judicial interpretation of the Supreme Court of China. The Judge decided that the Guaranty Law of the People's Republic of China did not govern the Demand Guarantee and, thus, the court could apply international practice if appropriate. According to URDG 458, the Guarantee is independent from the underlying contract and the guarantor must pay demand in conformity with the Guarantee. However, in international business practice, there is an exception for fraud. In this exception, if the beneficiary commits fraud, the guarantor shall not make the payment. The determination of whether there is fraud is usually made based on the underlying transaction. The Judge ruled that Buyer demanded payment even though Seller had fulfilled its obligation under the contract; therefore, Buyer's act constituted fraud and voided the demand.

Local Bank and Counter Guarantor appealed as third party beneficiaries, questioning the trial court's jurisdiction over the dispute and the distribution of trial fees. The He Fei Intermediate People's Court, Judge Qi Donghai, Zhu Guoquan and Wan Han affirmed the trial court's decision in a per curiam decision, holding (1) the trial court had jurisdiction over the dispute because it was the court of the place of tort in this case, excluding the choice of the jurisdiction in the contract and (2) the demand was void because it violated the principle of good faith.

Comment by DCW: It is not clear how the independence principle or fraud exception relate to a post-honor action by the buyer against the seller. Presumably, the tort was the alleged fraud.

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* This summary is based on transcripts in English and Chinese of decisions provided by Mr. JIN Saibo, a partner of Commerce & Finance Law Offices. jinsaibo@tongshang.com

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