Article

Factual Summary: In order to build, construct, and deliver a new 2x14 Megawatt WHRB Power Plant for 315,000 TPY Direct Reduction Rotary Kiln Plant located in South Kalimantan, Indonesia, to be owned and operated by PT. Meratus Jaya Iron & Steel, contract owner Pt. Krakatau Engineering appointed contractor Jiangsu Taihu Boiler Co. Ltd. to provide owner with engineering, procurement, construction, erection, installation, commissioning, performance test, start-up, services, equipment, and materials for completion of the Power Plant.

To assure completion of the project, Jiangsu Taihu Boiler Co. Ltd. (Applicant) obtained a performance guarantee and advance payment guarantee issued by Bank of China, Wuxi Branch, China (Guarantor) in favor of Pt. Krakatau Engineering (Beneficiary) as required by the contract. Both guarantees were issued subject to the 'Uniform Rules for Demand Guarantees' (ICC Publication No. 458, hereinafter URDG 458) and expired on 4 July 2011.

Both guarantees stated: "WE, ... HEREBY IRREVOCABLY UNDERTAKE TO PAY YOU IMMEDIATELY ANY SUM OR SUMS NOT EXCEEDING IN TOTAL AMOUNT OF ..., UPON RECEIPT BY US OF YOUR FIRST DEMAND IN WRITING AND YOUR WRITTEN STATEMENT STATING: I) THE CONTRACTOR IS IN BREACH OF HIS OBLIGATION(S) UNDER THE CONTRACT."

Applicant and Beneficiary signed the underlying contract on 25 March 2010 for USD 20,300,000 and IDR 47,000,000,000. Later on 21 July 2010 and 22 December 2010, "Amendment No. 1 of the Contract" and "Amendment No. 2 of the Contract") were signed and stamped by both parties.

On 26 May 2011, Beneficiary sent a notice titled "Default Notice" to Applicant stating that Applicant was not able to complete agreed projects according to amendments of the contract and Applicant recognized its default stated in the "Default Notice" before the trial court.

Due to Applicant's default, both parties signed a MINUTE OF MEETING (MoM) on 15 June 2011.

The MoM stated that Applicant failed to fulfill its obligation under the respective contract and amendments thereof, and was in breach of the contract, therefore Beneficiary was entitled to withdraw Applicant's performance bank guarantee.

The MoM also stated that Applicant promised to compensate USD 1,500,000 to Beneficiary due to Applicant 's breach of contract and extended the validity of the advance payment guarantee until 4 January 2012 before expiration of the present advance payment guarantee.

The MoM further stated that Applicant shall continue the remaining shipment as scheduled in the MoM and issue the packing list. Applicant also allows Beneficiary to take over or to continue subcontract directly with Applicant's entire vendor/subcontractor and Applicant will make available all information required by Beneficiary in respect of Applicant's vendor.

Furthermore, according to the MoM, if Applicant is unable to fulfill the contents agreed in the MoM, then Beneficiary is entitled to withdraw immediately the advance payment guarantee. If Applicant fulfills its obligations stated in the MoM, both parties will not make any legal claims on each other and the obligation of both Beneficiary and Applicant shall be deemed fulfilled.

The MoM also stated that it would be re-written as an amendment to the previous contract between Beneficiary and Applicant. However, if by 3 July 2011 the amendment cannot be reached by Beneficiary and Applicant, the content of MoM shall legally be applicable as an amendment.

On 4 July 2011, Guarantor honored Beneficiary's claim under the performance guarantee.

On 1 July 2011, Guarantor received Beneficiary's claim for payment under the advance payment guarantee accompanied with Beneficiary's statement as required by the guarantee and "Default Notice". On the same day, Applicant contacted Beneficiary requesting it to withdraw the claim.

Applicant considered Beneficiary's claim to be fraudulent because both parties had amended the obligations of the contract by way of the MoM and Beneficiary's claim was made when it had already given up its rights to claim under the advance payment guarantee and actually performed the MoM. Applicant insisted that Beneficiary utilized the independent nature of the demand guarantee to disguise the facts and made an abusive claim on Guarantor, and as such act was fraudulent, Beneficiary should bear the consequences of tort. Therefore, Applicant requested the Wuxi Intermediary People's Court to order Beneficiary to stop claiming under the advance payment guarantee and to enjoin Guarantor from paying under the guarantee as well. The trial court issued an injunction order on 8 July 2011.

On trial, Wuxi Intermediary People's Court entered judgment for Beneficiary and announced the cancellation of the injunction order. On appeal by Applicant, Jiangsu Supreme People's Court affirmed the trial court's decision.

Legal Analysis:

1. Fraud:

On Applicant's appeal, Jiangsu Supreme People's Court found no fraud evidence existed.

I. Court's legal analysis and decisions for the performance guarantee:

For Beneficiary's claim under the performance guarantee, the Court analyzed whether the MoM had legal effect and whether the applicant defaulted based on the following:

(1) the MoM does not bear the legal effect of amending the underlying contract since the persons signing the MoM do not have written authority and violate the beneficiary's constitution of the board of directors.

(2) the MoM does not comply with the necessary requirements of the underlying contract for amendment. According to No. 32.3 of the contract, the amendment of the contract may only be made in writing between both parties and the conditions of the contract or progress of the project cannot be amended by the MoM or other informal documents, and the amendment can only be made through formal amendment. Applicant is also clear that the MoM has to be in effect when it is signed by authorized representatives of both parties. In fact, the MoM submitted by Applicant to Beneficiary on 16 June was never signed by Beneficiary.

(3) the MoM violates the agreement in the underlying contract that MoM cannot be used to amend the contract. Actually, the statement in the MoM regarding the effectiveness of the MoM contradicts with No. 32.3 of the underlying contract. Therefore, under the circumstances that the MoM is not signed, the conditions in the underlying contract are not amended by law.

(4) the MoM was not performed as well. The Court stated: The act of Beneficiary's claim under the performance guarantee and taking over of the sub-contractors cannot be considered as performance of the MoM.

First, Applicant did not fulfill the agreement in the MoM that it should ship the remaining products on 25 June 2011 and 15 July 2011, issue packing lists, compensate Beneficiary USD 1,500,000 and extend the validity of the advance payment guarantee.

Secondly, Applicant's claim under the performance guarantee is in accordance with the agreement in the underlying contract, i.e., Beneficiary is entitled to demand payment under the performance guarantee when Applicant defaults.

Finally, the Court does not support Applicant's argument that the agreed transfer in the underlying contract and change of subcontract have to be agreed by Applicant since Beneficiary has the right to transfer or change according to article 25 of the underlying contract.

Therefore, Jiangsu Supreme People's Court concluded:

"[Applicant] signed the MoM with [project manager of Beneficiary] and [manager of legal compliance department of Beneficiary] without the presentation of [Beneficiary's] clear authorization from these two persons. And the MoM violated the agreement that the underlying contract cannot be amended in the form of minute of meeting and any revision must be in the form of amendment of the contract. The MoM did not either have [Beneficiary's] subsequent endorsement and or actual performance. The action of [Beneficiary's managers] is considered an unauthorized agency action, and [Applicant] is not in comparatively good faith and without fault, these two persons' acts hence do not constitute agency by estoppel act as well. Consequently, the MoM does not have any legal binding effect on [Beneficiary], neither does it have legal effects on amending the underlying contract".

II. Court's legal analysis and decisions for the advance payment guarantee:

Applicant raised in the appellate court that Beneficiary did not follow the contract which stated: "The original amounts of said Advance Payment Guarantees shall be reduced by a figure equivalent to the installment percentages of the Contract Sum paid in according with Section 8, as and when such payments have been made by Owner to Contractor".

Applicant insisted that Beneficiary's act of claiming the full amount of the advance payment constituted fraud. Beneficiary denied that its claim was a fraudulent act. Beneficiary refuted that according to article 8.17 of the underlying contract, "The guarantees issued on behalf of the Contractor pursuant to Section 8.16 shall serve as security for the performance the Contractor of all of its obligations under this Contract. In the event Owner at any time has any claim against Contractor for failure of the Contractor to perform such obligations, Owner shall, on demand, be entitled to make drawings under the guarantees (for either the full amount, or partial amounts, thereunder) in accordance with the terms thereof".

The Jiangsu Supreme People's Court stated:

"In determining whether the presented documents by the beneficiary of the guarantee to the obligor are fake or fraudulent, though the People's Court should not have the overall relationships in the underlying transactions under trial, it still may conduct necessary and limited check of the contents of the underlying contract related to the guarantee and the performance thereof, which may be helpful in deciding whether there does exist fraud. The sphere of the limited check should be restricted to whether the beneficiary makes abusive claim despite that it already knowingly realize that there is no default fact or other undue payments by the debtor in the underlying transaction. The documents presented in compliance with the stipulations of the guarantee are valid evidence inferring the default fact by the debtor of the underlying transaction.

The People's Court can only issue injunction for the guarantee when the applicant requesting injunction can sufficiently and clearly prove that he has completely fulfilled the debts under the underlying transaction, and the beneficiary may be clearly and correctly found in making fraudulent claim of the guarantee. The Court cannot consider cases such that there are disputes existed in the performance of underlying transactions, beneficiary also defaults and etc as fraud. When there are great disputes between the two parties and when jurisdiction or arbitration over the underlying contract are needed for ascertaining the facts, the People's Court cannot overstep the authority in fraud dispute cases to decide, instead, the Court shall fully respect the "Pay first, argue later" commercial arrangement established by independent guarantee rules.

In this case, first of all, [Beneficiary] presented all the required complying documents to [Guarantor] clearly stating that [Applicant] is in breach of his obligations under the contract, and demanded the full amount of advance payment guarantee from [Guarantor]. Secondly, despite of the fact that [Applicant] submitted evidence proving that they did not violate the advance payment agreement in the underlying contract, however, such evidence is insufficient in proving that they had completely fulfilled their obligations in accordance with the underlying contract in respect of advance payment agreement and there are no default facts existed, and [Beneficiary] does not recognize such as well. Finally, [Applicant] and [Beneficiary] have differing interpretations in article 8.16 and 8.17 of the underlying contract, and [Applicant's] understanding that the claiming amount under the advance payment guarantee should be deducted by a figure equivalent to the installment percentages of the contract sum paid was not included in the claiming conditions of the advance payment guarantee.

Therefore, as [Applicant] fails to provide evidence that they have fully fulfilled all obligations under the underlying contract, and the act of [Beneficiary's] demand for full amount of advance payment according to the requirement of the guarantee based on [Applicant's] default and its understanding of the claiming articles in the underlying contract cannot be considered as constituting fraud".

2. Jurisdiction:

Based on URDG 458 Article 27 and Article 44 of "Law of the Application of Law for Foreign-related Civil Relations of the People's Republic of China", both the trial court and appellate court determined that the jurisdiction is in the place of business of the guarantee issuer, Bank of China Wuxi Branch, and place of tort, i.e., the place where Applicant's rights may be infringed.

However, the Jiangsu Supreme Court overturned the trial court's decision that the employees' signing act should apply to laws having jurisdiction over Beneficiary. The trial court noted that No. 32.8 of the contract stated that the jurisdiction is in Indonesia and shall be construed according to Indonesian laws. It further decided, based on article 14 of "Law of the Application of Law for Foreign-related Civil Relations of the People's Republic of China", that the act of the Beneficiary's employees shall be subject to the jurisdiction of Beneficiary's registration locality, i.e., Indonesian laws. The appellate court, however, supported Applicant's argument that the nature of Beneficiary's employees' act of signing is an agency relationship by law and the locality where the MoM was signed is in mainland China. As such, the jurisdiction over the agency act should be the laws of P.R. China instead of Indonesia.

Comments by Jun XU:

1. Fraud:

It is encouraging that courts in China tend to be more and more cautious in issuing injunctions in guarantee or letter of credit cases in the respect of fraud so as to maintain the commercial mechanism of demand guarantee or letter of credit business.

In this case, the courts decided that bank guarantees issued subject to international demand guarantee rules, URDG 458, are independent from the underlying transactions and no additional evidence is needed as a part of the claim except for the stipulated documents required by the guarantees.

The appellate court clearly distinguishes the methods of settling disputes under guarantees from those under underlying contracts. In order to emphasize its point, the appellate court even went further to quote a universally recognized famous principle of demand guarantees, i.e. "pay first, argue later". It is the first time that such quotation has appeared in the judgment of a P.R. China court and reflects the judge's understanding and recognition of independent demand guarantee disputes resolution.

The court's attitude about the abusive claim by the applicant also reflects the judge's respect towards the independent demand guarantee's international rules.

2. Jurisdiction:

There are two issues relating to jurisdiction: disputes under the demand guarantee and the beneficiary's employees' signing act.

For the disputes under the demand, since the guarantee does not stipulate jurisdiction issue in case of disputes under the guarantee, both the trial court and appellate court respect URDG 458 which the guarantee is subject to and also observe local law.

The court quoted URDG 458 Article 27 which states: "Unless otherwise provided in the Guarantee or Counter-Guarantee, its governing law shall be that of the place of business of the Guarantor or Instructing Party (as the case may be), or, if the Guarantor or Instructing Party has more than one place of business, that of the branch that issued the Guarantee or Counter-Guarantee."

The appellate court also quoted "Law of the Application of Law for Foreign-related Civil Relations of the People's Republic of China" Article 44 which states: "The laws at the place of tort shall apply to liabilities for tort, but if the parties have a mutual habitual residence, the laws at the mutual habitual residence shall apply. If the parties choose the applicable laws by agreement after any tort takes place, the agreement shall prevail."

However, for issues outside the guarantee, the trial court and appellate court differ. The trial court only looks at the employees' act itself, while the appellate court probes into the nature of the act.

The trial court quoted "Law of the Application of Law for Foreign-related Civil Relations of the People's Republic of China" Article 14 which states: "The laws at the locality of registration shall apply to such items as the civil rights capacities, civil acts capacities, organizational institutions, rights and obligations of shareholders, etc. of a legal person and its branch. If the main business place of a legal person is inconsistent with the locality of registration, the laws of the main business place may apply. The main business place of a legal person shall be its habitual residence."

The appellate court accepted the applicant's argument that "Law of the Application of Law for Foreign-related Civil Relations of the People's Republic of China" Article 16 should be applied instead of Article 14. Article 16 states: "The laws at the locality of agency act shall apply to agency, but the laws at the locality of agency relation shall apply to the civil relations between the principal and the agent. The parties concerned may choose the laws applicable to entrustment of agency by agreement."

* Jun Xu, Senior Product Manager, Bank of China, Jiangsu Branch, China; Member of ICC DOCDEX.

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