Article

Factual Summary: In order to purchase one lot of newly manufactured bulk material handling equipment from Shanghai Zhenhua Port Machinery Co., Ltd (applicant), Seabulk Systems Inc. (Beneficiary) signed a contract with the Applicant for CAD11,500,000.00.

According to the contract, the Beneficiary must make the first payment CAD2,300.00, being 20% of the contract value, not later than 15 days from its receipt of an advance payment guarantee covering such amount and other required documents, and the Beneficiary must make the second payment of CAD3,450,000.00 , being 30% of the contract value under LC, not later than 120 days from the Seller's presentation of an advance payment guarantee covering such amount and other related documents. For the third payment of CAD2,300,000.00, being 20% of the contract value, the Beneficiary is also required to provide an advance payment guarantee covering such amount.

The contract agrees that the rights and obligations of the contract, both parties of the contract, and related claim or disputes shall be subject to law of England.

On 18 September 2007, Bank of China, Shanghai Branch, China (Guarantor) issued an advance payment guarantee in favor of Seabulk Systems Inc (Beneficiary) for the amount of CAD3,450,000.00, at the request of the applicant, for the second payment subject to the 'Uniform Rules for Demand Guarantees' (ICC Publication No. 458, hereinafter URDG 458). The guarantee was advised through Indian Overseas Bank, Hong Kong. The Guarantor also issued other two advance payment guarantees each in the amount of CAD2,300.000.00 and one performance guarantee at different time at the request of the Applicant.

The guarantee stated: "WE, IRRESPECTIVE OF THE VALIDITY AND THE LEGAL EFFECTS OF THE ABOVE-MENTIONED CONTRACT AND WAIVING ALL RIGHTS OF OBJECTION AND DEFENSE ARISING THEREFROM, HEREBY IRREVOCABLY UNDERTAKE TO PAY YOU ANY SUM OR SUMS NOT EXCEEDING IN TOTAL THE ABOVE-MENTIONED MAXIMUM AMOUNT, I.E. CAD3,450,000.00 (CANADIAN DOLLARS THREE MILLION FOUR UNDRED FIFTY THOUSAND ONLY), UPON RECEIPT BY US OF YOUR DULY SIGNED DEMAND FOR PAYMENT IN WRITING STATING THAT THE PRINCIPAL IS IN BREACH OF HIS OBLIGATION(S) UNDER THE UNDERLYING CONTRACT AND THE RESPECT IN WHICH THE PRINCIPAL IS IN BREACH.

IT IS A CONTITION FOR ANY CLAIM AND PAYMENT TO BE MADE UNDER THIS GUARANTEE THAT THE ADVANCE PAYMENT REFEREED TO ABOVE MUST HAVE RECEIVED BY THE PRINCIPAL ON THIS ACCOUNT HELD WITH US.

FOR THE PURPOSE OF IDENTIFICATION YOUR PAYMENT MUST BEAR OR BE ACCOMPANIED BY A SIGNED CONFIRMATION OF ONE OF OUR CORRESPONDENT BANKS STATING THAT THE LATTER HAS VERIFIED YOUR SIGNATURE(S) APPEARING ON THE SAID REQUEST FOR PAYMENT.

YOUR DEMAND IS ALSO ACCEPTABLE IF TRANSMITTED TO US IN FULL BY DULY ENCODED SWIFT THROUGH ONE OF OUR CORRESPONDENT BANKS CONFIRMING THAT YOUR ORIGINAL DEMAND HAS BEEN FORWARDED TO US BY REGISTERED MAIL OR COURIER SERVICE AND THE SAID BANK HAS VERIFIED YOUR SIGNATURE(S) APPEARING THEREON.

THE AMOUNT OF THIS GUARANTEE WILL AUTOMATICALLY BE REDUCED IN PROPORTION TO THE VALUE OF EACH DELIVERY UPON RERESENTAION BY THE PRINCIAPL TO US OF COPIES OF THE COMMERCIAL INVOICE AND THE CORRESPONDING ACCEPTANCE CERTIFICATE.

THIS GUARANTEE SHALL EXPIRE ONE IT HAS BEEN REDUCED TO NIL OR ON MARCH 31ST, 2009(HEREINAFTER REFERRED TO AS 'THE EXPIRY DATE') AT THE LATEST. ANY CLAIM MUST BE RECEIVED BY US BY THE EXPIRY DATE. UPON EXPIRY THIS GUARANTEE SHALL AUTOMATICALLY BECOME NUL AND VOID EVEN THOUGH THE ORIGINAL DOCUMENT IS NOT RETURNED TO US OR WE HAVE NOT RECEIVED ANY CONFIRMATION FOR CANCELLATION FROM YOU."

On 21st September 2007, Indian Overseas Bank signed "The Deed of Assignment" with the Beneficiary for financing purpose.

On 5th November 2007, Indian Overseas Bank(Assignee) signed with the Beneficiary an "Assignment Agreement", on which the Beneficiary agrees unconditionally and irrevocably to assign to the Assignee all its rights, remedies, liens, power, title and interest that the Assignor has under the advance payment guarantee(abbr. as 'Assigned Interests') against the Bank and/or the Guarantor.

On 8th November 2007, Indian Overseas Bank advised the Guarantor and forwarded the "Deed of Assignment" to the Guarantor.

In its letter of 19th November 2007 to the Guarantor, the Assignee states "Kindly acknowledge the same and confirm by your authenticated Swift message to us that you have duly registered and recorded the assignment on your above Guarantee in our bank's favor and your shall remit all money/s demanded by the beneficiary M/s Seabulk Systems Inc directly and/or through us to our bank only."

On 21st November 2007, the Guarantor replied the Assignee via SWIFT message:"We hereby confirm that we have duly registered and recorded the assignment on our above guarantees in your bank's favor and we shall remit all money/s demanded by Seabulk System Inc. through your good bank."

On 9th ,26th November 2007 and 20th January 2009, Beneficiary made advance payment to the Applicant in the amount of CAD2,300,000.00, CAD3,450,000.00 and CAD2,300,000.00, respectively.

Due to the disputes between the Beneficiary and the equipment testing company located in Quebec, the Beneficiary informed the Applicant that it would delay or refuse payment, and therefore requested the Applicant stop all work at the arriving port Quebec until the settlement of the disputes. The Applicant agreed but required written confirmation from the Beneficiary. Among other commitments, the Beneficiary confirmed that the Purchase Agreement signed on 25th May 2007 remained valid.

On 28th December 2009, the Guarantor advised the Assignee that the validity of the guarantee was extended to 7th May 2010.

On 30th April 2010, the Beneficiary advised the Assignee that the Applicant did not perform its contractual obligations and requested the Assignee to act in regards to the default facts including claiming under the four guarantees under disputes.

On 4th May 2010, the Guarantor received the Assignee's demand acting as the beneficiary of the guarantee for a total amount of CAD9,200,000.00 under the above mentioned four guarantees, including CAD2,300,000.00 for the guarantee under disputes. At the same time, the Assignee transmitted the Beneficiary's demand advice.

On 10th May 2010, the Guarantor refused payment and advised the Assignee via SWIFT message: "WE CONFIRM THE RECEIPT OF THE DOCUMENT SENT TO US BY COURIER, HOWEVER AFTER CHECKING THE DOCUMENTS, WE DO NOT FIND THE WRITTEN DEMANDS FOR PAYMENT MADE BY THE BENEFICIARY SEABULK SYSTEMS INC. TO US WHICH SHALL BE CONSTITUED AS THE VALID CLAIMING DOCUMENTS REQUIRED UNDER OUR GUARANTEES."

However, the Assignee insisted that it had presented a written demand before expiry of the guarantee.

On 11th May 2010, the Applicant applied for an injunction from Shanghai Supreme People's Court for the reason that the Assignee committed fraud under the guarantee.

On 25th May 2010, Shanghai Supreme People's Court ordered the Guarantor to stop payment under the guarantee.

On 25th June 2010, the Applicant sued the Assignee and listed the Beneficiary and the Guarantor as a third party defendant, requesting the court to stop the Guarantor's payment of CAD2,300,000.00 to the Assignee under the guarantee.

The trial court decided that the Assignee is entitled to demand under the guarantee, however, based on the facts, the Assignee made false statements. The court affirmed the Applicant's request to stop the Guarantor's payment to the Assignee because the demand is considered abusive and improper.

On appeal, Shanghai Supreme People's Court overturned the trial's court ruling regarding the Assignee's demanding rights and upheld the trial court's decision that the Guarantor was permitted to stop payment under the guarantee to an unlawful demanding party.

Legal Analysis:

1. Rights to demand

The Shanghai Supreme People's Court analyzed the reason for its decision that the Assignee is not entitled to demand under the guarantee as follows:

"...the Assignee requested in its SWIFT message regarding confirmation of the assignment 'confirm that ...you shall remit all money/s demanded by the applicant directly and/or through us to our bank only.' The Assignee requested the Guarantor to amend the word 'the applicant' to ' Seabulk Systems Inc.' due to incorrect use of the word 'the applicant'.

In December 2009, in the message about the extension of the guarantee to on 7th May 2010 the Guarantor advised to the Assignee, it states that ' Others remain unchanged. Pls advise the beneficiary accordingly.

The court took into consideration the fact that the guarantee expressly stated that it is subject to URDG458.

URDG458 Article 1 states: "These Rules apply to any demand guarantee and amendment thereto which a Guarantor (as hereinafter described) has been instructed to issue and which states that it is subject to the Uniform Rules for Demand Guarantees of the International Chamber of Commerce (Publication N°458) and are binding on all parties thereto except as otherwise expressly stated in the Guarantee or any amendment thereto."

URDG458 Article 4 states: "The Beneficiary's right to make a demand under a Guarantee is not assignable unless expressly stated in the Guarantee or in an amendment thereto."

The guarantee under dispute does not stipulate that the Beneficiary's right of demanding payment may be assigned, and all the parties of the guarantee did not agree to make an express amendment regarding that as well. Despite that the Beneficiary signed a 'Deed of Assignment' with the Assignee and assigned its rights under the guarantee to the Assignee. However, since the Guarantor was not involved in the signing of the agreement, such 'Deed of Assignment' obviously does not constitute an amendment to the guarantee.

Thereafter, in the Assignee's correspondence with the Guarantor and in the Guarantor's reply, the usage of phrase 'in one's favor' itself is ambiguous, which may be translated into Chinese as '...as beneficiary' or 'be advantageous to ...'. On the other hand, such correspondence never mentions the Assignee as 'Beneficiary'. Instead, the Assignee requested the Guarantor to 'confirm that..you shall remit all money/s demanded by the applicant directly and/ or through us to our bank only.' Due to the incorrect usage of the word 'the applicant', the Assignee again requested the Guarantor to amend it into 'Seabulk Systems Inc.', and the Guarantor replied that it 'confirm that...we shall remit all money/s demanded by Seabulk Systems Inc. through your good bank.'

From the wording of the above correspondence, Seabulk Systems Inc. is the party entitled to demand payment. Obviously, the above correspondence does not state that the beneficiary's rights of demanding payment are assigned to the Assignee. In further consideration of the fact that the Guarantor's guarantee extension message to the Assignee still requests the Assignee to advise the beneficiary, it can be seen that the Guarantor does not treat the Assignee as the new beneficiary, i.e., the parties of the guarantee does not reach unanimous agreement on whether the guarantee beneficiary's rights of demanding payment may be assigned.

Based on above facts, according to the rules of URDG458, the court does not consider that the beneficiary's rights of demanding payment under the guarantee has been assigned to the Assignee. However, the rights of the Beneficiary to assign its proceeds entitled under the guarantee to the Assignee are not affected.

Therefore, the court affirms the Applicant's request that the Assignee is not the beneficiary of the guarantee and the Assignee is not entitled to execute the rights of demanding payment under the guarantee. As consequence of which, the Assignee is not entitled to demand payment under the guarantee in its own name.

2. Fraud and abusive demand:

The Shanghai Supreme People's Court stated that it is not necessary to further establish whether the Assignee's demand under the guarantee in dispute constitutes fraud or abusive demand based on the decision made regarding the validity of the Assignee's demanding rights..

Despite that the trial court acknowledges the right of the Assignee to demand payment based on its reasoning on how to interpret the phrase "in one's favor", it still decided that the Assignee's demand was abusive and improper.

The trial court analyzed that the conflicting points of view of the Applicant and the Assignee relates to the balance between the arrangement of quick speed in obtaining demanded payment and the phenomena that the guarantee could be easily abusive. The trial court referred to the purpose of demand guarantee mentioned in the introduction of URDG458 that the beneficiary wishes to have the protection provided by the demand guarantee, in the event of the principal's default in the underlying transaction, and the demand guarantee helps realize that purpose in enabling the beneficiary to promptly get paid when the obligations in the underlying contract are not fulfilled. The trial court further pointed out that URDG458 states that, when recognizing the beneficiary's needs based on the consideration of fairness and faith, the guarantee has a right to obtain a written statement in respect of which it is in breach. The court notices that URDG458 mentions that the rule is not only to protect the beneficiary but also to protect the applicant from the infringement of improper demand under the guarantee, and the two aspects need to be balanced. The trial court analyzes that since the purpose of guarantee is to protect the beneficiary from the risks of the Applicant's default, therefore, to determine whether the beneficiary's drawing of the guarantee due to the principal's default is "fraudulent" or "obvious abusive", local laws should be applied in combination with the purpose of the specific guarantee, and whether the risks it guarantees arise.

The beneficiary claims that the applicant defaulted in three aspects. However, in analyzing the factual events, the trial court concludes that, since it is the beneficiary's contention that the condition for the applicant to fulfill the contractual requirement of delivering maintenance guarantee is not established, the beneficiary cannot be considered defaulted.

The trial court concludes:

When considering the facts, it is necessary to determine the demanding action of the Assignee. URDG458 mentions different concepts, i.e., "fraudulent" or "obvious abuse" or "improper drawing" guarantee. As for fraud, the Article 68 of Opinions of the Supreme People's Court on Several Issues concerning the Implementation of the General Principles of the Civil Law of the People's Republic of China states that, "when one party intentionally inform the other party of false facts, or intentionally conceal the truth to entice the other party to make incorrect decision, such action shall be considered as fraud." However, as the local law does not clearly define "obvious abusive" or "improper drawing" of guarantee, the principle of honest and faith should be considered in judgment.

According to the definition of 'fraud', the claiming party under the guarantee can only be considered fraudulent when there is 'intentional' fraud. The Assignee may not be clear about the underlying contract between the Applicant and the Beneficiary, therefore, the court is unable to determine if there is intentional fraud by the Assignee, and hence the demand by the Assignee cannot be considered guarantee fraud. However, the rights of the Assignee comes from the Beneficiary's assignment. According to the principle of the assignment of the creditor's right, when there is flaw in the assigned rights, the opposite party to the assignor is naturally entitled to raise defenses. Based on the evidence provided by the applicant, especially the correspondence between the applicant and the beneficiary, the assignee should have been able to know that the beneficiary's so called claim that the applicant's default action does not exist, if the assignee continues to demand under such circumstance, then it violates against the principle of honest and faith, and the assignee should be considered 'obvious abusive' or 'improper drawing' of the guarantee. As a consequence, the assignee's demand is 'obvious abusive' or 'improper drawing."

2. Jurisdiction:

In deciding the jurisdiction, the trial court points out that URDG458 clearly stipulates that the rule does not affect local law's principle or rules regarding fraud or obvious abusive r improper drawing of the guarantee. Since China is the result place where the infringement incurs, the case is applicable to the jurisdiction of P.R.China.

Comments by Jun XU:

1. Assignment

The Assignee demanded payment under the guarantee relying on its assignment agreement between itself and the beneficiary and the Guarantor's acknowledgement to its assignment.

However, the guarantee is subject to URDG 458. Based on the principle of URDG, the guarantor's acknowledgment of the assignment notified by the assignee is insufficient to meet the requirement of the rule for the guarantor to agree to the assignment.

URDG458 Article 4 of the rule makes it clear that "The Beneficiary's right to make a demand under a guarantee is not assignable unless expressly stated in the Guarantee or in an amendment thereto."

The Shanghai Supreme People's Court is correct in referring to URDG458 rules in determining whether the Assignee is entitled tothe right to make a demand under the guarantee. The original guarantee does not exclude Article 4 of URDG458 in allowing the assignee to demand payment under the guarantee. Furthermore, the Guarantor's acknowledgement to the assignment is not an amendment to the guarantee. Instead, the Guarantor makes clear that it "confirm that...we shall remit all money/s demanded by Seabulk Systems Inc. through your good bank", which means that the Guarantor shall make payment when demanded by the Beneficiary, and the Assignee also corrected its previous assignment notice confirming that the demand shall be made by the Beneficiary.

The court also is correct in its understanding that the effectiveness of an assignment of rights between the Assignor and the Beneficiary does not require the Guarantor's consent.

In guarantees subject to either URDG 458 or URDG758, differing from transfers, assignment under a guarantee only gives the assignee the right of receiving the proceeds of a guarantee when a complying demand is made by the assignor (in this case, the Beneficiary), and the payment shall be made to the assignor instead of the assignee unless agreed by the guarantor in the guarantee or the amendment thereto.

Compared with URDG458, URDG 758 is even clearer regarding the guarantor's right in not paying an assignee. URDG758 Article 33(g) states: "Whether or not the guarantee states that it is transferable, and subject to the provisions of the applicable law: (i.) the beneficiary may assign any proceeds to which it may be or may become entitled under the guarantee; (ii.) however, the guarantor shall not be obliged to pay an assignee of these proceeds unless the guarantor has agreed to do so." [Emphasis added].

However, neither URDG458 nor URDG758 touches the issue of acknowledgment of an assignment. ISP98 Rule 6.07 is more instructive in operation for the issuer or nominated person when required to acknowledge the assignment, and it is also very clear that the assignee is only entitled to the proceeds assigned even when the acknowledgment is made. ISP98 Rule 6.07 states:

"(a). Unless applicable law otherwise requires, an issuer or nominated person is not obligated to give effect to an assignment of proceeds which it has not acknowledged; and

(ii.) is not obligated to acknowledge the assignment.

(b.) If an assignment is acknowledged:

(i.) the acknowledgment confers no rights with respect to the standby to the assignee who is only entitled to the proceeds assigned, if any, and whose rights may be affected by amendment or cancellation; and

(ii.) the rights of the assignee are subject to:

(a) the existence of any net proceeds payable to the beneficiary by the person making the acknowledgment;

(b) rights of nominated persons and transferee beneficiaries;

(c) rights of other acknowledged assignees; and

(d) any other rights or interests that may have priority under applicable law."

2. Correspondence

The case is a reminder for banks handling guarantee business. Banks should be more cautious in its correspondence when facing the requirement of acknowledgement. The major conflicting view of points between the Assignee and the guarantor is the interpretation regarding the acknowledgment of the assignment. In cross-border transactions, due to language interpretation issues and different legal systems, even one word may cause major problems in the correspondence between two parties whose native languages are not different. Therefore, banks are suggested to make themselves crystal clear, i.e., if they wish to be the beneficiary, they are suggested to use such words instead of "in one's favor", and the guarantor is suggested to reply clearly that they only accept demand directly from the original beneficiary of the guarantee instead of from the assignee

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

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.