ICC Digital Library Forum

I agree with T.O. Lee, we need to jump start this section;therefore, I'm posting the following issue seeking the members' feedback.

An unconditional counter-guarantee was issued by an international bank favouring a Saudi bank with a 30-day buffer period on the expiry date, i.e. the expiry date of the counter-guarantee was longer than the expiry date of the bond that was to be issued by the Saudi bank, by 30 days. The local bond was also an unconditional demand guarantee and both bonds were made subject to the Saudi law.

The beneficiary (a private entity) of the local bond later submitted an “extend or pay” request to the Saudi bank well within its validity, i.e. 50+ days prior to its expiry date. His request was transmitted by the Saudi bank to the counter-guaranteeing bank the following day but due to a lack of response from the latter, three reminders followed all of which remained unanswered. One day after the local bond’s expiry, the beneficiary came back demanding payment of the full LG value since the Saudi bank had failed to extend the bond within its validity. The counter-guaranteeing bank was immediately contacted and this time the bank quickly responded but instead of honouring payment, an extension was given as per bene’s original request. Its response was given within the counter-guarantee’s validity. However, the beneficiary who insisted on full payment rejected the extension. Finally, payment was made by the Saudi bank after having once again contacted the counter-guaranteeing bank.

Comments / Questions
1. The Saudi bank, as a guarantor, failed to firstly extend the bond upon receipt of bene’s demand and then follow through with the instructing party, i.e. the counter-guaranteeing bank. As a guarantor, the bank is liable as per the terms specified in the guarantee. Unfortunately this is the local practice followed by several banks as they feel that they are protected by doing so! Certainly this is not the right practice. If the bank has decided to take on its books the risk of the counter-guaranteeing bank and has done so by properly booking the contingent liability / credit facility then the extension should have been processed otherwise what’s the difference then between this scenario and a guarantee that is simply advised based on a request from the issuing bank and without any engagement from the advising bank? None!!
2. The counter-guaranteeing bank’s response came after a long delay but for the sake of this argument, can the bank refuse payment by simply claiming that its response was still given within the counter-guarantee’s validity?

Dimitri

Dimitri,

Your question is tempting but we would not dare to touch it since we know something about Muslim banking, which is built on the Koran concepts, that may be different from intentional banking in certain areas. For example interest is not allowed.

We think this question should be better answered by our friend in Saudi Arabia, Hatem who is quiet for a while during the World Cup 2002 period. We wonder whether he is now still in Japan?

www.tolee.com

[edited 7/1/02 4:00:11 AM]

Dimitri,

Without responsibility:

1. I do not share your view regarding 1. With a ‘pay or extend’ demand, the beneficiary demands payment, but also says it would accept an expiry extension in lieu of payment. Unless the guarantee terms specify the guarantor must grant any extension request of the beneficiary, the guarantor does not have any authority to extend the guarantee. Therefore it cannot do this unilaterally. Consequently, it must obtain its principal’s instructions. If this takes too long for the beneficiary then the beneficiary can simply withdraw the option to extend and demand payment.
2. I’m afraid I do not understand your question (point 2). I would observe that provided a complying demand is made on the instructing party (the counter-guarantor) on or before the expiry of the counter-guarantee it is obliged to pay if the option to extend is withdrawn, even if the withdrawal occurs after the expiry of the counter-guarantee.

Jeremy

T.O. Lee,
FYI, I have been in this part of the world for quite a long time. This is not a question on an Islamic product; therefore, there are no religious considerations in letters of guarantee issued by banks in this marketplace.

Jeremy,
The letters of guarantee issued in Saudi that are favouring gov’t departments / ministries have an “extend or pay clause” in them, i.e. the Saudi bank (the guarantor) is liable as per this specific LG term. This is a regulatory requirement and it means that the beneficiary can make a demand for payment on the guarantor bank but offer as an alternative to payment the choice of extending the guarantee. Such a request, of course, will have to be received within the LG validity. The customer on the other side is compelled to extend the guarantee to avoid the alternative demand for payment. It is also the market practice to apply the same LG text for private beneficiaries too.

Point 2. Your observation is correct. Although the guarantor’s request for extension was withdrawn and payment was demanded instead, the counter-guaranteeing bank agreed to the extension.

Dimitri

Dimitri

Our internal records suggest Saudi Arabian guarantees are simply extendible at the beneficiary’s request, i.e. without the need to demand payment as an alternative. Assuming this is so (please say if it isn’t), it seems odd that a beneficiary would lodge a pay or extend demand, rather than just an extension demand. Perhaps the giving of unnecessary options is the source of the problem?

Jeremy

Dimitri,

Thanks for the information about LG in the Kingdom of Saudi Arabia.

Jeremy,

"Extend or Pay" is a special feature in ISP 98 and also a banking practice, particularly in USA, as reflected in Article 3.09 in ISP 98. Members may search in DC Pro for the full text.

www.tolee.com

T.O.,

Thanks for this. As luck would have it, I was already aware that ISP98, as well as URDG, contains e/p provisions.

Jeremy

Jeremy,

Your presentation style of "ISP98" in your response reminds us to raise an interesting question about ISP 98 in ISP98 section, which so far has been neglected by most practitioners.

www.tolee.com

Jeremy,
The answer to your question is: It isn’t.

To make it clearer, let me quote to you the concerned section of a bond. As previously mentioned this text, which is meant for gov’t beneficiaries, is dictated by the Saudi Arabian Monetary Agency (Central Bank). However, some local banks use the same text for private beneficiaries too.

“This guarantee shall remain valid and in full force and effect up to the end of the …. day of ….. of the year ….. provided that it is a condition of this guarantee that, in the event you give the guarantor on or prior to the said expiry date of this guarantee (or any subsequent extension of that expiry date in accordance with this proviso) signed written notification requesting an extension, the Guarantor will (a) automatically extend this guarantee for such period (not exceeding 365 days) from that expiry date or extension as you may specify in that notification or (b) pay the amount of the guarantee.”

Would you be able to provide me with the text you have in your internal records for LG’s issued in Saudi Arabia? I would be interested to know.

Dimitri

Dimitri

The text you have quoted seems only to require the beneficiary to demand extension, i.e. not to demand payment or extension. However, extension having been demanded, the guarantor then (to me curiously) appears to have the option of either extending or paying. Perhaps the intention is to allow the guarantor to terminate its liability by payment? Whatever, I can well understand a guarantor that has the choice of paying or extending not taking unilateral action until either it has received its principal’s instructions or the beneficiary has withdrawn the option of extension. It is not as if the beneficiary’s position is jeopardised or disadvantaged in any significant way, as the option to simply demand payment is always there.

We do not have a particular text quoted in our internal records, just the information that many of the guarantees issued by Saudi Arabian banks are extendible at the beneficiary's request, and the counter-guarantees we are required to give reflect this.

Regards, Jeremy