Business
is all about long-term and trust. At least, this is how textbooks and
annual reports present the topic. The practice is, oftentimes,
different. And because business partners don’t trust each-other, we
need third parties they can trust. This is why bank guarantees exist.
They can ensure that contracts are performed and payments made.
Because
distrust is so widespread in business – sorry... – because bank
guarantees are used very often, the International Chamber of Commerce
(ICC) has published, back in 1992, Uniform Rules for Demand
Guarantees (called first URDG 458 and, since 2010, URDG 758).
What
is a guarantee?
A
guarantee is a “signed
undertaking, however named or prescribed, providing for payment on
presentation of a complying demand”.
In short: “I will pay if you ask me to do so”.
The
reference “however named or prescribed” says that the content
prevails over the form. In other words, you can call your guarantee
whatever you like as long as it contains a payment obligation vs. a
complying demand.
“Clear
drafting is the linchpin of a successful international demand
guarantee practice.”
Why
are guarantees called “demand” guarantees?
It
is not because there is a huge demand for their issuance. Rather, the
reason is that the Beneficiary can demand payment immediately,
independent of the underlying relationship. At this stage, we are
faced with an obvious contradiction:
On
the one hand, demand guarantees usually refer to the underlying
relationship and calling a guarantee requires the Beneficiary to
indicate in what respect the applicant is in breach of the underlying
relationship.
On
the other hand, the Guarantor has to honor the guarantee, no matter
what the underlying relationship is about.
It’s
a bit like annual appraisal sessions: Your boss has to ask for your
view on the approval even though the decision about your fate has
already been taken a long time ago…
When
do URDG 758 apply?
They
apply when you refer to them. Full stop. However, any specific
agreement between the parties always prevails.
URDG
758 Schéma
Basic
schema
Detailed
schema
The
life of a demand guarantee
Instructing
The
instruction of a bank to issue a guarantee should be clear and
precise and avoid excessive detail. It should clarify
- Applicant
- Beneficiary
- Guarantor
- Amount and currency (A variation of the guarantee amount is possible if the guarantee provides for it.)
- Expiry (This refers to the time before which a presentation must be made. It can be described by a date or event.)
- Party liable for payment of any charges
Issuing
A
guarantee is irrevocable on issue even if it does not say so
specifically. Once issued, the Guarantor is not obliged to accept
amendments of the guarantee.
Transferring
Transferring
a guarantee means making it available to a new Beneficiary. Under ICC
rules, the guarantee must explicitly mention such possibility and the
Guarantor must consent to the new Beneficiary. By contrast,
transferring a counter guarantee is, by default, impossible.
Calling
In
theory, calling a guarantee should not depend on conditions other
than a date or a lapse of a period. In practice, this may be
different, namely as regards the provision of documents that indicate
compliance with the above conditions.
When
the Beneficiary wants to call a guarantee, he must do so at the place
of issuance or any other specified place, indicating in what respect
the Applicant is in breach of the underlying relationship. Partial
and multiple demands are possible; details obviously depend on the
guarantee.
The
Guarantor informs the Instructing Party about the demand for payment.
However, it cannot prevent such payment as, again, the guarantee is
on first demand.
Extend
or pay
Extend
or pay is a kind of institutionalized blackmail: The Beneficiary asks
the Guarantor either to extend its validity or to pay under the
guarantee. As opposed to blackmail under criminal Law, extend or pay
requests are perfectly legal under ICC URDG 758. It is important to
point out that the Instructing Party cannot influence on the decision
of the Guarantor.
Reducing
/ Expiring / Terminating
The
parties can reduce the principal of a guarantee by
- (partially) paying the underlying claim;
- providing for reduction under specific circumstances (so called variation.);
- a (partial) release on the part of the Beneficiary.
A
guarantee expires when
- the underlying claim has been paid entirely;
- the Beneficiary declares a total release;
- the expiry date (by default 3 years) has been reached.
The
theory of guarantees is not difficult to understand. However, the
practice can become quickly very tricky: The first reason is that
every guarantee is drafted differently. Second, when a guarantee is
called, the relationships are usually controversial which creates a
huge potential for conflicts.
Resource:
ICC
Uniform Rules for Demand Guarantees (URDG 758)
