Thursday, June 18, 2015

ICC Uniform Rules for Demand Guarantees (URDG 758) – In Guarantees we trust…


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)