Court Intervention in Guarantee Transactions

For many years,I used to think that court interventions in bank guarantee transactions were harmful to the credibility of the international bank guarantee. Bank guarantees are an unconditional payment undertaking of banks and thus when a claim is made by the beneficiary,usually with a statement of the applicant's default or failure to carry out contractual obligations,payment would be made forthwith. There is no need for proof of the applicant's default in this procedure. The mere statement by the beneficiary would trigger payment.

With a bank guarantee ensuring the performance of the applicant,the beneficiary would rest assured that the applicant would carry out his contractual obligations; if he does not do so,the beneficiary can simply ask his banker to send a claim for payment to the issuing bank of the bank guarantee.

Not having much opportunity to come across court interventions in bank guarantees,I agreed with banking commentators as well as legal commentators that the courts should try to stay out of bank guarantee transactions.

Then in 2011 a Singapore case JBE Properties Pte Ltd v Gammon Pte Ltd came out from the Singapore court. In this case,the principle of unconscionability was used to stop payment on a claim made by the beneficiary under a bank guarantee.

For a long time,only fraud was allowed to stop payment under a bank guarantee. But unlike a letter of credit transaction,where the facts of fraud would be easily proved,such as by shipping stones instead of the contracted goods under the letter of credit,it was often difficult to prove that the claim made by the beneficiary under a bank guarantee was a fraudulent one. Thus in most cases,although the applicants had complied with their contractual obligations,the courts did not allow the stop payment to be applied to a bank guarantee transaction.

Thus the Singapore court,after examining the facts of the case,found that the applicant had carried out his contractual obligations and yet the beneficiary had called on the bank guarantee. It concluded that the call under the bank guarantee was not fraudulent but unconscionable,and thus stopped the payment under the bank guarantee.

Different Bank Guarantee Court Cases

After this case,I came across a number of claims made under bank guarantee where the applicant would apply to the court for an injunction or an attachment to the payment of the bank guarantee and the court issuing such injunctions or attachments. These devices are usually temporary measures under the law to stop payment on a bank guarantee so as to have both parties -- the beneficiary and the applicant -- appear before the court to argue their case. The procedures are not simple and the applicant is ordered to place funds with the court to ensure that the beneficiary would not be unduly harmed by the temporary measures. It is difficult to imagine an applicant abusing such devices to stop payment on bank guarantees where there had been a contractual breach and the beneficiary had rightfully made a claim under the bank guarantee.

Use of Bank Guarantees in International Trade

Large numbers of bank guarantees are issued and sometimes they are for very large amounts. Usually the text of the bank guarantee is drafted by lawyers and  the wordings often are difficult for bankers to understand. But as these same phrasings are used frequently,bankers gradually get used to them. Despite the complexity of the wordings,the procedures at the bank handling bank guarantees are quite simple. When the applicant submits an application for the issuance of a bank guarantee,the credit line of the applicant is checked,and once it is determined to be in order,the text of the bank guarantee is checked by an expert at the bank. In most cases,the wordings as required by the beneficiary are approved and the bank guarantee is issued.

Most applicants are very concerned with their international reputation and thus they do everything possible not to bring about such a call under the bank guarantee. In fact,very few calls are made under bank guarantees,and when there is a force majeure event or something similar to that where the applicant has not been able to comply with its contractual obligations,the beneficiary makes the call under the bank guarantee and it is duly paid by the bank.

However,with the downturn in the economy or due to changes in circumstances,disputes may arise between the beneficiary and the applicant. Instead of working out their differences reasonably between themselves or through arbitration,the beneficiary goes ahead and calls on the bank guarantee. In such cases,the applicant has usually carried out his contractual obligations and the facts usually do not call for such a claim under the bank guarantee.

Uniform Rules for Demand Guarantees

The Uniform Rules for Demand Guarantee published by the International Chamber of Commerce Banking Commission make clear how best practices in bank guarantees are carried out by international banks. However,the rules are made by bankers and thus do not provide much guidance as to where the law enters the picture. As there is no law on bank guarantees passed by any legislature in any country,the courts -- when adjudicating on bank guarantee cases -- look to the above rules but do not find the answer to questions before the court.

Injunctions and Attachments

In the past when courts issued injunctions or attachments to bank guarantee transactions,we would regard them as undermining the reliability of the bank guarantee for international traders. But after examining the various cases where such injunctions had been issued,I found that the facts were such as to warrant  intervention by the courts.

There had been many instances where banking and legal commentators were becoming alarmed by the rise in the use of unconscionability as a separate basis other than fraud to stop payment. They voiced concerns that the reliability of the bank guarantee might be questioned by many in the international trading community. But bankers and traders themselves did not join these commentators in taking this position.

Short History of English Law

In the early days of English common law,there were courts of law,and certain writs were prescribed for various actions in court. The conditions of the writs were very strictly adhered to and any failure to meet these conditions would block the applicant in the quest for perceived justice. After a while,this was seen as intolerable and people went directly to the king for the justice. The king passed on the cases to the Lord Chancellor who would listen to the complaint of the applicant and provide measures that seemed appropriate in the case. This was called the court of equity and this court developed in conjunction with the courts of law where often the applicant was not able to get the justice he deserved.

United States Courts