Bank Guarantees and 'Extend or Pay' Requests

By Chang-Soon Thomas Song, Esq.  

Every day banks around the world handle bank guarantees facilitating the carrying out of contractual obligations between international parties. The bank guarantee is a simple mechanism whereby once the beneficiary declares to the issuing bank of the guarantee that the applicant has failed to fulfill his contractual obligations (a default statement)，payment is made by the issuing bank.

Although the amounts of bank guarantees can be quite large，ranging from thousands of dollars to millions of dollars，requests for payment under a bank guarantee are rarely made. When the exceptional request for payment is made，the issuing bank makes payment within a reasonable period of time. There is no refusal to pay based on some discrepancy in the request for payment.

Depending on the area in which the beneficiary resides，sometimes reissuance of a bank guarantee is used or at other times a direct issuance of a bank guarantee is used. Regardless of whether the issuing bank is an overseas bank or a local bank where the beneficiary resides，bank guarantees are normally paid without incident.

At times，there are wrongful claims for payment under a bank guarantee. This is a matter of either fraud，abuse of right or unconscionability，depending on the legal jurisdiction of the bank guarantee in question. The present article，however，is not about that issue but rather the issue of an "extend or pay" request under a bank guarantee ¨C a matter that is often not fully understood by traders，lawyers and even bankers.

Expiration

Most people take for granted that once a bank guarantee is issued with an expiry date，unless the applicant agrees to extend the bank guarantee，the bank guarantee expires on the given expiry date. Thus，people are shocked when they discover that the bank guarantee they had issued does not expire at the given expiry date.

For the bank credit review officer，this may be a very serious issue. The bank had approved the issuance of a bank guarantee for a given expiry date after considering the various credit review variables such as the credit standing of the applicant，economic conditions，the credibility of the beneficiary，the transaction in question as well as many other variables which are important in the approval of the issuance of the bank guarantee.

The bank credit review officer takes for granted that the bank guarantee will expire at the given expiry date unless he approves an extension of the said bank guarantee.

This understanding of the bank guarantee by the bank credit officer is quite normal as the letter of credit is not extended unless he approves the extension.

However，a bank guarantee is unlike a letter of credit which is used to make payment for trade transactions. The bank guarantee is issued to ensure compliance of contractual obligations of the applicant towards the beneficiary. Even if the bank officer decides not to approve an extension，he will find that he has to do so. If the issuing bank does not extend the bank guarantee at the request of the beneficiary，then the issuing bank must pay the beneficiary the amount of the bank guarantee.

To see why this is the case，let us examine the extension of pay request under the bank guarantee.

Correct Interpretation

Lord Steyn of the English House of Lords once said that when a judge is unable to understand the reason behind a given rule which is to be applied to a case before him，he should be very careful when applying that rule. After all，rules are made for a purpose and unless the purpose is understood by the judge，a correct application is not possible.

Rules are made to facilitate the resolution of cases which occur repeatedly in similar forms. Rather than reviewing all such cases from the very beginning over and over again，a rule can be applied without too much effort. When a new situation differs fundamentally from the facts pertaining to the rule，then the situation is distinguished from former cases and another rule is applied.

The key to the above process is "context." Even when the words used are the same，when we look at the context of the sentence in which a particular word is used，as well as the situation taken as a whole，we sometimes find that even the very same words have to be interpreted differently. Words have meaning only when there is a particular context given to those words. There is no meaning to a word which is alone in space without any context.

The bank guarantee is covered by the rule called the Uniform Rules for Demand Bank Guarantees. The "extend or pay" request is explained in those rules.

Default Statement

The bank guarantee business is a profitable one for banks. There is no outlay of cash such as in making loans and yet the banks are paid commission for issuing the bank guarantees. Furthermore，the beneficiary of the bank guarantee rarely makes a claim for payment under the bank guarantee.

Bank guarantees are used in international contracts and here reputation once ruined cannot be recovered by any means. Thus，the applicant of the bank guarantee not only endeavors to comply with all contractual obligations covered by the bank guarantee but also does everything possible to avoid any call for payment by the beneficiary under the bank guarantee as that would damage his international reputation.

Although the beneficiary can simply present the default statement (stating to the issuing bank that the applicant had failed to fulfill his contractual obligations) and receive payment，he rarely does so. The purpose of the beneficiary in requiring the bank guarantee is not to receive quick payment from the issuing bank but to ensure that the applicant fulfills his contractual obligations under the bank guarantee. Thus，there are very few calls for payment under bank guarantees.

However，compliance by the applicant is sometimes delayed and an "extend or pay" request is occasionally made by the beneficiary. The applicant may refuse to extend the bank guarantee，and when the guarantee is not extended，the issuing bank is required to make payment to the beneficiary. Thus all "extend or pay" requests by the beneficiary result in extension of the bank guarantee by the issuing banks.

In recent times，insurance companies have discovered the profitability of the bank guarantee business and have worked with banks to provide such bank guarantees to their customers. A customer could apply to a bank for a guarantee but he can also apply to an insurance company for a counter guarantee in favor of a bank so that the bank can issue a bank guarantee in turn.

In one case，an insurance company had been approached by a customer for the issuance of a bank guarantee in a foreign country. The insurance company approved the customer's application and requested a bank to issue a bank guarantee in the foreign country. The bank duly complied and sent a reissuance request to the foreign bank by sending the bank a counter bank guarantee and the foreign bank also duly issued a bank guarantee in favor of the beneficiary.

In order for the applicant to issue the bank guarantee to the foreign beneficiary，the insurance company，the bank in the insurance company's country and the foreign bank all cooperated to make the above transaction possible.

Then the beneficiary made an "extend or pay" request of the foreign bank which duly extended the bank guarantee. The foreign bank contacted the bank in the insurance company's country and the latter bank also duly extended their counter guarantee to the foreign bank.

And then the bank in the insurance company country requested extension to the insurance company. The insurance company refused to extend its counter guarantee to the bank. The bank then claimed payment based on the refusal to extend the counter guarantee，but the insurance company again refused payment.

The insurance company seems to have judged that under the circumstances，it was free to decline to extend its counter guarantee to the bank in the insurance company's country.

The present article reviews the refusal by the insurance company to extend its counter guarantee in favor of the bank in the insurer's country. Is the insurance company correct in assuming that it does not have to extend its counter guarantee in this case? The answer is no.

The insurer does not have the power to refuse extension of its counter guarantee. It can of course make payment under its counter guarantee to the bank in its country but as it has refused to make payment this implies it does not want to make payment. Although it is an insurance company，once it takes up the bank guarantee business and apply the Uniform Rules for Demand Bank Guarantees，it has to comply with the rules just like any bank. es for Demand Bank Guarantees summarize the international bank guarantee practice of the banks. Unlike a statute，the articles in the said Rules have to be understood in the context of the bank guarantee practice which they were made to represent so that traders，bankers，lawyers can all see clearly the bank guarantee practice of the international banks.

The Uniform Rules

The Uniform Rules for Demand Bank Guarantees summarize the international bank guarantee practices for banks. Unlike a statute，the articles in the Uniform Rules have to be understood in the context of the bank guarantee practice. They were designed to make the guarantee practices of international banks understandable to traders，lawyers and judges as