WHETHER IT IS APPROPRIATE TO DRAW AGAINST A GUARANTEE

(Excerpt from TRADE SERVICES UPDATE Volume 12, Issue 3, May – June 2010)

Is It Appropriate to Draw against a Guarantee?

Question:

We come across the case below, and would like to kindly have your opinion on this one:
Company A sold their machines (for USD 60,000.00) to Thailand under contract no.xxx. The payment was to be settled by an LC (for USD 60,000.00), which stipulated that 90 per cent was paid against shipping documents, and 10 per cent against a certificate of quality. Also, company A was the beneficiary of a payment guarantee under the same contract, which only required a claim and statement, subject to URDG 458 for USD 6,000.00.
The result: Company A was only paid for USD 54,000.00 and failed to get the final payment of 10 per cent (i.e. USD 6,000.00) due to some defects in the second presentation of the LC (e.g., late presentation).
To offset some loss, is it appropriate for company A to draw against the above guarantee? (Technically, we think this is workable.)
But we also note that the second presentation under the LC also indicated some machinery defects shown in the certificate of quality, and thus, is it proper to do so under this situation?
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Answer from Belgium:

As both the LC and the guarantee are separate and independent instruments, it is perfectly possible that the beneficiary of the guarantee also claims under the LG notwithstanding the fact that he also did not have to pay for the 10 per cent under the LC.
It even does not matter whether the reason for the rejection of the 10 per cent under the LC is the same (or not) than the reason for the claim under the LG

Emile Rummens
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Answer from Canada:

I would like to share my experience from a Hong Kong high court.
We have two separate cases from one and the same client; one dispute is regards on LC and the other, a sales contract. The LC deals with the documents presented and is not concerned with the other terms in the sales contract. So a party may win in one trial and lose in the other, depending on the nature of the disputes themselves.
Due to the independent principle of the LC, these two disputes should be on trial in two separate courts. But in order to save time, the judge decides to put the two cases on trial in the same court room. So if the trial for this query is in Hong Kong under the same judge, then the guarantee, the LC, and the sales contract will be on trial in the same court and the results may be different.
The beneficiary in the guarantee may not win in this case due to the poor quality of the goods.

T. O. Lee
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Answer from Vietnam:

The LC and LG are two separate instruments, therefore, payments under these instruments should be made separately notwithstanding that they are issued by the same bank.The beneficiary can make a demand under the LG. The guarantor must honour the complying demand unless there is a court order preventing the payment pending the settlement of the dispute over the quality of the goods.

Nguyen Huu Duc
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Answer from India:

I am in total agreement with Nguyen. The two are distinctly separate transactions. They operate under different rules. They must be treated and also processed separately on their individual merits. The rest does not matter.

Rupnarayan Bose
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Answer from Singapore:

Whether the seller wishes to claim under the BG depends upon the purpose of his / her claim. If the goods are in defective condition and therefore the balance of 10 per cent was not paid by the buyer, morally, whether the seller should claim under the BG is something only the seller knows. Of course, if there is a claim, the guarantor will honour unless there is an injunction or stop payment order given by the court.

Soh Chee Seng
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Answer from USA:

Notwithstanding that these are two separate undertakings, if the 10 per cent guarantee was meant to cover an eventual contract non-payment then the beneficiary may have the right to draw against it. If the 10 per cent guarantee requires a statement that the beneficiary may honestly make, then they are within their rights to draw against the guarantee. Any defects, purported/alleged or real are aspects that need to be settled by the underlying contract.

Glenn Ransier
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Answer from Spain:

I complete agree with the comments that the letter of credit and guarantee are two separate transactions, issued by the same bank, completely independent.

Xavier Fornt
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Answer from South Korea:

Can the beneficiary of the bank guarantee claim under a guarantee that has been issued in its favour?
[Answer]Yes.
Chang-Soon Thomas Song
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Answer from Denmark:

I agree with the comments that the bank guarantee and the documentary credit are independent transactions. The beneficiary of the bank guarantee can make the claim, if he decides to do so.

Jakob Ingerslev
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Answer from Ukraine:

There’s no doubt that the beneficiary can claim and both transactions are independent.
But the question is how to refuse payment under the guarantee when the bank and the applicant are sure that the beneficiary has no moral right to claim due to the poor quality of the goods.
Based on the information given it's hard to offer something. All security should be in the conditions of the guarantee itself. Are there any accompanying documents that are required together with the claim that ensure shipment/quality, etc.? Why would the buyer agree to the issuance of such a guarantee if he issued an LC for the full amount of shipment?
We try to clear up all such issues before issuance of the LC and/or guarantee and advise our customers to avoid additional risks. Certainly the bank (under all other positive conditions) will issue any LC and guarantee it considers acceptable; in this case the applicant must be aware of and ready for any risks undertaken.
On the other hand, if there were no defects in the goods the applicant would have to waive the discrepancies, but he did not. Now it's a question of the applicant's morality, perhaps the beneficiary has all moral and actual rights to claim.

Lyudmila Yeremenko
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Answer from Switzerland:

There is something I do not understand.
I agree that the beneficiary may (it does not mean he will succeed) draw against the guarantee. Two separate instruments, no dispute.
But why would the buyer issue such a guarantee? By issuing the guarantee, the buyer tells the seller that if the 10 per cent is not paid under the credit because the certificate of quality is not presented or is discrepant (quality not meeting the requirements of the credit?) or, as it seems to be the case here, it is presented too late, he (the seller) does not have to worry, he just has to make a claim under the guarantee. In other words the 10 per cent will be paid anyway, whatever happens. I admit I do not see the point. Have I missed something?

Daniel Devahive
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Answer from Canada:

If the goods really are defective, we may bundle the two cases, one on banker's guarantee and one on sales contract so that the two disputes will be on trial in one and the same courtroom. In that case the buyer will get paid under the independent guarantee but he has to reverse the payment due to default in the sa
les contract by supplying defective goods.
The concern for the buyer is whether the court would agree to handle the disputes together. Since most courts are very busy, some courts may be happy to accept such a request from the buyer. I encountered one case in Hong Kong where the trade fraud and LC disputes were bundled together in one courtroom.
This is more effective than applying for a court injunction, which is very difficult to get, particularly in the United States where the buyer has to prove to the court that he has sustained irreparable harm, a higher standard than pure monitory losses.

T. O. Lee