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Disputes involving demand guarantees

Demand guarantees are among the most popular methods of securing international commercial transactions. They may be used to secure both the payment of fees and satisfactory performance of particular works. The popularity of these guarantees (sometimes also referred to as payment guarantees) can be attributed to the fact that they are issued by trustworthy and globally recognisable financial institutions (usually banks and insurance companies), and their operation is governed by universal rules well-understood in the business community. Guarantees are also independent of the underlying relationship between the parties, and the payment conditions are based on objective criteria, eliminating the potential for unexpected interpretations and actions by the parties. Given these factors, it is understandable that disputes regarding payment guarantees can usually be avoided. However, when they do occur, they usually involve substantial sums, with the potential to affect the financial liquidity of the companies involved.

Unlike most commercial contracts (e.g. sales contracts and leases), financial guarantee contracts are not regulated by national law. The Polish Banking Law contains only fragmentary rules regarding guarantee contracts allowing the parties freedom in drafting their provisions. In these circumstances, market practice forms the basis for most agreements, which has led to the development of a nearly universal set of rules governing how payment guarantees function. One of the most popular options is the Uniform Rules for Demand Guarantees (URDG) developed by the International Chamber of Commerce in Paris. The first version was issued in 1992, and the latest one, modified to reflect decades of practical experience and market demands, was published in 2010. This latest version is customarily referred to as “URDG 758”.

URDG 758 is a set of standard contract provisions. However, their acceptance by parties to the contract does not mean that they are unconditionally bound by them. Parties can agree to address some issues in ways differing from the standard URDG 758 approach. This includes choice of law and jurisdiction matters. In practice, such changes are rarely implemented and in most instances are limited to technical matters (e.g. deadlines).

URDG 758 provisions

Under URDG, a guarantee becomes effective when it leaves the control of the guarantor, regardless of whether the beneficiary receives it (unless the parties agree to a later effective date). Once issued, the guarantee is irrevocable and the beneficiary may file a demand with the guarantor.

Guarantees issued under URDG 758 terms are demand guarantees, which means that the obligation to pay the guarantee amount comes into existence upon the beneficiary’s delivery of a written demand (with the required documents listed in the guarantee contract) and the guarantor’s subsequent determination that the presentation constitutes a complying demand. These are the only conditions for payment that may be used. The obligation for payment of the guarantee amount is not conditioned upon an actual failure to perform (or unsatisfactory performance) of the applicant’s obligations created by the underlying relationship. Under URDG 758, the beneficiary must file a statement indicating in what respects the applicant is in breach of its obligations under the underlying relationship.

A demand under the guarantee is made through a “presentation,” which consists of the demand and any documents specified by the guarantee being delivered to the guarantor. The requirement of filing such additional documents must be incorporated into the terms of the guarantee. Usually, these documents consist of statements certifying that the construction work was defectively performed, expert opinions on the subject, as well as a supporting statement in which the beneficiary indicates the scope of the applicant’s defective performance of the obligation. The demand and supporting statement must not be dated prior to the guarantee’s effective date. This requirement does not apply to other documents being presented.

A presentation must be made to the guarantor on or before the date of expiry at the place of issue, or a different place if specified in the guarantee. In general, the presentation must be complete unless it indicates that it will be completed at a later date (no later than the date of expiry).

The guarantor is obligated to examine the demand with due care to determine whether it fulfils all of the requirements listed in the agreement. In principle, the examination shall take place within five business days following the date of presentation.

The guarantor may examine the presentation exclusively on the basis of the presented documents, in effect examining only whether the formal requirements for payment established by the agreement were satisfied (whether it is a “complying” presentation). This is particularly applicable to the submitted expert opinions and beneficiary’s statements. The guarantor only examines whether the documents satisfy the formal requirements stated by the financial guarantee contract and does not verify their factual or substantial assertions.

A demand will be deemed to be compliant if it fulfils the conditions stated in the guarantee and, potentially, URDG provisions not excluded by the guarantee as well as the international practice of demand guarantees. Data submitted in the presented documents does not need to be identical, as long as none of it conflicts with other submitted data.

A demand under the guarantee is non-complying primarily if the submitted documents—including the demand document itself—do not adhere to the guarantee’s terms, or if the amount of the demand exceeds the guarantee amount (if the additional documents or statements required by the guarantee agreement indicate amounts whose sum is smaller than the demanded amount).

If a demand is non-complying, the guarantor, in its sole judgement, may reject such a demand or ask the instructing party for a waiver of the discrepancies. The guarantor is obligated to notify the presenting party of a rejection of the demand without delay (no later than the fifth business day following the presentation). The guarantor’s rejection notice must contain a statement that it is rejecting the demand as well as a list of all discrepancies which caused the rejection.

Refusal to pay due to incompleteness of presentation or formal errors

It is standard practice for guarantor institutions to thoroughly examine whether the guarantee’s conditions for payment have been satisfied. This is understandable, as a guarantor’s failure to identify formal errors and its subsequent payment to the beneficiary may prevent the guarantor from seeking indemnity from the instructing party which ordered the guarantee.

If the conditions for payment are not met, the guarantor may refuse to pay the guarantee amount. This is not a major issue if the guarantee remains in force. In such instances, the beneficiary may complete and refile the demand for payment. Under URDG 758, such circumstances do not allow the guarantor to refuse to pay in reliance on causes not indicated in the initial rejection notice.

A more complex situation occurs when the refusal to pay is issued following the guarantee’s date of expiry. In those circumstances, the guarantee’s beneficiary is unable to complete (amend) and refile its demand. This usually leads to conflicts between the beneficiary and the guarantor.

While many demand guarantee disputes are settled in arbitration, some reach the courts. Polish case law on this subject is plentiful and restrictive. Polish courts frequently find that formal errors provide reasonable grounds for the refusal to issue payment of the guarantee amounts.

For example, a frequently occurring formal error involves addressing the demand to the wrong entity (frequently the incorrect branch office or a different entity in the guarantor’s capital group). Guarantors take varied approaches to this question: some accept such misaddressed demands while others refuse payment, claiming that a demand under the guarantee is invalid if it is not addressed to the entity named in the guarantee. The latter formalistic approach raises doubts, especially in matters of obvious and minor errors which do not create reasonable doubts as to the actual intention of the party filing a demand under the guarantee. After all, one of the key principles of the Polish legal system is that questions of declarations of intent are decided on the basis of their common-sense understanding corresponding to the party’s actual intent in situations where the addressee knows or should reasonably know the author’s true intent (falsa demonstratio non nocet).

On multiple occasions the Supreme Court of Poland has held that an author’s actual intent may not be considered void due to an inadequacy in the wording used, where the statement’s addressee understands its true sense in light of the totality of the circumstances (e.g. judgment of 30 January 2004, Case I CK 129/03). In another ruling, the Supreme Court held that the case’s context and the parties’ prior dealings are relevant in evaluating a declaration of intent (judgment of 14 December 2016, Case II PK 276/15). The URDG also mandates that documents presented in a demand under the guarantee be examined in context with all the other documents.

Nonetheless, there are plenty of judgments holding that formal errors in matters involving financial guarantee contracts may form the basis for a refusal of payment, even if similar errors would not be significant in other matters due to the totality of the context. These holdings rely on the fact that a formally complying demand is a contractually mandated condition for the effectiveness of the guarantee payment obligation. For example, in the Supreme Court judgment of 20 September 2013 (Case II CSK 670/12), the court held that the failure to transmit the demand through the intermediary of the beneficiary’s bank, and sending the demand without that bank’s confirmation that the demand was signed by individuals authorised to enter into legally binding commitments on behalf of the beneficiary, constituted formal errors justifying a refusal of payment. In short, a guarantor has the right to refuse payment if formal requirements are not fulfilled.

Impact of the underlying relationship on the validity of guarantee payments

In general, the guarantee agreement is independent of the underlying relationship (the one between the applicant] and the beneficiary on which the guarantee is based, e.g. a construction contract). This means that the latter relationship has no impact on the guarantor’s obligation to pay the guarantee amount upon the beneficiary’s demand. In practice, however, the instructing party (which gives instructions to issue a guarantee) often attempts to rely on claims related to the performance of the underlying relationship to stop the guarantee’s beneficiary from receiving the guarantee payment. Most often, the instructing party files a court claim seeking legal protections that would estop the guarantee’s beneficiary from obtaining the payment of the guarantee amount.

In some instances courts have secured such claims by withholding the payment of the guarantee amount, while others refuse to do so. The court’s decision is, to a large extent, based on its evaluation of the guarantee’s legal character. Supporters of an “abstract” conception of guarantees emphasise the guarantee relationship’s fundamental independence from the underlying relationship. This approach results in a finding that the guarantor may refuse payment of the guarantee amount based only on reasons related to the guarantee agreement. Such reasons include failure to follow the requirements regarding the demand presentation’s form, omissions in the presentation, or addressing the demand to an incorrect entity. The practical effect of this approach is that the plaintiff seeking to secure such a claim may not raise issues that relate exclusively to the underlying relationship.

On the other hand, proponents of the “causal” conception of guarantees argue that in addition to specific claims related to the guarantee contract’s terms, issues related directly to the terms of the underlying relationship should also be considered.

The Supreme Court has addressed this issue on several occasions, holding that the character of the relationship created by the bank guarantee contract depends on how it was drafted. The result may either be an “abstract” contract (independent of the underlying relationship) or a “causal” one (where the obligation for payment exists only if there is a valid underlying claim to be covered). Further, the Supreme Court has held that the use of the popular “payable on first demand” or “unconditional guarantee” wording to describe the guarantee suggests that the agreement reflects the “abstract” conception. In such circumstances, the parties may not invoke claims based on the underlying relationship (e.g. Supreme Court judgments of 6 March 2015, Case III CSK 155/14, 10 February 2010, Case V CSK 233/09, and 29 November 2013, Case I CSK 90/13).

Lower court judgments are not as uniform. Some courts refuse to secure claims through a withholding of guarantee payments, arguing that such practices are inconsistent with the nature and intent of guarantees, based on the quick and certain resolution of beneficiaries’ claims without the prior need to determine whether there is a valid legal basis for such payments (e.g. Poznań Court of Appeal order of 11 March 2013, Case I ACz 311/13, and Kraków District Court order of 10 July 2014, Case IX GCo 131/14). Others often avoid analysing the guarantee’s legal and business character and simply provide interim relief though an injunction on the issuance of a guarantee payment or the acceptance of payments issued by the guarantor under the guarantee relationship (e.g. Gdańsk Court of Appeal order of 10 January 2013, Case I ACz 1326/12, and Wrocław District Court order of 5 November 2013, Case I Co 491/13).

Patryk Polek, Maciej Zych, adwokat, Łukasz Lasek, adwokat, Dispute Resolution & Arbitration practice, Wardyński & Partners