Case: Bank guarantee, litigation practice.

Ospanova Gulnar
Partner

Case: Bank guarantee, litigation practice.

      Background Information

A foreign company, operating in Kazakhstan through its subsidiary (the Contractor), after winning the tender for government procurement concluded a Contract with the state-owned company (the Customer) for the carrying out of construction work.

In pursuance of the Contract, the Contractor concluded with a Kazakh legal entity (the Subcontractor) a Subcontract, under which the Subcontractor undertakes to perform the work specified in the summary sheet, which is an integral part of the Contract, while the Contractor undertakes to pay for the work performed by the Contractor and approved by the Engineer (the person designated by the Customer under the Contract).

In accordance with the terms of the Subcontract, the Contractor shall make within 7 days to the Subcontractor an advance payment, while in its turn, the Subcontractor shall provide a bank guarantee for the same amount.

After payment by the Contractor of the advance payment to secure the fulfillment by the Subcontractor of its obligations under the Subcontract, the bank serving the Subcontractor (further the Bank) issued a bank guarantee to the Contractor (further the Bank Guarantee).

According to the Bank Guarantee, the Bank undertakes an irrevocable obligation to pay the Contractor within 5 calendar days, an amount not exceeding the amount of the advance payment on its first written demand for payment, confirming that the Subcontractor has failed to fulfill its obligations under the Subcontract.

In the repeated violation by the Subcontractor of the terms of the Subcontract (the Subcontractor was behind the project schedule for more than 30 days), which had not been eliminated despite repeated written warnings, the Contractor sent to the Subcontractor a written notice of termination of the Subcontract, and also sent to the Bank a written demand to pay the guarantee amount. In its letter to the Bank the Contractor pointed out that the Subcontractor had failed to fulfill its obligations under the Subcontract.

However, the Bank did not fulfilled that demand and in its reply to the Contractor stated that it disagreed with the stated sum payable, since the Bank sought from the Subcontractor to clarify the situation and was produced the documents confirming that the Subcontractor had not violated the contractual obligations.

The Contractor had intended to initiate a lawsuit against the Bank; however, the Subcontractor was ahead of the Contractor and filed a claim against the Contractor as to the recognition of its demand to the Bank that the latter would pay the bank guarantee as illegal.
By court decision the claim was satisfied. The plaintiff's claims and the court's decision which satisfied the claims are not based on the law.

The Court concluded that the actions of the Contractor on demanding from the Bank to perform the bank guarantee are illegal and unjustified, violating the rights and legitimate interests of the Subcontractor.

Meanwhile, the Plaintiff's claims are not consistent with the nature of relations on the bank guarantee that are specified in the rules of civil law (Civil Code of the Republic of Kazakhstan, Article 329).

Analysis of the situation

The civil law does not provide for the right of the debtor to file a claim on its own to ban the performance of the bank guarantee. Participation of the debtor in the proceeding on the dispute concerning the performance of the bank guarantee is provided for the Civil Code of the Republic of Kazakhstan, Article 333, Item 1, according to which "the guarantor is obliged before meeting the demand of the creditor to notify the debtor of this first, and if any claim has been filed against the guarantor, the guarantor shall attract the debtor for participation in the case. Otherwise, the debtor has a right to assert against the recourse of the guarantor all the objections it had against the creditor."

Thus, only in case the creditor files a claim to the guarantor, providing that the latter has refused to perform its obligations under the bank guarantee, the debtor may participate in the process on the side of the guarantor.

According to the Civil Code of the Republic of Kazakhstan, Article 329 (Bank Guarantee), by virtue of the bank guarantee, the guarantor undertakes before the creditor of another entity (the debtor) to be liable for the performance of the obligations of that entity either wholly, or in part in solidarity with the debtor, except for the cases stipulated in legislative acts. The entities that have jointly given the bank guarantee, shall be jointly and severally liable to the creditor, unless otherwise is provided by the contract of bank guarantee. The contract of bank guarantee can be concluded also to ensure the obligation that will arise in the future.

Based on the provisions of the Civil Code of Kazakhstan, Article 331, the bank guarantee arises under a written contract of bank guarantee. Second-tier banks may issue bank guarantees under a license of the authorized body.

The guarantor is vested with the right under the laws (the Civil Code of Kazakhstan, Article 333) to raise objections against the creditor’s claims, which the debtor could have produced, unless otherwise is stated in the contract of bank guarantee. The provisions of this norm is an exception to the rules on the execution of the joint and several liability, pursuant to which the debtor is generally not entitled to raise any objections against the creditor’s claims which are based on such relationships of other debtors to the creditor, in which the said debtor is not involved (see the Civil Code, Article 287, Item 5). The exception to this rule is provided for in connection with the essence of relations between the guarantor and the debtor in the performance by the guarantee of its principal obligation, in particular, in connection with the fact that the guarantor has a right of subrogation before the debtor.

The limitation of the guarantor’s right to raise objections against the creditor’s claims can come out only of the terms of the bank guarantee contract; for example, if the terms of the bank guarantee contract provide for the unconditional satisfaction of the creditor’s claims by the relevant first application. Banks give such kind of bank guarantees. This happened in our case.

Relations arising out of the bank guarantee bind the guarantor (the bank) with the creditor (the beneficiary).The bank guarantee, by its nature, is a separate agreement, independent of the main body of the contract, on which it is based; thus, the guarantor is in no way connected with such contract, despite the fact that the reference to it is contained in the bank guarantee. The basis of the bank guarantee is the contract of bank guarantee between the bank and the beneficiary. In our case, the Bank is the guarantor and the Contractor is the beneficiary.

The debtor (in our case, the Subcontractor), the obligation of which before the creditor is secured by the bank guarantee, is not directly involved in relations on the bank guarantee. Thus, the debtor, not being party to the contract of bank guarantee is not entitled to contest actions of the creditor as to enforce the bank guarantee. Enforcement of the bank warranty is carried out in accordance with the terms of the bank guarantee.

In our case, according to the terms of the bank guarantee, the bank guarantee is irrevocable. The bank guarantee is also unconditional, because it contains the indication that the money is paid on the first written demand for payment, confirming that the Subcontractor has failed to fulfill its obligations under the Contract.

The foregoing means that the Bank is entitled to refuse to pay the amounts under the Bank Guarantee, only if the demand does not meet the above conditions. The demand of the Contractor met the conditions of the Bank Guarantee and was subject to enforcement by the Bank within 5 calendar days. The Bank was not entitled to refuse to perform its obligations under the bank guarantee, referring to the performance of the obligations by the debtor (Subcontractor) or any other circumstances. That is, regardless of whether the debtor had performed the obligation properly or not, the Bank was obliged to fulfill the written demand of the beneficiary (the Contractor) by pay to the latter the amount specified in the bank guarantee.

This is the essence of an irrevocable and unconditional bank guarantee. The debtor is not entitled, also through the courts, to prohibit the creditor to demand from the bank as the guarantor the performance of the bank guarantee; otherwise, the bank guarantee loses its sense.

In the present case, the court in its decision legalized violation by the Bank of the bank guarantee.

The Contractor, by laying a demand to the Bank to pay the amount of the bank guarantee, with such its action did not violate any rights or legitimate interests of the Subcontractor. In this case, the Bank shall pay to the beneficiary only with its own money. As for the recourse of the Bank, the debtor (Subcontractor) by agreeing an irrevocable and unconditional bank guarantee assumed all risks associated with such guarantee, including the risk of possible negligence of the creditor.

At this stage, the court decision on the case is being appealed by the defendant (the Contractor) to a higher court.
It should be noted that this kind of cases and illegal court decisions on them, unfortunately, are numerous. The task of the lawyers is to break such vicious jurisprudence.

Summary

In conclusion, we note that irrevocable and unconditional bank guarantees are widely used in international practice. In fact, it is exactly the guarantee that is usually understood under the bank guarantee. Thus, according to the Uniform Rules for bank guarantees on first demand (of International Chamber of Commerce), "a bank guarantee by its nature is a separate agreement independent of the main body of the contract or bidding documents, on which it is based, so the guarantor is in no way related to such contract or the bids, despite the fact that the reference to them is contained in the bank guarantee. The obligation of the guarantor is to pay the amount stated in the bank guarantee, on presentation of a relevant written demand to pay and other documents specified in the bank guarantee, which in their essence are in accordance with the conditions described in the bank guarantee."

The bank guarantee is called unconditional because no conditions are required for the guarantor to perform it. Moreover, even if the debtor presents clear evidence of its fulfillment of the obligation secured by the bank guarantee, the guarantor has no right to refuse to fulfill its obligation under the bank guarantee, citing the fact that the debtor has not violated its obligation. That is why the unconditional bank guarantee is the most reliable security.

For clarity, we provide an example of the rules in the Civil Code of the Russian Federation which govern the bank guarantee. The Civil Code of the Russian Federation, Article 376, Item 2 provides that if it became known to the guarantor before satisfaction the beneficiary’s demands that the main obligation secured by the bank guarantee, is already performed in whole or in part, or terminated for other reasons, or became invalid, it shall immediately notify the beneficiary and the principal of that. Repeated demand of the beneficiary, received by the guarantor after such notice, shall be satisfied.

Thus, a bank guarantee is the most reliable security of fulfillment of obligations, since the creditor has the possibility of getting the performance of it from the bank as the guarantor, irrespectively of any whatsoever circumstances. If the creditor, acting in bad faith, for example, after improper fulfillment by the debtor of its obligations under the contract, receives also from the bank as the guarantor the amount of the bank guarantee, the debtor is entitled to recover from it all losses, incurred by it, including all amounts paid by it as a recourse to the guarantor bank (Civil Code of the Republic of Kazakhstan, Article 350, Article 9, Item 4).

Prepared by Gulnar Ospanova, Partner, Legal Consulting Company "Artyushenko & Partners"
Published in RCBK magazine, November 2013, #11 (235).