General Features of Independent Guarantees

8.05 Independent guarantees^[720] are used to guarantee the performance of a range of obligations in various settings, including construction, finance, and international trade.^[721] In international trade transactions, the sale or supply contract may provide that one party must procure a per­formance bond in favour of the other.

8.06 Despite the use of the word ‘guarantee’ in some of the terms associated with such under­takings, they operate differently from the more familiar type of bank guarantees used in suretyship contracts, which are secondary obligations whereby the guarantor is liable to pay only if the principal debtor is in default. In contrast, in an independent guarantee, the bank's duty to pay is a primary obligation that is not conditional upon any default by the applicant. An important preliminary question in any dispute related to independent guar­antees is whether the bank's payment obligation is a truly independent one. In other words, whether the obligation is conditional or unconditional. The discussion in this chapter ap­plies only to unconditional guarantees, ie those that are independent of the underlying con­tract.

An independent guarantee transaction typically involves at least three contracts.^[723] The first is the contract between the applicant and the beneficiary. This could be for the supply of goods or services, or for the payment of money (‘the underlying contract'). Its terms will require the applicant to procure an independent guarantee in favour of the beneficiary, usu­ally for a percentage of the contract price. This will guarantee proper performance of the applicant's obligations and the beneficiary can seek payment under the guarantee if the ap­plicant breaches the contract. The second contract is between the applicant and the bank,^[724] when the applicant approaches the bank to issue the required independent guarantee. In return, the applicant promises to reimburse the bank if the bank pays the beneficiary upon a conforming demand. The third contract is between the bank and the beneficiary. This is the independent guarantee itself. Here, the bank promises to pay the beneficiary if the latter makes a conforming demand. The requirements of a valid demand will be set out in the independent guarantee, and this will vary, according to the instructions given to the bank by the particular applicant. It is important to have an understanding of these different con­tracts in order to appreciate how the autonomy principle and the fraud or unconscionability exception operates.

8.08

Three main situations in which issues related to the fraud exception may arise in litigation are: (i) where the beneficiary is suing the bank for a refusal to pay on the independent guar­antee in the face of a complying demand; (ii) where the bank is seeking reimbursement from the applicant but the applicant asserts that the bank should not have paid as it had knowledge of the beneficiary's fraud; and (iii) where the applicant is seeking an injunction to restrain payment on the guarantee. The fraud exception applies in all three situations, although the rationale for its application and the standards of proof required may vary in each case.

URDG), which apply to demand guarantees; and the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit (adopted 26 January 1996, UNGA Res 50/48, entered into force 1 January 2000) (here­after UN Convention on IGs and Stand-by LCs), intended for use with all types of independent guarantees, in­cluding standby credits.

to grant an injunction restraining payment on a performance bond despite a conforming demand. The issue of Unconscionability has never arisen in relation to the first two situ­ations. Returning to the contracts outlined in the previous paragraph, if the question to be decided by the courts is whether the bank has a contractual duty to pay the beneficiary on a conforming demand, the contract that takes centre stage is the one between the bank and the beneficiary. The autonomy principle applies, subject only to the fraud exception. On the other hand, if the question is whether the courts should intervene to grant an injunction, which is the focus of this chapter, the contract between the applicant and the beneficiary is also of relevance as this determines the obligations and expectations of the parties in rela­tion to each other.

III.