New rules on guarantees or when must another person's debts be paid without objection?

13.10.2010

Inese Heinacka
Senior Associate
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In large procurement tenders, construction projects, as well as in other transactions involving significant sums, a guarantee is often required. In these cases a third party (most often a bank) guarantees another person's - the debtor's - obligations and in case of non-fulfilment of these obligations the third party undertakes to pay the beneficiary of the guarantee. In the midst of summer work, many may have missed the coming into force of the new ICC Uniform Rules for

Demand Guarantees 758 on 1 July ("URDG 758").

What is a guarantee?

Those who know, ask for guarantees because guarantees facilitate the rights of the beneficiary of the guarantee to receive the sum of money claimed without having to lengthily prove the grounds for payment of the guarantee and the amount of the sum claimed.

In practice, however, the commonly seen opinion that a guarantee is the same as a surety but merely under a different name is false. It is important to remember that a guarantee, unlike a surety, is independent from the transaction under which the guarantee is issued. The guarantor's obligation to pay is not connected to the relations between the debtor and the beneficiary of a guarantee nor are disputes arising from a transaction the basis of the guarantee. To put it briefly - if a guarantor receives a demand to pay under the terms of the guarantee, then having inspected the demand and having concluded that it complies with the guarantee the guarantor must pay without objection and without verifying the validity of the reasons behind the demand.

In the meanwhile it should be understood that a guarantee makes the debtor's life easier at least at the beginning because it often ensures application of more beneficial provisions in a transaction or serves as a pre-condition for the transaction itself.

What regulates guarantees?

In this field, the ICC (International Chamber of Commerce) rules for demand guarantees are very important. They are recognised internationally and widely applied. The World Bank and several internationally known industry associations, for example, FIDIC (International Federation of Consulting Engineers) incorporate them in their forms. As in some countries, for example in Latvia, unlike Lithuania and Estonia, these guarantees are not regulated directly in national law, then in order to use a guarantee complying with international practice, a direct reference to the ICC rules on demand guarantees should be included in the document itself.

News in International Practice

On 1 July this year, the new ICC Uniform Rules for Demand Guarantees ("URDG 758") came into force. The previous ICC guarantee rules No 458 were first published long ago, in 1991. Taking into account the most recent technological changes and globalisation tendencies, significant work on development of new guarantee rules has been completed. The immense scope of this work could be characterised by a couple of numbers - their development took two and a half years, while in total more than 600 commentaries from 52 states were submitted.

Several important changes are worth noting:

  • The new URDG are more precise. The previous URDG used such terms as "reasonable time" or "reasonable care". Now, upon receiving a guarantee demand the guarantor must inspect the demand within five business days instead of a reasonable time.
  • The independence of the guarantee from the obligation for which the guarantee has been issued is stressed to a larger extent. The new rules clearly indicate that the guarantor cannot revoke unilaterally. The previous rules allowed revocation unless the parties had agreed otherwise.
  • The new URDG provide a more detailed procedure on how to act upon receiving a guarantee demand, how to act in cases when only a part of the claim guarantee sum is payable or several demands are submitted for one guarantee.
  • The rules also provide several novelties, for example, change of guarantee currency if payment in the respective currency is impossible. Likewise, a new termination mechanism is indicated in case a guarantee does not state an expiry term or terminating event.

It should be noted that the new URDG also replicate several rules from ICC UCP 660 rules (Uniform Customs and Practice for Documentary Credits) used in relation to letters of credit. The drafters of URDG 758 have indicated that for application of these rules, the UCP 600 explanations provided are recommended. The previous demand guarantee rules 458 do not lose their force automatically and can still be applied.

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