Independence of Bank Guarantee in Russian Law

The principle of independence of the bank guarantee in the view of the recent decision of the Supreme Commercial Court of Russia.

While the Russian legal community has been discussing anticipated changes to the Civil Code, the Supreme Commercial Court has resolved one of the most problematic issues on the bank guarantee regulation: in its decision in the case №А40-63658/11-25-407 the court considered whether a bank can assess the underlying obligation and what the scope of such assessment can be (decision No. 6040/12 of 2 October 2012).

Artem Sirota
Partner

Sirota & Mosgo Law Firm
+7 495 234 18 75
artem.sirota@sirotamosgo.ru

The facts of the case are as follows. Upon the request of the contractor (principal) the bank (guarantor) issued to the customer (beneficiary) a guarantee whereas the guarantor secured the obligation to return an advance payment. The guarantee was to be paid out on the condition that the first duly signed claim for payment (with the indication that the contractor did not perform its obligations) has been made. It further follows from the facts of the case that the customer was entitled to receive back the advance payment.

Notwithstanding the customer’s claim, the contractor refused to return the advance payment, and the customer addressed the bank with the claim for payment of the guaranteed amount. The bank, however, also refused to pay. It claimed that it was not under the obligation to pay due to the fact that the customer did not prove that the main obligation was in fact breached. The position of the bank was upheld by the courts of the first and second instances. Fortunately, the Supreme Commercial Court reached the opposite conclusion and ruled in favour of the beneficiary.

Below are the most essential ideas established by the court:

First, the SCC has established that Article 374 of the Russian Civil Code (which sets forth the beneficiary’s obligation to indicate the facts and the nature of the main obligation in its claim) does not entitle the guarantor to check such non-performance. In fact, according to the SCC, this provision enables the guarantor to determine whether the violation took place solely on the formal grounds.

Second, the SCC has indicated that the beneficiary does not need to provide details of which obligations of the main contract have been violated.

Third, the SCC has explained how the terms of the bank guarantee are to be construed in case of ambiguity. Since the guarantors (banks or insurance companies) carry out professional activity in the financial market, the interpretation of the bank guarantee shall be carried out in the interest of the beneficiary with the aim of securing the main obligation.

Moreover, the SCC has pointed out that the guarantee must be executed as quickly as possible without anticipation of the debtor’s (principal’s) objection. Only non-performance of the terms and conditions of the guarantee itself can be grounds for refusal under the bank guarantee.

3. Therefore, the SCC took a liberal approach when giving answers to the most problematic and disputable issues regarding the bank guarantee. In order to assess how important the decision of the SCC is to the legal and business community it is necessary to look back at the problems that were rather often encountered by companies and their lawyers.

4. At first glance it may seem from the Russian Civil Code that a bank guarantee is one of the most effective security methods which provides the beneficiary with the easiest and fastest access to the money owed to him. Thus, under a bank guarantee, the bank (guarantor) shall issue upon the request of another person (principal) a written obligation to pay to the creditor (beneficiary) a certain amount of money against the submission of a written claim on its payment by the latter.

5. Nevertheless, the bank guarantee proved to be extremely problematic and close to impossible to enforce. This was caused by a rather inconsistent manner the concept

of independence of the bank guarantee is fixed in the Russian Civil Code. On the one hand, Article 370 of the Russian Civil Code sets forth that the guarantor’s obligations towards the beneficiary are not dependent upon the secured (main) obligation. On the other hand, Article 374 establishes that in its claim the beneficiary shall describe the violation of the main obligation. Moreover, the current version of Article 375 does not limit the guarantor solely to “external features” of the documents provided by the beneficiary while the guarantor analyses them in order to decide whether or not to pay the guaranteed amount (as it is now recommended in the Draft changes to the Civil Code).

6. These three provisions were construed by the courts so as to require submission of evidence confirming that the obligation was violated by the principal. This made the bank guarantee practically unenforceable for the reason indicated below. In fact, there are two cases that actually got to the SCC (Decision of the SCC of RF dated 04.05.2007 No. 4208/07 in the case No. А40-80337/05-42-643,), but the Panel of the SCC refused to consider them, thereby ignoring the following apparent problematic situation.

7. The non-performance of the main obligation is a negative fact, therefore logically it is impossible to determine the list of evidence that can be deemed sufficient in order to consider the fact proven. In other words, according to Russian courts, the beneficiary’s obligation was to submit an undetermined list of evidence. Apparently such an interpretation gave the guarantor space for abuse. In other words, the guarantor, a person that unilaterally undertook an obligation, was able to control the condition under which it became obliged to pay out the guaranteed amount under the bank guarantee. Consequently, such an interpretation gave the guarantor an easy way to refuse performance under the bank guarantee with reference to lack of evidence of non-performance.

8. It should be noted that the described approach of the Russian courts contradicts the established international bank practice with this regard. Thus, under international bank practice the absence of the beneficiary’s right to assess the substantive side of the relations between the beneficiary and the principal is a cornerstone of the bank guarantee. This in turn requires the beneficiary to rely solely on the documents indicated in the guarantee (i.e. their conformity to the requirements indicated in the bank guarantee, as well as their consistency), and in case such are absent – only on the written claim of the beneficiary. Should the bank guarantee fail to establish precise conditions (list of documents) necessary for the guarantee to be paid out, such a guarantee shall be deemed a guarantee on-demand and be satisfied by the guarantor without the necessity to prove the non-performance of the main obligation. Therefore, as established by international bank practice, the guarantor’s obligation to make the payment is not dependent on the actual non-performance under the main obligation by the principal.

9. The present international approach that has developed over the years has an obvious economic explanation. Thus, it is not in the interest of the guarantor to lose its time and money in order to find out who is right and who is wrong in the dispute regarding the main obligation. It is far more reasonable to pay out the guaranteed amount and recover it immediately from the principal. For reasons unknown, notwithstanding the apparent convenience and economic reasonability, this approach was not widespread in Russia.

10. It is therefore obvious that the recent Decision of the SCC is far more liberal than the established court practice that regulated the issue in the past. It is definitely a breakthrough and in line with the widely discussed Draft changes to the Civil Code that comprise new regulations aimed at strengthening the bank guarantee independence. Hopefully these changes will be the beginning of the new progressive legal thought in Russia which is line with the approach taken by the international community, an approach which is based on healthy economic relations, rather than the desire to abuse one’s rights.

11. Based on the new Decision of the SCC beneficiaries will most probably be able to preclude the guarantors’ abusive attempts to demand submission of evidence that the main obligation was not performed. It should, however, be noted that the decision of the SCC at hand can be reviewed upon discovery of new facts, therefore it can be changed in the future.

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