The parties of a contract (“main contract”) may require the counter party to commit certain guarantees in order to protect their rights in case of a violation of certain contractual obligations such as delivery of a product or a service. Letter of guarantees are preferred in contrast to other collaterals such as pledges, mortgages and surety bonds which are more costly, take a long time to be converted into cash and rules applicable may vary from country-to-country. For this reason, letter of guarantees has started to be preferred especially in terms of contracts involving international elements.
Legal Characteristics of the Letter of Guarantees under Turkish Law
The Letter of Guarantee is a contract issued by “the Bank” which is addressed to “the Guaranteed Party” in order to secure the fulfillment of specific act(s) of “the Guarantor”, by payment of a certain amount to the Guaranteed Party.
Guarantee letters are not regulated under Turkish Law. For this reason, similar provision regarding “guarantee of performance by third party”, stated on Article 128 of Turkish Code of Obligations, will apply to the disputes concerning letter of guarantees. Although the legal characteristics of the letter of guarantees are various in doctrine, dominant opinion along with Court of Cassation judgments, states that the letter of guarantees are a form of guarantee agreements.
With legal interpretations and court precedents, elements of the letter of guarantees are formed on a certain level. Accordingly, following conditions shall apply:
Predetermined Risks: “Risk” can be defined as the material damage of the party to be affected (Guaranteed Party) by the consequences of an event/act. With guarantee letters, the Bank undertakes the responsibility of the Guarantors act by the obligation to retrieve the material damage to the Guaranteed Party, limited with the amount written on the letter of guarantee. The parties should determine the risks (specifically, clearly and without a room for any hesitation) in advance, since these risks are secured with letter of guarantees.
For the violation of the contractual obligations other than the specified risks on the letter of guarantees, the Guarantee Party is not entitled to liquidate the letter of guarantees. This is because it would be incompatible with the nature of a guarantee agreement to say all kinds of debts born and to be born of an uncertain act will be secured under a letter of guarantee. For example, if the parties agreed the risk as “the Guarantor not delivering a product on time”, the quality of the product is not secured with the letter of guarantee.
In addition, other risks and obligations undertaken by the parties of the main agreement after the issue date of the letter of guarantee will not be secured by the letter of guarantee without the approval of the Guarantor. It is crucial to state that in case the Bank undertakes the risks by knowing the contact price, the amendments made in the essential terms of the main contract, which does not increase the contract price, does not relieve the Bank from the obligation to pay the guaranteed amount to the Guarantee Party.
Specified Promised Amount: There needs to be a specific amount promised by the guarantee letter since the uncertainty cannot be guaranteed. For this reason, without obligation to indicate limitation, dimensions of the risks need to be specified on the guarantee letter.
A certain risk is guaranteed with a letter of guarantee. This risk generally arises in the form of undertaking the act of the Guarantor. If this risk arises, the Guaranteed Party is entitled to liquidate up to the maximum guarantee amount specified in the letter of guarantee from the Bank. Furthermore, the Bank is not obliged to investigate whether or not the risk has occurred. If the Guarantee Party requests encashment even if the risk has not been born, the Guarantor who paid the amount to the Bank can claim for the return of the guaranteed amount from the Guaranteed Party according to unjust enrichment provisions.
Undertaking an Independent Obligation: Banks undertake an independent obligation with the letter of guarantees that they issue notwithstanding to the main contract or the relationship between the Guaranteed Party and the Guarantor. The Bank issuing the guarantee letter undertakes to pay a certain amount without any hesitation and without a need for a court decision. When the risk occurs, the Guarantor will become a debtor to the bank that pays amount stated in the letter of the guarantee to the Guaranteed Party. Unless the Bank pays the guaranteed amount to the Guaranteed Party, the Bank is not entitled to demand this amount from the Guarantor.
Request for Payment: The letter of guarantee issued by the Bank shall clearly state the circumstances in which the conditions are fulfilled and what kind of documents shall be submitted (invoice, court decision etc.) from the Guarantee Party for the payment of the Bank.
Since the Bank undertakes to pay immediately with the first request for payment of the Guaranteed Party, it is not possible to determine that the request is unjust. However, if the letter of guarantee is subject to a conditional payment and if there are specific documents asked on the letter of guarantee for the payment, the Bank is obliged to investigate the fulfilment of these circumstances and pay accordingly.
What is the Deadline for the Payment Request?
Letters of guarantee are divided into two groups as performance bonds bid bonds. Letter of guarantee which the liability of the Bank is limited to certain period of time is defined as bid bonds; In case where no such limitation is stated, letter of guarantee is defined as performance bonds.
The general statute of limitation of 10 years shall apply for the performance bonds as per Turkish Code of Obligations Article 146. The beginning of the statute of limitation is the date of the realization of the risk. For bid bonds, if the material damage is incurred between the issue date of the letter of guarantee and the end of the time limit stated on the letter of guarantee, the Guaranteed Party is entitled to make a payment request within 10 years of statute of limitation. In other words, unless otherwise agreed, expiration of the time limit stated on the guarantee does not relieve the Bank to make a payment until the 10 years of statute of limitation ends.
Is There Any Way to Prevent the Liquidation of the Letter of Guarantee?
According to the 11th Circuit of the Court of Cassation, there are two ways to stop the liquidation of the letter of guarantees: The bank making a plea or the Guarantor taking a preliminary injunction decision.
The Bank, as a party to the guarantee agreement, may make a plea to the Guaranteed Party in order to prevent the encashment. In a decision of the Court of Cassation Assembly of Civil Chambers in 1981, it is stated that the Bank is obliged to pay the guaranteed amount to the Guaranteed Party upon the first request. However, the Bank may refrain from paying the guaranteed amount of the letter by making a plea such as the expiry of the letter of guarantee or forgery.
It is possible for the Bank to abstain from its obligations by proving that the guarantee agreement is not valid, and the risk is not realized. The Bank claiming the Guarantee Party abused its rights, is obliged to bring conclusive evidence. The Bank which refrains to make a payment without stating a valid reason is responsible for the damages caused by the late payment to the Guarantee Party.
Preliminary injunction is a temporary legal protection which secures the guaranteed amount from being liquidated by the Guarantee Party wrongfully. In case there is no preliminary injunction decision enacted by an “official authority” according to the Articles 389-399 of the Code of Civil Procedure (“Law No. 6100”), the Bank is liable to pay the guaranteed amount to the Guarantee Party. In conclusion, the only way for the guarantor to prevent the encashment of the letter of guarantee is getting the preliminary injunction decision. It has a profound importance for the Guarantor to ask preliminary injunction decision imposition within a week from the date of the decision, if not the decision shall become void according to Article 393 of the Law No.6100.
As per Article 392 of the Law No. 6100, the court may require the Guarantor to provide appropriate assurance as a condition to grant a preliminary injunction considering the high financial value of the performance bonds. The party who obtained a preliminary injunction decision from a court shall commence court proceedings within 2 weeks, if not the preliminary injunction decision shall become void according to Article 397 of the Law No.6100.
The preliminary injunction decision to be submitted by the Guarantor after the payment request which has been duly examined and accepted by the Bank does not prevent the Bank from making the payment to the Guaranteed Party. For the payment requests after the submission of the preliminary injunction decision, the Bank which pays the guaranteed amount by disregarding the preliminary injunction decision is responsible for the wrongful act and cannot ask the Guarantor for the payment made to the Guaranteed Party because the Bank has a liability to protect the customer (the Guarantor) . Additionally, the statement on the guarantee letter saying “the preliminary injunction decisions will be disregarded”, is not valid.
Can the counter-party liquidate the whole amount secured by the letter of guarantee?
Court of Cassation 15th Circuit held that unless there is a specific provision on the main agreement regarding the encashment the whole amount of the letter of guarantees; the excess payment (the payment exceeding the material damage) to the Guarantee Party will be deemed wrongful. The court ruled that only the amount of reparation shall be paid by to the Guaranteed Party.
Can you claim any rights against the Bank?
The Bank is obliged to pay the amount specified on the guarantee letter with the first written request of the Guaranteed Party. Consequently, The Bank which issues the letter of guarantees shall not be held accountable in case the Guaranteed Party liquidates letter of guarantees wrongfully (unless there is a conditional payment which the Bank is responsible to investigate the fulfillment of the conditions stated.).
According to the Court of Cassation 11th Circuit it is unjust to accuse the bank for the wrongful payment. It is negligent behavior of the Guarantor to not make an application to get a preliminary injunction decision.
In the last instance, there not many claims can be put forward against the Bank other than the compensation in case of the violation of the obligation to investigate.