An independent letter of guarantee involves a legal relationship between the applicant, the issuer and the beneficiary. Without an arbitration clause in a letter of guarantee, it is unclear whether the arbitration clause in the underlying contract can also bind the issuer. A recent Supreme People's Court ruling provides a clear answer to this question.
On 31 August 2011 Dalian Huarui Heavy Industry Group Co Ltd, an equipment supplier, signed a supply agreement (the underlying contract) with an Australian company, Forge Group Constructions Pty Ltd. Clause 28 of the underlying contract was an arbitration clause, which stipulated that "the place of arbitration is Singapore, and Arbitration shall be conducted in accordance with UNCITRAL Arbitration Rules in force on the date of signature of this Agreement". Further, Attachment E to the underlying contract stipulated that:
When the guarantor is a non-Australian company, any disputes, claims arising directly or indirectly from, or in connection with, this Contract shall be submitted for arbitration and finally settled by arbitration in accordance with the Arbitration Rules of the Australian International Commercial Arbitration Centre.
Subsequently, the underlying contract's buyer changed from Forge Group to Duro Felguera Australia Pty Ltd. On 18 September 2013 Dalian Huarui entrusted the Liaoning branch of Bank of China to issue a letter of guarantee for Rmb100 million to Duro. The letter of guarantee stated that "[t]his unconditional performance Guarantee is governed and interpreted by Western Australian law".(1) The letter of guarantee contained no jurisdictional clause.
On 24 February 2016 Duro sent a letter to Dalian Huarui, stating that Duro had terminated all contractual obligations with the general contractor, but that the contractual relationship with Dalian Huarui was not affected. Further, Duro required Dalian Huarui to continue to perform the underlying contract and asked Dalian Huarui and its sub-contractors to suspend their construction activities and evacuate the site without communication with the owner, general contractor or any relevant sub-contractors.
On 18 March 2016 Duro sent a letter to Dalian Huarui asking it to suspend performance of the underlying contract and make up the amount of the so-called guarantee within a time limit or the contract would be terminated immediately. On 7 April 2016 Duro requested immediate payment of the guaranteed amount. Based on the above series of unreasonable acts, Dalian Huarui believed that Duro had abused its right of claim under the guarantee, violated the basic principle of good faith and conducted guarantee fraud.
On 15 April 2016 Dalian Huarui filed a complaint against Duro as the defendant and the Liaoning branch of Bank of China as the third party. Dalian Huarui asserted in its complaint that Duro had fabricated the breach of the underlying contract and fraudulently demanded the guarantee from the issuer. Further, Dalian Huarui filed claims:
- confirming the existence of guarantee fraud in the claims process; and
- ordering the third party to terminate payment of the guarantee to Duro.
On the same day, Dalian Huarui also applied to the first-instance court for property preservation.(2) On 19 April 2016 the court issued an injunction which held that the Liaoning branch of Bank of China should suspend the payment of the letter of guarantee. According to Article 101.2 of Civil Procedure Law:
The people's court shall make a ruling within 48 hours after receiving the application. Where it rules to take preservative measures, the ruling shall be enforced immediately.
Therefore, the injunction came into force immediately and neither party had the right to appeal.
Duro filed an objection to jurisdiction with the first-instance court. After trial, the court held that the legal relationship in the case was the guarantee contract legal relationship between the Liaoning branch of Bank of China and Duro Australia, not the underlying contract legal relationship between Dalian Huarui and Duro. Therefore, it was a foreign-related commercial infringement case. Further, the infringement was located in Liaoning Province and the object of action was Rmb100 million and was therefore under the jurisdiction of the court. The first-instance court therefore rejected the defendant's objection to jurisdiction. Duro appealed to the Supreme People's Court for a jurisdictional ruling.
On 31 October 2017 the Supreme People's Court rejected the appeal and upheld the original ruling. The court held that the matter was a foreign-related case and the law of the forum court should be applied. Dalian Huarui claimed that Duro's fraudulent claim for money from the issuer had infringed Dalian Huarui's property interests by fabricating the facts of a breach of the underlying contract. Thus, the dispute concerned the letter of guarantee.
According to the content of the letter of guarantee, the disputed guarantee was a demand guarantee (ie, the beneficiary did not have to prove that the applicant had breached the underlying contract and the beneficiary could demand payment from the issuing bank if it met the conditions stipulated in the letter of guarantee). Further, the guarantee was part of an independent guarantee, which meant that the issuer's payment obligation was independent of the underlying transaction. However, independence is not absolute and fraud is the most important exception to the principle of an independent guarantee. Moreover, the guarantee contained no arbitration or dispute settlement clause. Therefore, the dispute over claims of fraud under the guarantee were not subject to the arbitration clause in the underlying contract.
The dispute was not subject to the arbitration clause in Attachment E of the underlying contract. Res judicata of the award therefore extended to the issuer of the guarantee. The issuer's expression of consent was the precondition for it to be bound by the abovementioned arbitration clause. However, there was no arbitration clause in the letter of guarantee and Duro failed to submit evidence to prove that the issuer had accepted the abovementioned arbitration clause in other forms. Further, the dispute was not bound by the arbitration clause in the underlying contract, because the arbitration clause was an agreement between Dalian Huarui and Duro, which did not bind third parties.
Regarding jurisdiction and in view of the letter of guarantee's lack of a jurisdiction agreement, the court found that the dispute involved fraud concerning the letter of guarantee and was therefore a tort dispute. According to Clause 21.2 of the Provisions of the Supreme People's Court on Several Issues concerning the Trial of Independent Guarantee Dispute Case, disputes fall under the jurisdiction of the people's court where the issuer of the independent guarantee or the defendant reside. The issuer of the letter of guarantee in the case at hand was the Liaoning branch of Bank of China, located in Liaoning Province. Therefore, the first-instance court (the Liaoning Provincial Higher People's Court) had jurisdiction.
According to Clause 21.2 of the Provisions of the Supreme People's Court on Several Issues concerning the Trial of Independent Guarantee Dispute Case:
Fraudulent disputes over the independent guarantee shall be within the jurisdiction of the people's court at the place of the domicile of the issuer of the independent guarantee under which the application for suspension of payment is filed or the domicile of the defendant, unless the parties has agreed in writing that any other court has jurisdiction over it or the disputes be settled through arbitration. Where a party claims the court having jurisdiction over the case determined by the dispute resolution clauses in the underlying contract or the independent letter of guarantee, such claim shall not be supported by the people's court.
The above case shows how to apply Clause 21.2 and interpret the phrase "the parties submit their written agreements to arbitration". First, the letter of guarantee had a demand guarantee and the beneficiary did not need to submit evidence of a breach of the underlying contract when requesting payment. Second, the letter of guarantee was an independent guarantee, established to guarantee the performance of the underlying contract. However, once established, the letter of guarantee was independent of the underlying contract. Third, although there were two separate arbitration clauses between the applicant and the beneficiary, they were not legally binding on the issuer of the guarantee. Thus, there was no exception to Clause 21.2.
The parties' consensus on the applicable law in the independent guarantee was considered to be an agreement for substantive issues. However, the Supreme People's Court ruled that jurisdiction over fraudulent disputes under the letter of guarantee was a procedural issue which is governed by the law of the forum court.
At present, this case is only a procedural ruling, involving procedural matters of jurisdiction and property preservation. The substantive issue (ie, whether the third party, Liaoning branch of Bank of China, has the right to refuse to pay the guarantee) has not been heard by the Supreme People's Court. According to public sources, the plaintiff Dalian Huarui withdrew its lawsuit in August 2019.
In the cases where the execution of a judgment may become impossible or difficult or otherwise harmful to the parties concerned because of the acts of one party or for other reasons, the people's court may, at the application of the other party, make a ruling to preserve the assets of the other party or order the other party to perform certain acts or to prohibit the other party from committing certain acts; where no application is filed by either party, the people's court may also rule to take preservation measures when it deems necessary.
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