Background

On I December 2016, The PRC Supreme Court's Judicial Interpretation on Disputes over Independent Letter of Guarantee (Interpretation) came into force. The Interpretation sets out special rules that will apply to "Independent Letters of Guarantee", which differ from the general principles applicable to ordinary guarantees under the PRC Guarantee Law.

An Independent Letter of Guarantee is effectively a demand guarantee whereby the Guarantor will guarantee payment of a sum of money on demand, provided the terms on the face of the Guarantee are complied with. Under an Independent Letter of Guarantee, it is not necessary for the creditor to exhaust its rights against the debtor under the underlying contract before it can make a claim against the Guarantor. As such, these types of guarantee are commonly used in construction and ship building contracts (where cash flow is often critical) to guarantee payment.

Summary

Pursuant to the Interpretation:

  1. Where the Uniform Rules for Demand Guarantees (which are international standards published by the International Chamber of Commerce) have been referred to in the Independent Letter of Guarantee, those rules will be deemed to be incorporated by reference;
  2. The Guarantor of an Independent Letter of Guarantee must make payment under the Guarantee when the claim documents specified in the Guarantee have been presented. It is not necessary for the creditor to exhaust its rights against the debtor under the underlying contract;
  3. The Guarantor cannot defend any claim by a creditor based on arguments which could be raised by the debtor under the underlying contract (such as misrepresentation, frustration or illegality etc);
  4. An application for withholding payment under an Independent Letter of Guarantee may be made if the demand for payment is fraudulent (the Interpretation sets out what amounts to fraud in this context);
  5. Jurisdiction and governing law clauses should be respected by the Chinese Courts;
  6. Only "banks or non-bank financial institutions" are entitled to issue Independent Letters of Guarantee, which means that guarantees issued by any other entities, even if they meet the other criteria, will not fall within the ambit of the Interpretation.

The response to the Interpretation in China has been mostly positive as it filled in some gaps in the PRC Guarantee Law and provided much needed clarity in relation to the enforcement of these types of guarantees.