The rapid development of the commercial implementation of independent letters of guarantee has caused the number of cases heard by the courts involving such to also increase over the years. On November 18, 2016, the Judicial Committee of the Supreme People’s Court promulgated the Provisions of the Supreme People’s Court on Hearing Disputes Over Independent Letters of Guarantee (hereinafter, the “Provisions”), which came into effect on December 1, 2016. The Provisions contain specific requirements for major issues, such as the definition of an independent letter of guarantee, what constitutes fraud in relation to independent letters of guarantee, and suspension of payment of an independent letter of guarantee ordered by a people’s court. This is expected to be beneficial in unifying the local courts’ approach to disputes involving independent letters of guarantee so that there is a legal basis for sustainable development of independent letters of guarantee as a financial instrument in this country.
With respect to the meaning and definition of an independent letter of guarantee, the Provisions provide that an independent letter of guarantee is a promise of payment presented by the issuer conditioned on the presentation of certain documents by the beneficiary, upon which the issuer will be independently obliged to provide payment. The Provisions contain the following specific requirements for the definition of an independent letter of guarantee: (1) two elements must be present, namely, the documents serving as the basis of payment and the maximum amount; and (2) there are three scenarios where it is sufficient to deem that the issuer has indicated the intent to provide an independent letter of guarantee, namely, (a) payment will be made upon demand; (b) agreeing to applying the model rules for transactions involving independent letters of guarantee, such as the Uniform Rules for Demand Guarantee of the International Chamber of Commerce or (c) the ability to confirm the independence and documentation of the issuer’s payment obligation based on the contents of the letter of guarantee, which means that the issuer’s payment obligation is independent of the underlying transactional relationship and the legal relationship concerning the application for the letter of guarantee, and that the issuer is only assuming responsibility for payment when the required documentation is presented. The Provisions also point out that although an independent letter of guarantee functions to guarantee the satisfaction of claims, it does not fall under the scope of the statutory guarantees under the Guarantee Law of this country, thus, it is not governed by the guarantee provisions under the Guarantee Law of this country.
In addition, the Provisions specifically provide for exceptions for fraud associated with an independent letter of guarantee and set the standard of evidentiary proof as beyond a reasonable doubt for a finding of fraud. Article 12 of the Provisions categorizes fraud into three scenarios, namely, sham transactions, document fraud, and clear abuse of payment requests. Since there may be confusion between clear abuse of payment requests and disputes over breach of underlying transaction contract, Article 12, Paragraphs 3 and 4 respectively provide that the decision must be based on judicial decisions or arbitration awards for the underlying transaction and evidence that has been verified by the beneficiary to prevent substantive hearing of breach-of-contract disputes in cases involving independent letters of guarantee. In view of the practical complexity and diversity of fraud involving letters of guarantee, Article 12, Paragraph 5 contains general miscellaneous provisions regarding other circumstances where the beneficiary has clearly abused payment demands. For circumstances where fraud involving independent letters of guarantee can be established beyond reasonable doubt, the Provisions state that a people’s court should rule that the issuer may terminate the payment under the independent letter of guarantee.
In addition, the Provisions also strictly stipulate the terms and conditions and the procedures for terminating payment under a letter of guarantee in a court ruling. Certain conditions must be met for termination of payment, include requiring the petitioner for the termination to produce evidence substantiating a high probability of fraud and the irreparable harm that will result to the petitioner if payment is not terminated immediately. The security provided by the payment termination petitioner should be sufficient to compensate the counterparty for potential losses and to protect the interest of bona fide third parties pursuant to the requirements under “exceptions of fraud exceptions.” This means that if the issuer has made the payment in good faith pursuant to an independent letter of guarantee, the court may not order a termination pf payment even in case of fraud by the beneficiary in order to protect the issuer’s right of recourse against the independent letter of guarantee i.e. a counter guarantee. In addition, the Provisions also stipulate the period and details regarding payment termination petitions, reconsideration agencies, and compensation liabilities for erroneous applications to strictly regulate the payment termination procedure and prevent them from being abused, thereby effectively ensuring procedural fairness and uniformity in justice.