Return of the Letter of Guarantee – Waiver of the Beneficiary’s Rights?

S. 26Return of the Letter of Guarantee – Waiver of the Beneficiary’s Rights?

Key Words: Bankgarantie; Einheitliche Richtlinien für auf Anfordern zahlbare Garantien; Rückstellung Garantieurkunde; UN-Convention on Independent Guarantees and Stand-by Letters of Credit; Verzicht.

JEL-Classification: D 14, D 18, G 21, K 12, K 23.

1. Introduction

The question whether the return of the letter of guarantee to the guaranteeing bank in itself is sufficient to terminate the right of the beneficiary to demand payment under the guarantee, seems to be a matter of general interest in international trade. Specimens of such bank guarantees found on the internet often include conditions like the following in in their clauses:

"The guarantee expires fully and automatically if:

(i) the request for payment under the guarantee has not been presented to our Bank within the guarantee validity period or,

(ii) the original guarantee document has been returned to our Bank, or,

(iii) the maximum amount of the guarantee has been paid.”

Quite obviously, there will be no dispute if the beneficiary himself deliberately returns the letter of guarantee without demanding payment from the bank. This will especially be the case if the beneficiary has received proper performance of the underlying contract by the applicant (ie the debtor). However, in the two cases that were recently decided by the Austrian Supreme Court the applicant had not fulfilled his contractual obligations, and the guarantee document was returned to the guaranteeing bank not by the beneficiary but by a third person.

The two cases are interesting not only because of the legal aspects which were dealt with under Austrian law. They also give insight into fraudulent practices in international trade, as the letters of guarantee were returned to the bank by a third person not authorised to do so by the beneficiary. Therefore banks, as guarantors, should be made aware of the threats and develop strategies to avoid fraud.

I will approach the material questions in two steps: Firstly I will give a brief overview of the relevant Articles of the ICC Uniform Rules for Demand Guarantees and the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit. Secondly I will discuss the two decisions rendered by the Austrian Supreme Court.

2. ICC Uniform Rules for Demand Guarantees

According to Art 23 of the Uniform Rules for Demand Guarantees the obligation of the guarantor under the guarantee expires whenever the letter of guarantee is returned to him. Art 23 reads as follows (emphasis added):

"Irrespective of any expiry provision contained therein, a Guarantee shall be cancelled on presentation to the Guarantor of the Guarantee itself or the Beneficiary’s written statement of release from liability under the Guarantee, whether or not, in the latter case, the Guarantee or any amendments thereto are returned”.

If these Uniform Rules apply to a bank guarantee, the rights of the beneficiary are terminated with the return of the document even if the parties – ie the issuing bank and the beneficiary – did not include a specific clause in the document to this effect.

3. United Nations Convention on Independent Guarantees and Stand-by Letters of Credit

The UN-Convention, which was not signed by Austria yet, also contains a provision dealing with the return of the guarantee document in Art 11. However, under the Convention the return of the guarantee will only result in a cessation of the right of the beneficiary to demand payment if the parties have expressly agreed so in the guarantee.

Art 11 subparagraph 2 states (emphasis added):

"2. The undertaking may stipulate, or the guarantor/issuer and the beneficiary may agree elsewhere, that return of the document embodying the undertaking to the guarantor/issuer, or a procedure functionally equivalent to the return of the document in the case of the issuance of the undertaking in non-paper form, is required for the cessation of the right to demand payment, either alone or in conjunction with one of theS. 27events referred to in subparagraphs (a) and (b) of paragraph 1 of this article. ….”

Though, if the UN Convention is applicable, the bank may stipulate that the return of the guarantee document as such terminates the rights of the beneficiary. In the two Austrian cases neither the Uniform Rules for Demand Guarantees nor the UN Convention applied. However, in both cases the guarantee documents comprised clauses similar to the specimen guarantee that I obtained from the internet and that was cited above.

And now let us have a look on what happened to the guarantee documents:

4. Austrian Supreme Court (Oberster Gerichtshof), Decision of October 18, 2005, 1 Ob 206/05h

In July 2001 the defendant, an Austrian bank, issued, on request of its customer, a bank guarantee in the amount of EUR 7,994 in favour of the plaintiff. The letter of guarantee contained a clause stating that the guarantee "shall expire upon return of the letter of guarantee” and in any case on April 30, 2011.

Two years later, in 2003, the plaintiff demanded payment. To his surprise the bank objected that the guarantee had already expired in August 2001, when the letter of guarantee had been returned to the bank without comment. It was not possible to establish who had returned the letter of guarantee to the defendant bank; in any case it had not been the plaintiff himself. Furthermore, it remained uncertain whether the defendant bank even was in the position to identify the person who returned the guarantee document.

In fact, the letter of guarantee had been lost by the plaintiff soon after its issue. Despite having noticed the loss, the plaintiff did not inform the defendant bank.

The Court of First Instance dismissed the plaintiff’s claim. It held that the bank guarantee had expired upon the return of the letter of guarantee and that the defendant bank did not have a duty to enquire about the reasons of the return. The Court of Appeal reversed the decision of the Court of First Instance and allowed further appeal to the Austrian Supreme Court (OGH).

The OGH followed the reasoning of the Court of Appeal and ordered the bank to pay. The court held that the rules of interpretation in §§ 914, 915 of the Austrian Civil Code (ABGB) apply also to the contract of guarantee. In interpreting the contract, regard shall thus be given, in particular, to the nature and purpose of the contract as well as to good faith and fair dealing.

At this stage of the deliberations, the clause concerning the return of the guarantee is of essence: As stipulated in the letter of guarantee, the return of the letter of guarantee is an implicit declaration of waiver. However, this (implied) declaration of intent is a matter of interpretation. According to § 863 Civil Code, particularly stringent criteria are applied in the context of a waiver of rights. An act can only be seen as implicit waiver of a right if there are no judicious reasons to doubt that the beneficiary does not wish to claim payment in the future.

Therefore, the clause concerning the expiration of the bank guarantee upon return of the document should be given a restrictive interpretation, as not every return of the letter of guarantee (for example by a finder or a thief of the document) can be seen as expiration of the guarantee. From the simple fact that the letter of guarantee had been returned, it cannot be concluded that the beneficiary waived (by implication) his right to call the guarantee. Only if the return of the document is accompanied by the beneficiary’s will to waive the rights under the guarantee, can it be interpreted as expiration of the guarantee.

The Supreme Court ruled that the beneficiary alone is entitled to renounce the guarantee, and in order to do so he must prove his legal status as beneficiary. Thus the bank has the responsibility to examine the entitlement of the beneficiary.

Taking the facts into account, the Austrian Supreme Court held that it could not be concluded beyond reasonable doubt that the beneficiary was to waive his right to claim the guarantee, when the letter of guarantee was returned without any comment and already shortly after its issuing. The Supreme Court came to the conclusion that the bank had the duty to enquire further whether the plaintiff intended the guarantee to be expired or not. As the bank failed to do so, it is not protected in its reliance upon the existence of a declaration of waiver. Therefore the bank’s objection that the beneficiary contributed to his loss by not informing the bank is not decisive.

The Supreme Court consequently dismissed the appeal of the defendant bank and ordered it to honour the guarantee even though the letter of guarantee had been returned to the bank already some years before the beneficiary demanded payment.

5. Austrian Supreme Court, Decision of September 11, 2007, 1 Ob 44/07p

In the second case the letter of guarantee was returned to the bank with comment. Therefore, the Austrian courts came to a different solution:

On February 23 and March 15, 2004 the defendant Austrian bank had been requested by its Bulgarian bank subsidiary, which was instructed by the applicant, to issue an advance payment guarantee in favour of the plaintiff – an Italian manufacturer of steel pipes. The applicant was a Bulgarian company pretending to be a seller of steel. The underlying agreements between the applicant and the beneficiary were two purported contracts for the delivery of steel pipes for the price of EUR 4,321,000. The first contract, signed on February 13, 2004, determined a period of delivery of 45/60 days after the receipt of the advance payment. 50% of the purchase price was to be paid in advance against an advance payment guarantee, the remaining balance of 50% ten days after receipt of the goods. The second contract was signed on March 10, 2004, and contained similar terms.

The indirect bank guarantees should secure the Italian buyer to get back the advance payment if the seller failed to deliver the steel pipes. Both guarantee documents contained a clause stating that the guarantee shall expire upon return of the letter of guarantee. Again we see that this type of clause is very common in international trade.

S. 28Following the orders of the seller, the Bulgarian bank subsidiary instructed the defendant bank to hand over the letter of guarantee to a person by the name of Del Ponte and forwarded his telephone and passport number. Although this special instruction was given in the written application of the Bulgarian bank to its Austrian parent, the banks were not ordered to embody it into the guarantee document.

In fact, the seller (the applicant) was a swindler who never intended to deliver the steel. And Mr. Del Ponte was not a representative of the plaintiff, but colluded with the seller as a member of an Italian criminal gang operating in various countries, especially Austria, Italy and Switzerland. Let us see now what means the seller and Mr. Del Ponte used to get the advance payment into their pocket:

The English meaning of the Italian word "ponte” is "bridge”. However, Mr. Del Ponte did not build a bridge between the bank and the beneficiary, rather he acted as an interceptor: The original letters of guarantee were handed over to Mr. Del Ponte by an employee of the defendant in Vienna after he had checked his – of course forged – identity. Mr. Del Ponte then produced very good colour forgeries of the two original letters of guarantee. He sent the counterfeit copies to two Italian banks where the plaintiff kept its accounts. The copies were forwarded without an accompanying letter using a sender that indicated the mail was posted by the Austrian guaranteeing bank. Both Italian banks did not notice that the copies were not the original letters of guarantee. At both banks, employees made a request to the defendant bank via SWIFT, who certified in both cases, also via SWIFT, "that the guarantee, signed by Ms … (Deputy vice president) was valid”. Hereupon the pre-financing of the down payment in the amount of EUR 1,696,000 was authorised and the funds were transferred to the account of the seller with the Bulgarian bank.

The Bulgarian bank blocked the funds to make sure that the banks would be reimbursed in case the beneficiary demanded payment under the guarantee. In order to get the bank to release the funds to the seller, the fraudsters needed to return the original guarantee documents to the issuing bank.

To that end Mr. Del Ponte sent the original documents accompanied by – as now known – forged letters to the defendant bank. In these letters, representatives of the plaintive Italian corporation confirmed that the obligations of the seller under the purchase contract had been fulfilled and therefore asked for revocation of the bank guarantee. The employees of the defendant bank concluded that the letters, which contained the (forged) company logo and stamp, came from the plaintive Italian corporation. So the Austrian and the Bulgarian bank thought that the obligation under the guarantee was terminated and released the blocked funds to the seller.

As the steel was not delivered, the plaintiff demanded payment under the guarantees in May 2004. Surprisingly it was notified by the defendant bank about the return of the letters of guarantee and a denial of liability.

The plaintiff sued the Austrian bank claiming damages resulting from the dishonouring of the bank guarantees. The defendant bank was alleged to have failed in its duty of diligence and care. The plaintiff brought forward that the power of representation of Mr. Del Ponte should have been checked before handing out the letters of guarantee to him and further enquiries should have been made on the occasion of the early return of the bank guarantees.

The Court of First Instance dismissed the plaintiff’s claim. The Court of Appeal confirmed the decision, stating that it was not common in the international banking practice to enquire about the power of representation of the recipient when handing over the letter of guarantee.

In its further appeal to the Supreme Court the plaintiff argued, firstly, that the defendant bank failed in its duty to examine the power of representation of Mr. Del Ponte when it handed out the letter of guarantee to him. The Supreme Court dismissed this argument and stated that it is generally accepted that the guaranteeing bank must comply strictly with the instructions of the principal (in this case the instructing Bulgarian bank) and must follow the orders concerning the wording of the guarantee. Banks are not required to examine the terms of the underlying contract (in order to determine the intention of the parties) as this would foil the independent character of the bank guarantee. The Supreme Court confirmed the reasoning of the lower instances that the examination of the power of representation of Mr. Del Ponte was not part of the tasks of the defendant bank. Following the instructions of the applicant and the Bulgarian bank, the defendant bank’s duty only was to verify his identity.

Secondly, the plaintiff argued that the defendant bank had failed in its duty to inform the plaintiff about the dangers of a bank guarantee which is to be handed out to a representative of the beneficiary. However, the bank had already established before the Court of First Instance that the provision to hand over the guarantee to a named individual person is common in banking practice. The Supreme Court ruled that the order to hand over the guarantee is a clear and unambiguous provision of the contract. Therefore neither error nor difficulties concerning the transaction could have been anticipated by the bank.

Thirdly, the Supreme Court held that the verification via SWIFT by the Austrian bank could not be seen as confirmation that the Italian bank was holding the ‘original’ letter of guarantee, but only as confirmation that the defendant bank had issued a guarantee with a certain content which had been signed by the authorized representatives of the defendant.

The plaintiff further argued that there had been a breach of the duty of care when the letter of guarantee was returned. However, the Supreme Court confirmed that there had been neither lack of care nor a conduct contrary to the contractual obligations in the course of returning the letter of guarantee. In this respect, the return of the bank guarantees could be seen – even when applying accurate care and diligence – as a waiver as provided in the contracts of guarantee.

On these grounds the appeal of the Italian steel manufacturer was dismissed by the Supreme Court. The Supreme Court, of course, had to distinguish the case from the case 1 Ob 206/05h, which I have discussed before. The Court came to the conclusion that the advance payment case was not comparable with the decision 1 Ob 206/05h in which the guarantee had been returned by an unknown person without comment and shortly after its issuance. In the current case, the guarantees had been returned contrasting to the decision 1 Ob 206/05h not very shortly after the issue, but 10 to 14 days later (so that the defendant bank could assume that the steel was already delivered). A return before the expiration date is also not uncommon in banking practice as it reduces the bank commission. In addition the returned bank guarantees were accompanied by a letter which contained no evident signs of forgery and had a consistent and coherent content.

6. Conclusion

As I was involved in the second case as Attorney of one of the parties, I am not in the position to discuss whether the decisions of the Austrian Supreme Court are right or wrong. However, I would like to draw some conclusions about precautions that banks should take when they issue and deal with guarantees:

S. 29Firstly, even if the letter of guarantee expressly states that the obligations of the bank are cancelled by the return of the guarantee document, the bank cannot rely under all circumstances that the return of the document will be considered as a waiver of the beneficiary’s rights. In particular, if the document is returned without an accompanying letter which explains the reasons for the return of the document, the bank bears the risk that the courts will hold that the bank is still obliged to honour the guarantee.

Secondly, if the applicant orders the bank to hand out the letter of guarantee to a person, this agreement could also be embodied in the guarantee document. In this case the beneficiary is made aware of the fact and is able to avoid or at least reveal interception.

Thirdly, if the guaranteeing bank confirms the validity of a guarantee, it is wise to state clearly that the confirmation only means that the guarantee was signed by persons holding a power of attorney of the issuing bank and not that the beneficiary actually has the original of the letter of guarantee in his hands. This, of course, has always to be proved by the beneficiary and his banks for themselves.

Raimund Bollenberger

RA Univ.-Prof. Dr. Raimund Bollenberger, Wirtschaftsuniversität Wien; e-mail: raimund.bollenberger@wu-wien.ac.at