Keywords: independent guarantee, standby letter of credit, guarantee fraud, fraud exception, principle of independence, demand payment, stop payment, foreign-related litigation, agency of overseas bank, withdrawal of lawsuit
In June 2023, a certain building materials design institute in Chengdu (hereinafter referred to as "Chengdu Design Institute") filed a lawsuit against a certain commercial bank in Egypt (hereinafter referred to as "Egyptian Bank") for fraud related to a letter of guarantee. I represented Egyptian Bank in responding to the lawsuit. This case is extremely complex, involving multiple related lawsuits conducted simultaneously in China and Egypt. The differences in legal systems, language barriers (most of the materials are in Arabic), coupled with the application of the Uniform Rules for Demand Guarantees (URDG758) of the International Chamber of Commerce, have added significant difficulty to the trial of this case.
This case is significantly different from ordinary guarantee fraud disputes, and the fundamental reason for its occurrence lies in the arbitration award substituting the release of the guarantee with cash payment. At the same time, due to the insolvency of the debtor (the beneficiary of the guarantee), the creditor, Chengdu Design Institute, is exposed to great risks.
This case, which spanned two years, was ultimately resolved through amicable settlement, thanks to the concerted efforts of judges from China and Egypt, lawyers from all four parties, and the involved parties. Simultaneously, this case was recognized by the Sichuan High Court as one of the top ten exemplary commercial trials of 2023. I would now like to share with you the insights gained from handling this case, as well as the pertinent legal knowledge points:
I. Conclusion of the underlying contract
On April 20, 2015, Chengdu Building Materials Design Institute Co., Ltd. (hereinafter referred to as "Chengdu Design Institute") and Egypt's South Valley Cement Co. Ltd. (hereinafter referred to as "SVCC") signed a general contracting agreement for the construction of a cement plant in Egypt. The total contract amount was USD 31,744,643 + EUR 6,776,143. The advance payment amounted to USD 2,507,190 and EUR 48,428, with the remaining payment to be gradually disbursed according to the progress. The contract also stipulated that before SVCC made the aforementioned advance payment, Chengdu Design Institute should issue six on-demand advance payment guarantees to SVCC.
II. Opening of Letter of Guarantee and Performance of Contract
On April 20, 2015, Chengdu Building Materials Design Institute Co., Ltd. (hereinafter referred to as "Chengdu Design Institute") and Egypt's South Valley Cement Co. Ltd. (hereinafter referred to as "SVCC") signed a general contracting agreement for the construction of a cement plant in Egypt. The total contract amount was USD 31,744,643 + EUR 6,776,143. The advance payment amounted to USD 2,507,190 and EUR 48,428, with the remaining amount to be paid progressively according to the progress. The contract also stipulated that before SVCC made the aforementioned advance payment, Chengdu Design Institute should issue six on-demand advance payment guarantees to SVCC.
After the issuance of the letter of guarantee, SVCC paid the advance project payment as agreed in the contract. Upon receiving the payment, Chengdu Design Institute began to construct the project.
III. Arising of disputes
However, during the construction process, SVCC failed to pay the project funds as agreed in the contract. By the time the project was completed in August 2018, approximately $3 million in project funds remained unpaid. However, by this point, SVCC was already deeply in debt and unable to pay the aforementioned project funds.
IV. Arbitration at the Cairo International Commercial Arbitration Center
On December 18, 2018, after multiple rounds of fruitless communication, Chengdu Design Institute, in accordance with the contract, initiated international commercial arbitration with the Cairo International Commercial Arbitration Center. The claims were: 1. SVCC should pay the due project payment of USD 3 million and interest; 2. SVCC should release the aforementioned six advance payment guarantees or pay the corresponding amounts of USD 2,507,190 and EUR 48,428, as well as interest. After a two-and-a-half-year trial, on March 31, 2021, the Cairo International Commercial Arbitration Center issued an arbitration award, ruling that SVCC should pay the due project payment of USD 3 million and interest. Additionally, considering SVCC's explicit statement during the trial that it would not release the aforementioned six guarantees, the arbitration tribunal ruled that SVCC should pay Chengdu Design Institute the corresponding amounts of USD 2,507,190 and EUR 48,428 from the guarantees.
V. Issues left over from arbitration awards
The arbitration application and final ruling of Chengdu Design Institute appear reasonable, but they conceal significant commercial risks:
According to this ruling, SVCC can retain six advance payment guarantees and claim USD 2,507,190 and EUR 48,428 from the Egyptian bank. The Egyptian bank will claim against ICBC based on the counter-guarantee guarantee, and ICBC will claim against Chengdu Design Institute based on the agreement. At the same time, SVCC should pay Chengdu Design Institute the corresponding USD 2,507,190 and EUR 48,428 from the guarantees.
For Chengdu Design Institute, the sum of $2,507,190 and €48,428, representing an inflow and an outflow, exactly offset each other, seemingly forming an equal exchange with no losses involved. However, the actual situation is quite different.
At this point, SVCC was on the brink of bankruptcy. As of June 2023, Chengdu Design Institute had failed to enforce any property from SVCC in accordance with the arbitration ruling. Meanwhile, SVCC was pursuing claims based on the guarantee letter.
For demand guarantees, in principle, regardless of the underlying legal relationship, as long as SVCC files a claim, the bank should make payment without any justification. This would result in Chengdu Design Institute not receiving any enforcement payment based on the arbitration award, but instead having to pay nearly $3 million upfront. This is unacceptable to Chengdu Design Institute.
VI. Chengdu Design Institute files a lawsuit for the return of the guarantee in Egypt
On December 29, 2021, Chengdu Design Institute filed a lawsuit against Egyptian Bank and SVCC at the Cairo Economic Court, alleging abuse of letter of guarantee rights or fraud involving the letter of guarantee. The institute demanded that SVCC return the involved letter of guarantee and refused any settlement. After reviewing the case, the Cairo Economic Court determined that Chengdu Design Institute had already initiated arbitration through the Cairo International Commercial Arbitration Center, requesting SVCC to pay in cash instead of returning the letter of guarantee. The arbitration tribunal also supported Chengdu Design Institute's application. The court could not violate the ruling of the arbitration tribunal, so it rejected Chengdu Design Institute's claim. On March 7, 2022, Chengdu Design Institute appealed to the Egyptian High Court against the judgment. Ultimately, the Egyptian High Court upheld the first-instance ruling of the Cairo Economic Court.
VII. SVCC and the Egyptian Bank claim compensation based on the guarantee
In April 2023, after the lawsuit filed by Chengdu Design Institute to demand the return of the letter of guarantee was rejected, SVCC filed a claim application to the Egyptian Bank based on the letter of guarantee. Upon receiving the application, the Egyptian Bank filed a claim application to the Industrial and Commercial Bank of China (ICBC) based on the counter-guarantee letter of guarantee. ICBC notified Chengdu Design Institute of the above claim application and stated that if there is no court ruling to stop payment, ICBC will make the compensation.
VIII. Chengdu Design Institute files a lawsuit against Egyptian banks for fraud in guarantees in China
Upon receiving the notice from ICBC, Chengdu Design Institute filed a request with the People's Court of Jinjiang District, Chengdu on June 1, 2023, seeking a suspension order from the court to ICBC on the grounds of guarantee fraud. After preliminary review, the Jinjiang Court deemed that the preliminary conditions for guarantee fraud had been met and ruled that ICBC should suspend payment of the claim from the Egyptian Bank. On June 14, 2023, the court officially accepted the case of guarantee fraud dispute brought by Chengdu Design Institute (plaintiff) against the Egyptian Bank (defendant), as well as SVCC (third party 1) and ICBC (third party 2). Chengdu Design Institute believes that, according to the ruling of the Cairo Regional Center for International Commercial Arbitration, it has no obligation to make any payment or compensation. The Egyptian Bank, knowing full well that SVCC had no right to claim, still filed a claim with ICBC, which constitutes fraud. According to Chinese law, the Egyptian Bank's claim against ICBC, despite knowing that SVCC had no right to claim, is an abuse of the right to request payment and constitutes independent guarantee fraud.
IX. SVCC's lawsuit against Egyptian banks for guarantee claims in Egypt
The Egyptian Bank notified SVCC of the lawsuit brought by Chengdu Design Institute in China. On June 8, 2023, SVCC filed a lawsuit against the Egyptian Bank at the Cairo Economic Court in Egypt, demanding payment under the guarantee involved in the case.
Ten, Egyptian banks are caught in a dilemma
On the one hand, SVCC has filed a lawsuit against the Egyptian Bank at the Cairo Economic Court, requesting the liquidation of six advance payment guarantees involved in the case. Given that the Egyptian court has rejected Chengdu Design Institute's request for SVCC to return the guarantees, it indicates that SVCC can reasonably hold onto the guarantees. According to the Uniform Rules for Demand Guarantees (URDG758) of the International Chamber of Commerce, the Egyptian court is likely to rule in favor of the Egyptian Bank making payments to SVCC. On the other hand, Chengdu Design Institute has filed a lawsuit against the Egyptian Bank for guarantee fraud in China, and the Chinese court has issued a ruling to Industrial and Commercial Bank of China (ICBC) to stop payment. If the Chinese court ultimately supports Chengdu Design Institute's request and the Egyptian court supports SVCC's request, the Egyptian Bank, as the intermediary bank connecting the transactions of both parties, may face difficulties in realizing its right of recourse.
XI. Representing Egyptian banks in litigation against fraud in guarantees
After receiving the notice from the People's Court of Jinjiang District, Chengdu, the Egyptian Bank entrusted us to handle this case. The case is extremely complex, involving multiple related lawsuits conducted simultaneously in two countries. There are significant differences in legal systems between the two countries, and most of the documents we received were in Arabic. After extensive preliminary preparations and several video conferences, we were able to fully understand the situation of the entire case.
XII. Key legal issues involved
1. The competent court for this case
According to Article 22, Paragraph 2 of the Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Cases Involving Independent Guarantee Disputes, as this case is an independent guarantee fraud case, and the court or arbitration institution with jurisdiction over the counter-guarantee guarantee has not been determined, the case shall be under the exclusive jurisdiction of the court in the place where the issuing bank of the guarantee, namely the Industrial and Commercial Bank of China (ICBC), is located.
Article 22, Paragraph 2 of the "Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Independent Guarantee Dispute Cases" stipulates that in cases of fraud involving foreign independent guarantees, if the parties cannot reach an agreement on the applicable law, the law of the habitual residence of the issuer of the independent guarantee against which payment is requested to be stopped shall apply; if the independent guarantee is issued by a branch institution legally registered and established by a financial institution, the law of the place where the branch institution is registered shall apply; if the parties have a common habitual residence, the law of their common habitual residence shall apply.
2. The issue of legal application in this case
In the communication message provided by the Egyptian bank to ICBC, it is stipulated that the applicable law for the counter-guarantee letter involved in the case is Egyptian law. However, Chinese courts generally believe that the applicable law for the counter-guarantee letter involved in the case only binds disputes arising from the issuance, transfer, payment, amendment, etc. under the counter-guarantee letter. Fraud disputes related to independent guarantees are infringement cases, and according to Article 44 of the Law on the Application of Law, infringement cases should be governed by the law of the place where the infringement occurred, that is, the law of the place where the issuer of the independent guarantee requested to stop payment, which is the Sichuan Provincial Branch of Industrial and Commercial Bank of China Limited, that is, Chinese law.
3. Whether the claim made by the Egyptian bank constitutes fraud
Although this case involves the claim filed by the Egyptian Bank against the Industrial and Commercial Bank of China (ICBC) based on a counter-guarantee, the substantive review should be focused on the claim filed by SVCC against the Egyptian Bank based on an advance payment guarantee. We believe that: (1) SVCC's claim against the Egyptian Bank based on the advance payment guarantee is reasonable. Neither the Cairo Economic Court nor the arbitration award has denied that SVCC can hold the six advance payment guarantees involved in the case. Regarding the arbitration award, in the arbitration request submitted by Chengdu Design Institute to the Cairo Regional International Commercial Arbitration Center, the arbitration tribunal was requested to rule that SVCC should return the six advance payment guarantees involved in the case or to rule that SVCC should pay the amounts under the guarantees involved, namely USD 2,507,190 and EUR 48,428.60. On March 31, 2021, the arbitration tribunal ruled that SVCC should pay the amounts under the six advance payment guarantees involved in lieu of the guarantee release obligation. Subsequently, Chengdu Design Institute filed a lawsuit at the Cairo Economic Court requesting SVCC to return the advance payment guarantees. The Cairo Economic Court rejected its claim and held that the economic performance obligation in the arbitration award superseded the obligation to return the guarantees. Therefore, both the arbitration tribunal and the Cairo Economic Court did not support Chengdu Design Institute's request for SVCC to return the guarantees, and it is reasonable for SVCC to hold the guarantees. Furthermore, if SVCC pays Chengdu Design Institute an equivalent amount of USD 2,507,190 and EUR 48,428.60 based on the arbitration award, SVCC will inevitably have the right to demand payment against the guarantees. Otherwise, Chengdu Design Institute will benefit doubly, while SVCC will suffer losses. (2) The claim filed by the Egyptian Bank based on the counter-guarantee is also reasonable and does not constitute fraud. According to Article 19(a) of the Uniform Rules for Demand Guarantees (URDG758), the issuer of the guarantee shall determine whether it constitutes a prima facie compliant presentation based solely on the presentation itself, without considering the underlying legal relationship. The Egyptian Bank received the claim application from SVCC on May 16, 2023, which was within the validity period of the guarantee and complied with the claim terms stipulated in the Advance Payment Guarantee According to Article 15(b) of the Uniform Rules for Demand Guarantees (URDG758), claims under a counter-guarantee must, in all circumstances, be supported by a statement from the party to whom the counter-guarantee was issued, indicating that a complying claim has been received under the guarantee or counter-guarantee issued by them. On May 21, 2023, the Egyptian Bank notified the Industrial and Commercial Bank of China (ICBC) of SVCC's claim application and, based on this, filed a claim application under the counter-guarantee. The claim messages were all filed in accordance with the provisions of the six Counter-Guarantee Advance Payment Guarantees involved in the case, and the claim statement of the third party, SVCC, was provided to ICBC in a timely manner the following day. Therefore, it meets the claim requirements stipulated in Article 15(b) of the Uniform Rules for Demand Guarantees (URDG758). Finally, the Egyptian Bank complies with the provisions of Article 16 of the Uniform Rules for Demand Guarantees (URDG758) regarding the notification of claims, which states that the guarantor shall notify the instructing party, or the counter-guarantor where applicable, without delay of any claim under the guarantee and any request for extension as an alternative. Throughout the entire claim process, the Egyptian Bank strictly adhered to the provisions of the claim notification, faithfully fulfilling its obligations, and there was no abuse of the right to claim payment as stipulated in Article 12 of the Independent Guarantee Regulations, where the guarantor knowingly claims payment from the counter-guarantor despite the beneficiary's fraud. (Image source: Bulletin of the Supreme People's Court of the People's Republic of China)
13. The judges of Jinjiang Court have made great efforts in this case
The principle of independence of independent guarantees poses a significant challenge for courts in their adjudication. On the one hand, according to the provisions of independent guarantees, as long as there is no fraudulent behavior and the claim is supported by documentary evidence, the issuing bank of the guarantee shall make unconditional payment. On the other hand, if the court rules against Chengdu Design Institute, it may result in losses for Chengdu Design Institute, leading to substantial unfairness. Under the organization of the judge, the case was heard twice and mediated by Duolun. Finally, all parties agreed to temporarily suspend the trial of the case, pending the verdict of SVCC's lawsuit against the Egyptian bank. If SVCC loses, the Egyptian bank will naturally withdraw its claim application to ICBC, and Chengdu Design Institute can withdraw its lawsuit. If SVCC wins, the Egyptian bank will inevitably seek compensation from ICBC based on the counter-guarantee guarantee, making the issue very complex.
XIV. Final resolution of the case
In October 2024, the Cairo Economic Court handed down a first-instance judgment, stating that although the arbitration ruling required SVCC to pay an advance payment of USD 2,507,190 and EUR 48,428 to Chengdu Design Institute in lieu of the release of the guarantee, SVCC failed to fulfill this obligation. Therefore, the Egyptian Bank was not required to make any payment to SVCC until SVCC fulfilled this obligation. Personally, I believe that the Egyptian court's judgment essentially broke through the provisions of the Uniform Rules for Demand Guarantees (URDG758), but it did achieve true fairness and justice. SVCC appealed to the Egyptian High Court against this judgment. In the second instance, after multiple meetings and communications among Chengdu Design Institute, Egyptian Bank, SVCC, and Industrial and Commercial Bank of China (ICBC), a settlement was finally reached: SVCC withdrew its lawsuit and released six advance payment guarantees. The Egyptian Bank withdrew its claim against ICBC and released six counter-guarantees. Chengdu Design Institute withdrew its lawsuit against the Egyptian Bank for guarantee fraud. All parties will bear their own expenses.
Fifteen Revelation
Independent guarantees are widely used by domestic companies in international trade, engineering contracting, overseas investment, and other businesses to enhance counterparty trust and ensure contract fulfillment. However, due to the "demand-pay" principle of independent guarantees, they are independent of the underlying contract and are easily abused or even become fraudulent tools. In recent years, Chinese enterprises have frequently encountered malicious claims for payment under guarantees from overseas partners, resulting in huge losses. Therefore, domestic enterprises must exercise extreme caution when issuing independent guarantees to foreign parties as performance tools, considering all possible scenarios in advance to avoid risks.