EXCERPT:
Where examination of the underlying transaction is necessary to establish fraud under an independent guarantee, courts shall adhere to the principle of limitation and necessity. A beneficiary’s breach under the underlying contract does not impair its right to present documents and make a demand for payment pursuant to the independent‑guarantee terms. Even if fraud exists under an independent guarantee, people’s courts shall not order suspension of payment under an independent counter‑guarantee where payment under the primary independent guarantee has already been made in good faith.
Case: Breach by the Beneficiary under the Underlying Contract Does Not Bar Its Demand for Payment under an Independent Guarantee
Abstract
Where examination of the underlying transaction is necessary to establish fraud under an independent guarantee, courts shall adhere to the principle of limitation and necessity. A beneficiary’s breach under the underlying contract does not impair its right to present documents and make a demand for payment pursuant to the independent‑guarantee terms. Even if fraud exists under an independent guarantee, people’s courts shall not order suspension of payment under an independent counter‑guarantee where payment under the primary independent guarantee has already been made in good faith.
Key Adjudicative Points
- Where examination of the underlying transaction is required to determine fraud under an independent guarantee, the principle of limitation and necessity shall apply. The scope of review is confined to whether the beneficiary knew that its counterparty under the underlying contract had committed no breach thereunder, or whether the beneficiary knew it possessed no valid claim for payment.
- A beneficiary’s breach of obligations under the underlying contract shall not affect its right to submit documents and demand payment under the independent guarantee.
- When assessing fraud under an independent counter‑guarantee: even if fraud occurs under the primary independent guarantee, people’s courts shall not order suspension of payment under the independent counter‑guarantee if payment under the primary independent guarantee has been effected in good faith.
Basic Facts
On 16 January 2010, Oriental Real Estate Development Co., Ltd. (“Oriental Real Estate”, as developer), Anhui Foreign Economic Construction (Group) Co., Ltd. (“Anhui FECC Group”, as contractor), and Anhui Foreign Economic Construction Central America S.A. (“Anhui FECC Central America”, as constructor) executed a Construction Contract for the Costa Rica Lakeview Mansion Project in San José, Republic of Costa Rica. The contract governed construction of three fourteen‑storey mixed‑use commercial‑residential buildings.
On 26 May 2010, Anhui FECC Group applied to China Construction Bank Anhui Branch (“CCB Anhui Branch”), requesting it to arrange for Banco de Costa Rica as the transferring‑issuing bank to issue a performance guarantee in favour of Oriental Real Estate for the Lakeview Mansion Project.
On 28 May 2010, Banco de Costa Rica issued Performance Guarantee No. G051225. CCB Anhui Branch acted as counter‑guarantor; Anhui FECC Group was the applicant and Oriental Real Estate the beneficiary. The guaranteed amount was USD 2,008,000. The guarantee originally expired on 12 October 2011 and was later extended to 12 February 2012. The guarantee was expressed as unconditional, irrevocable, mandatory and payable on demand. To trigger payment, the beneficiary was required to submit two copies of supporting documentation stating grounds for claim to the Foreign‑Trade Department of Banco de Costa Rica’s Head Office, together with a notarised declaration specifying the date on which Anhui FECC Central America had been notified of the breach giving rise to the claim, plus the original guarantee instrument and any amendments.
Simultaneously, CCB Anhui Branch issued Counter‑Guarantee No. 34147020000289 in favour of Banco de Costa Rica, undertaking to pay sums under the guarantee within twenty days upon receipt of Banco de Costa Rica’s demand. The counter‑guarantee was “unconditional, irrevocable and payable on demand” and stipulated compliance with ICC Publication 458, Uniform Rules for Demand Guarantees (URDG 458).
During performance of the Construction Contract, on 23 January 2012, architects José Brenes and Mauricio Mora issued a Project Inspection Report. The report documented defective and poor‑quality construction requiring rectification and repair.
On 7 February 2012, Anhui FECC Central America filed an arbitration claim with the Dispute‑Resolution Centre of the Costa Rican Association of Architects and Engineers against Oriental Real Estate, alleging non‑payment of progress sums for completed works. It sought contract termination and damages.
On 8 February 2012, Oriental Real Estate submitted claim documents to Banco de Costa Rica: demand‑for‑payment statement, breach notice, breach declaration and the Project Inspection Report, calling for payment under the guarantee.
On 10 February 2012, Banco de Costa Rica sent a telex to CCB Anhui Branch advising of Oriental Real Estate’s claim for USD 2,008,000 under Guarantee G051225 and demanding payment by 16 February 2012.
On 12 February 2012, upon application by Anhui FECC Central America, Chamber II of the Costa Rican Administrative‑Litigation Court issued an interim protective injunction ordering Banco de Costa Rica to suspend performance under Performance Guarantee G051225.
On 23 February 2012, Anhui FECC Group initiated litigation for guarantee‑fraud before Hefei Intermediate People’s Court and applied for suspension of payment under Guarantee G051225 and Counter‑Guarantee 34147020000289.
On 27 February 2012, the first‑instance court rendered Ruling (2012) He Min Si Chu Zi No. 00005‑1, ordering suspension of payment under both guarantees. The ruling was served on CCB Anhui Branch on 28 February 2012.
On 29 February 2012, CCB Anhui Branch telexed Banco de Costa Rica to notify it of the domestic court ruling and sent a copy of the ruling by post, which Banco de Costa Rica received on 5 March 2012.
On 6 March 2012, Chamber II of the Costa Rican Administrative‑Litigation Court dismissed Anhui FECC Central America’s application for interim relief and lifted the protective injunction.
On 20 March 2012, at Banco de Costa Rica’s request, CCB Anhui Branch extended the validity of Counter‑Guarantee 34147020000289.
On 21 March 2012, Banco de Costa Rica paid the full guaranteed amount to Oriental Real Estate under Guarantee G051225.
On 9 July 2013, the Costa Rican Association of Architects and Engineers rendered its arbitral award. It found Oriental Real Estate to be in material breach of the Construction Contract, ordered contract termination, and directed Oriental Real Estate to pay Anhui FECC Central America progress payments Nos. 1‑18 totalling USD 800,058.45 plus interest. The claim for payment for Work Lot 19 was rejected for lack of developer acceptance. Since sums under Guarantee G051225 had already been disbursed, the arbitral tribunal dismissed Anhui FECC Central America’s application for restitution of guarantee proceeds.
Adjudicative Outcome
- First Instance (Hefei Intermediate People’s Court, 9 April 2014), Civil Judgment (2012) He Min Si Chu Zi No. 00005:
- Oriental Real Estate’s demand under Performance Guarantee G051225 constituted guarantee fraud;
- CCB Anhui Branch shall cease paying USD 2,008,000 under Counter‑Guarantee 34147020000289 to Banco de Costa Rica;
- Other claims of Anhui FECC Group were dismissed.
Dissatisfied, Oriental Real Estate appealed.
- Second Instance (Anhui High People’s Court, 19 March 2015), Civil Judgment (2014) Wan Min Er Zhong Zi No. 00389: Appeal dismissed; original judgment affirmed.
Oriental Real Estate applied to the Supreme People’s Court for retrial.
- Retrial (Supreme People’s Court, 14 December 2017), Civil Judgment (2017) Zui Gao Fa Min Zai No. 134:
- Set aside the civil judgments of Anhui High People’s Court (2014) Wan Min Er Zhong Zi No. 00389 and Hefei Intermediate People’s Court (2012) He Min Si Chu Zi No. 00005;
- Dismiss all claims filed by Anhui FECC Group.
Reasoning of the Supreme People’s Court
I. Characterisation, jurisdiction and applicable‑law issues for this independent‑guarantee‑fraud dispute
Oriental Real Estate and Banco de Costa Rica are habitually resident outside China; this is a foreign‑related commercial dispute. Under Article 8 of the Law of the People’s Republic of China on Application of Law to Foreign‑related Civil‑Relations, characterisation of foreign‑related civil‑legal relationships is governed by lex fori (the law of the forum court).
Anhui FECC Group, parent company of Anhui FECC Central America, was the guarantee applicant. It procured CCB Anhui Branch to issue a demand counter‑guarantee in favour of Banco de Costa Rica, which in turn issued the primary performance guarantee for beneficiary Oriental Real Estate. The payment obligations of both banks under the instruments were independent of the underlying‑transaction and guarantee‑application relationships. Accordingly, the instruments qualify as a demand‑type independent guarantee and a corresponding independent counter‑guarantee.
Anhui FECC Group instituted guarantee‑fraud proceedings before the first‑instance court. The counter‑guarantee whose payment was sought to be suspended was issued by CCB Anhui Branch; the branch’s seat constituted the place where the alleged tortious harm occurred. The first‑instance court had jurisdiction as the forum of the tort. The guarantees explicitly incorporated the Uniform Rules for Demand Guarantees (URDG 458), whose provisions formed part of the contractual terms.
Pursuant to Article 44 of the Law on Application of Law to Foreign‑related Civil‑Relations, tort liability is governed by the law of the place of tort. Chinese domestic law governed the test for guarantee fraud on matters not covered by URDG 458. China is not a party to the United Nations Convention on Independent Guarantees and Stand‑by Letters of Credit, and the parties had neither agreed to apply it nor incorporated its provisions by reference. The Convention therefore did not apply.
II. Whether Oriental Real Estate, as beneficiary, possessed prima‑facie evidence substantiating its claim under the underlying contract
When hearing cases on independent guarantees and related counter‑guarantees, courts reviewing the underlying transaction must follow the principle of limitation and necessity. Review shall be restricted to whether the beneficiary knew that its counterparty under the underlying contract had committed no breach giving rise to guarantee‑payment. Excessive inquiry into the underlying merits would undermine the “pay‑on‑demand” foundation of independent‑guarantee institutions.
Fraud, under Article 68 of the Supreme People’s Court Opinions on Implementation of the General Principles of the Civil Law (Trial), consists of fabrication of facts or concealment of truth.
Performance Guarantee G051225 prescribed documents required for a demand: supporting documents explaining the grounds for calling, notice of the date when the contractor was notified of the claim, original guarantee instrument and amendments. For Anhui FECC Group to prove guarantee fraud, it needed to show either (1) that Oriental Real Estate submitted forged or materially false documents in support of its claim; or (2) that the claim was entirely devoid of factual or credible basis.
This guarantee secured against poor‑quality workmanship and other contractual breaches. Prima‑facie evidence of construction‑quality defects would satisfy the requirement for “supporting documents explaining grounds for calling”. The Project Inspection Report issued by the project‑supervision architects José Brenes and Mauricio Mora on 23 January 2012 recorded defective and shoddy work requiring rectification and constituted such prima‑facie evidence.
Neither the Construction Contract nor the guarantee mandated submission of that specific inspection report to Banco de Costa Rica on calling. Oriental Real Estate was entitled to select its supporting documentation; failure to submit the report did not defeat its guarantee‑entitlement. Nor did any instrument require the report to be prepared by AIA‑registered architects. Anhui FECC Group had accepted the two individuals as the developer’s on‑site supervisors during project execution and payment of progress sums. It was logically inconsistent for the applicant to rely on evidence confirming their supervisory status to impugn the truthfulness of their inspection report.
Anhui FECC Group adduced no further evidence showing Oriental Real Estate’s claim was fact‑baseless or that it tendered forged/falsified documents. Oriental Real Estate therefore had factual grounds for calling on the guarantee. The Project Inspection Report furnished prima‑facie proof of alleged contractor breach. Anhui FECC Group failed to prove the report was falsified, or that Oriental Real Estate knowingly made a call notwithstanding the absence of any underlying breach. Its claim under the guarantee accordingly did not amount to guarantee fraud.
III. Whether a beneficiary’s own breach under the underlying contract necessarily constitutes a fraudulent demand under the independent guarantee
Anhui FECC Group argued for a finding of fraud under Items (3), (4) and (5) of Article 12 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Independent‑Guarantee Dispute Cases. Even after judicial clarification during trial, Anhui FECC Group maintained that the case should be decided in accordance with the spirit of that judicial interpretation.
Independent guarantees are decoupled from the underlying transaction between applicant and beneficiary. The issuing bank reviews only document compliance and decides payment autonomously; its payment obligation is unaffected by defences arising from the underlying contract. For the beneficiary, submission of prima‑facie evidence of poor workmanship suffices to make a valid demand. A pre‑existing judgment or arbitral award confirming the counterparty’s breach is not required. Even where underlying litigation or arbitration is pending, the beneficiary’s guarantee‑rights remain intact absent a final determination that the underlying debtor bears no payment or indemnity liability.
Crucially: an award finding the beneficiary itself in breach under the underlying contract does not automatically satisfy the legal criteria for guarantee fraud. In this case, Oriental Real Estate’s alleged non‑payment of construction sums bore no logical causal link to the construction‑quality defects triggering the guarantee. A beneficiary’s own contractual breach is not a sufficient‑and‑necessary condition for guarantee fraud.
Item (3) of Article 12 of the independent‑guarantee judicial interpretation limits fraud‑findings to circumstances where “a court judgment or arbitral award confirms that the debtor under the underlying transaction has no payment or indemnity liability”. Absent contrary guarantee wording, review of the underlying contract must stay within the scope of risks secured by the guarantee. Courts must exercise great caution when treating the beneficiary’s own underlying‑contract breach as evidence of guarantee fraud.
The Costa Rican arbitral award of July 2013 found Oriental Real Estate in breach, yet the arbitration had been initiated by Anhui FECC Central America; Oriental Real Estate had not filed counter‑claims. The award found breach by Oriental Real Estate only on the claims asserted by the contractor, and it did not relieve Anhui FECC Central America of its own potential payment or indemnity liabilities. The arbitral award therefore could not trigger Item (3) of Article 12.
Furthermore, the record showed that Anhui FECC Central America had not fully performed its obligations under the Construction Contract. There was no proof that Oriental Real Estate had acknowledged full discharge of underlying obligations or that the guarantee‑triggering event had never occurred. No evidence demonstrated that Oriental Real Estate knowingly abused a claim it did not lawfully hold. Even applying the independent‑guarantee judicial interpretation as urged by Anhui FECC Group, guarantee fraud was not established.
IV. Issues pertaining to the independent counter‑guarantee
Under the nature of independent guarantees, the guarantor assumes a direct payment obligation vis‑à‑vis the beneficiary separate from the principal‑debt relationship. Defences available to the underlying debtor do not automatically inure to the independent guarantor. Moreover, suspected fraud under the primary guarantee does not ipso facto establish fraud in a demand made under a counter‑guarantee. Fraud on the part of the guarantee‑issuing bank under the counter‑guarantee is only made out where: the bank knows the beneficiary’s demand under the primary guarantee is fraudulent; it nonetheless pays in breach of good‑faith standards; and it then makes a demand for reimbursement under the counter‑guarantee.
Anhui FECC Group bore the evidential burden to prove that Banco de Costa Rica had paid Oriental Real Estate in full knowledge of fraudulent calling and in bad faith, and that it then made a fraudulent reimbursement‑demand under the counter‑guarantee. It failed to adduce such proof. Its application for suspension of payment under the counter‑guarantee was without factual foundation.
