Bank guarantees in international trade – part 3 – Between a rock and a hard place: the role of the guarantee bank

C-bank’s in-house lawyer, Nina, received the file on Friday afternoon. After half an hour she made a note: “Defer payment for two weeks, preliminary injunction?” and passed the file back to the customer advisor, who put it aside, reassured.

When a bank guarantee is called upon, the guarantee bank finds itself in a dilemma. On the one hand, it must fulfil its guarantee obligation to the guarantee creditor. On the other, it must also observe the contractual relationship with the guarantee debtor and must not pay the guarantee without authorisation because it then cannot legally debit its customer’s account with the paid amount.

In principle, the bank is obliged to pay the guaranteed sum under a guarantee payable on “first demand” if the claim under the guarantee is not considered abusive of the law and the contractual requirements for payment are met. To be able to assess this in the first place, the bank will usually ask its customer to provide essential documents – for example, the letters from both contracting parties concerning the problem that led to the guarantee case and any relevant contractual documents. This will always take a few days, which means that the payment of a guaranteed sum takes a certain amount of time.

But even once the documents have been provided, the bank is rarely in a position to form a clear picture of whether the payment of the guaranteed sum is an abuse of the law or not. It is too far away from the specific circumstances and backgrounds that the contracting parties are disputing, especially when it comes to delivery difficulties or the quality of delivered goods. The in-house lawyer’s note should be considered with these factors in mind. If the bank were to receive a preliminary injunction within a relatively short period of time prohibiting A-Ltd from calling upon the guarantee, the bank would have a solid reason for not paying the guaranteed sum. This would apply in any case if the court decision contained clear indications that A-Ltd calling upon the bank guarantee is an abuse of the law.

In view of the guarantee commitment it has made, however, the bank cannot in principle hide behind the courts, for example to await the outcome of court proceedings between the contracting parties conducted under interim legal protection. The outcome of such main proceedings can take several years, especially if evidence must be taken before the court can reach its decision. And it is not uncommon for court proceedings to continue into an appeal process, rather than ending after one instance. The payment of the guaranteed sum can therefore generally only be made conditional on a reasoned decision under interim legal protection. Only then is the purpose of the bank guarantee – to provide the guarantee creditor with liquid funds in a prompt manner – fulfilled. Disputes about the entitlement of the guarantee creditor to ultimately call upon the guaranteed sum usually have to be resolved after payment has been made.

From the bank’s point of view, it is therefore clear that both quick payment to the guarantee creditor and non-payment entail risks. If the bank pays quickly without being authorised to do so, it will not be able to demand reimbursement of the guaranteed sum from its customer. If, on the other hand, it does not pay, it could be sued by the guarantee creditor for payment and potentially also for damages if non-payment causes the guarantee creditor to incur a loss. The bank faces the additional risk of reputational damage, especially if it repeatedly delays payment under bank guarantees significantly, or even withholds payment entirely. If this is the case, the market’s acceptance of the bank as a reliable guarantor is likely to suffer.

In economic terms, the bank’s risk is typically likely to be greater in the event of premature but unauthorised payment than in the opposite case, in which it initially withholds payment. This is because the typical loss for the guarantee creditor in the event of non-payment lies in the costs of obtaining replacement funds (e.g. loan interest). In the event of unauthorised payment, however, the loss may be as much as the entire guaranteed sum if this cannot be recovered at a later date. In case of doubt, these considerations may lead some banks to refrain from paying the guaranteed sum for the time being.

All of this shows that Nina did her job well. She bought the bank, which finds itself between a rock and a hard place, some more time. She effectively gave the guarantee debtor the opportunity to convince a court of its position through a motion for a preliminary injunction. Whether or not this will succeed is unknown. But if it does, the bank will have done nothing wrong in refusing to pay the guaranteed sum.