SPC Issues Judicial Interpretation on Disputes Involving Independent Guarantees

On 18 November 2016, the SPC issued the Provisions on Certain Issues involving Trials of Independent Guarantee Disputes, which took effect 1 December 2016, to acknowledge the increasing use of these guarantees by Chinese banks and in cross-border commercial transactions.

According to the provisions, an independent guarantee (also known as a demand guarantee) refers to a written commitment by a bank or non-bank financial institution acting as guarantor to pay a specified or capped amount to a beneficiary on the strength of a demand for payment and documentation that satisfies the requirements specified in the guarantee.

The provisions apply to domestic and cross-border independent guarantees and distinguish independent guarantees from general guarantees and joint liability guarantees, which are governed by the Security Law of the People’s Republic of China 1995 (“1995 Security Law”).

Unlike general guarantees and joint liability guarantees, an independent guarantee is not ancillary to an underlying contract and the guarantor’s obligation is not secondary to the obligation of the primary obligor. As a result, an independent guarantee is not subject to the claims and defences of the underlying transaction.

Instead, the obligor of an independent guarantee generally is required to honour the beneficiary’s demand for payment where the documents presented conform to the documents specified in the guarantee, except where an enumerated instance of fraud occurs.

The provisions also permit an obligor to apply for interim relief against a payment demand upon the occurrence of any enumerated instance of fraud, but require the applicant to file a lawsuit or arbitration action to prove the fraud within 30 days of issuance of the preliminary injunction.

Market Reaction

Jianwei (Jerry) Fang, Partner, Zhong Lun Law Firm, Shanghai

“The provisions are widely applauded by practitioners and are expected to have a huge and positive impact on cases involving independent guarantees, which have been controversial due to certain provisions in the 1995 Security Law. The provisions acknowledge and respect common business practices, as independent guarantees have been widely used in domestic and cross-border transactions in recent years. They will also increase the credibility and acceptance of independent guarantees issued by Chinese financial institutions in cross border transactions, facilitating the efforts of Chinese enterprises to expand abroad.”

Action Items

General Counsel for financial institutions should closely study the rights and obligations of guarantors under independent guarantees. This also holds true for counsel for beneficiaries of independent guarantees, as well as any potential party to a dispute involving independent guarantees. Counsel interested in exploring the financing options and related protections available under Chinese law will also want to consider the impact of the provisions.