In a recently published ruling by the Amsterdam Court of Appeal, it was determined that a bank guarantee was not only provided as security for repayment/reimbursement of amounts paid in advance, but also for damages for breach of contract. The wording of an abstract bank guarantee remains of great importance, but is also assessed by the court in light of the underlying construction contract.
In brief, the facts
OpenIJ, a contractor consortium, is constructing a new sea lock on behalf of the Department of Public Works. This requires the construction of four lock gates and one dry dock gate. This has been subcontracted by OpenIJ to the South Korean company Geosung Tech for EUR 23,324,770.
The construction contract between OpenIJ and Geosung entails OpenIJ making a number of advance payments. If it later turns out that the prepayment exceeds the amount to which Geosung is entitled, OpenIJ is entitled to repayment under the construction contract. As security for this possible repayment to OpenIJ, Geosung (through its South Korean bank Busan) has instructed ING to provide a bank guarantee to OpenIJ for EUR 7,294,953.
There are several delays in the construction of the doors. OpenIJ calls in the bank guarantee for the full amount because it believes it is entitled to repay part of the prepaid amount. Geosung refuses and ING pays out the bank guarantee to OpenIJ. Geosung sues OpenIJ and ING.
The issue here is whether the bank guarantee also applies to damages that OpenIJ claims to suffer. Geosung thinks not because OpenIJ would not be entitled to compensation under the construction agreement. The preliminary relief judge and the Amsterdam Court of Appeal ruled otherwise: OpenIJ was entitled to invoke the bank guarantee and ING paid out justifiably.
Abstract Bank guarantee or not?
The characteristic of an abstract bank guarantee is that the bank's obligation to pay the guarantee is made independent of the underlying contractual relationship between the principal of the bank guarantee (Geosung) and the beneficiary (OpenIJ). The bank has an independent obligation to pay the amount specified in the bank guarantee at the first request of the beneficiary, if the conditions as defined in the guarantee are met. The background to this is "pay first, then talk." After payment is made, litigation may ensue as to exactly what is owed. A bank guarantee is not abstract if the bank has the right to refuse payment by invoking the defenses of the principal debtor (Geosung).
Geosung argues that there is no abstract bank guarantee, but that OpenIJ should have first litigated whether it was entitled to repayment under the construction contract. Indeed, the bank guarantee allegedly states that ING's payment obligation depends on whether OpenIJ is entitled to payment under the construction contract.
On the other hand, the same clause states that it is an irrevocable demand guarantee. The Uniform Rules of Demand Guarantees (URDG) have also been declared applicable. These rules are specific to bank guarantees of an abstract nature. Furthermore, the guarantee states that ING must pay out if OpenIJ makes a request to do so. If a default were necessary, this should have been explicitly stated in the bank guarantee. Finally, the bank guarantee is limited in duration. If litigation had been required first, OpenIJ would no longer have been able to draw under the guarantee because the term would have been provided.
In view of the above, the trial judge and the court held that the bank guarantee did not have limited coverage and was abstract in nature.
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Strict conformity
Whether OpenIJ as the beneficiary of the bank guarantee is entitled to pay out depends on whether the conditions in the guarantee have been met (strict conformity). If the conditions in the guarantee have been met, the bank must pay out. The Supreme Court has allowed an exception to this strict conformity in cases of fraud or arbitrariness by the beneficiary or by the principal of the bank guarantee."[1]
Geosung relies on this by claiming that reliance on the bank guarantee is manifestly fraudulent or arbitrary. According to Geosung, the bank guarantee would only concern repayment by Geosung under an undoing obligation if Geosung did not deliver the lock gates. The Amsterdam Court of Appeal comes to a different conclusion. In doing so, the court looked not only at the text of the bank guarantee, but also at the construction contract. The construction contract states that the bank guarantee serves as security for both Geosung's obligation to pay or repay, but also as security for any payment or obligation of Geosung under this agreement. It also covers damages for culpable default, such as for late delivery, the court said.
Conclusion
The underlying legal relationship (here, the construction contract) may play a role in interpreting an abstract bank guarantee if the strict wording of the guarantee does not provide sufficient clues. The construction contract required Geosung to provide security for any debt owed to OpenIJ under the construction contract. Compensation for breach of contract is thus covered by the bank guarantee.
[1] The restrictive effect of reasonableness and fairness may entail in the case of fraud or arbitrariness that, even if the strict conditions in the bank guarantee have been met, a reliance thereon by the bank need not be honored (HR 26 March 2004, ECLI:NL:HR:AO2778 concerning Anthea Yachting/ABN AMRO).
