More tips on how to make use of independent letters of guarantee

Due to the ambiguity of the provisions on the scope of application of independent letters of guarantee (LOG) in judicial practice in China, Chinese enterprises and financial institutions find themselves in a passive position in international commercial activities.

For example, in a certain foreign power station project, domestic company A is the general contractor and company B a subcontractor. Based on the general contract, company A issues an independent LOG to the foreign counterparty, while company B issues an independent LOG to company A in respect of the subcontracted portion. Company A then institutes an independent LOG legal action against the bank acting as company B’s guarantor.

Based on current trial practice, the independent LOG issued to the foreign counterparty by company A is valid and the bank acting as guarantor for company A is required to bear security liability; and once company A bears the liability and seeks recourse against the bank acting as guarantor for the subcontractor, company B, the independence of the independent LOG issued by company B could be denied because of a lack of a foreign element, thereby exposing the general contractor, company A, to a major performance and recourse risk.

Li Tao is a senior partner at Dacheng Law Offices