Performance of underlying contract and guarantee fraud

Independent guarantee is a financial guarantee instrument that is often used to assure rapid realization of the creditor’s right. When the guarantor reviews the documents presented by the beneficiary, if the documents are totally consistent with the provisions of the guarantee and superficially consistent with one another, the guarantor must undertake the payment obligation without the need to review the performance of the underlying contract, pursuant to the Uniform Rules for Demand Guarantees.

The performance of the underlying contract is not an item the guarantor must review when making the payment, but in practice the court will usually examine this factor once a guarantee fraud occurs. A typical case in this regard is of guarantee fraud under dispute involving Eastern Property, Anhui Foreign Economic Construction Group (AFECC), a bank in Costa Rica, and Anhui Branch of China Construction Bank Corporation (CCB Anhui). As the developer, Eastern signed a construction contract with the contractor, AFECC, and the actual construction company, AFECC Central America, a local subsidiary. After signing the contract, Eastern applied for payment of the amount under the guarantee to the guarantor bank on account of AFECC Central America’s default.

Considering that China had not explicitly stipulated independent guarantee or guarantee fraud when the case was heard, the People’s High Court of Anhui province drew the principle of fraud exception set out under international general practice and international treaties, and judged the conduct of the beneficiary Eastern to constitute a guarantee fraud. Under this case, the Anhui court asserted that it was necessary to perform a review of the performance of the underlying contract during the trial of a dispute pertaining to guarantee fraud.

Blake Yang is a senior associate and Franz Li is an associate at Martin Hu & Partners