Guarantees in the context of International contracting
- Spain
- 09/09/2002
INTRODUCTION
The common feature of payment guarantees is to function as a security measure in carrying on business relationships. Payment guarantees protect the beneficiary from the risk of loss resulting from the debtor´s breach of its obligations to the beneficiary.
Companies conducting international business transactions prefer the use of payment guarantees, which satisfy the liquidity needs of the beneficiary and avoid tying up the capital of the debtor. In the international context, payment guarantees require a mechanism for determining the applicable law, independent of the underlying transaction.
SUBSIDIARY GUARANTEES ( LA FIANZA)
Concept and Characteristics
A subsidiary guarantee is a contract in which the surety assumes a secondary obligation to guarantee payment of a debt of another, thereby becoming separately and personally liable to the creditor for the guaranteed obligation. A subsidiary guarantee is characterized by:
(1) Accessory nature: The guarantee is created by a separate writing which references and incorporates the guaranteed debt.
(2) Secondary nature: The obligation of the guarantor does not arise until the debtor defaults on its obligation, consistent with separate and ordered nature of the guarantor´s responsibility.
(3) Restrictive interpretation: Subsidiary guarantees must be created in a clear and express form, and will not be implied.
Subsidiary Guarantees in International Contracting
Subsidiary guarantees in the international context raise two important issues of private international law: (1) jurisdiction, and (2) applicable law.
Judicial forum
When disputes arising from a guarantee are submitted to judicial proceedings for resolution, international jurisdictional issues arise with respect to the competent judicial forum to determine the contractual issues. When the defendant is domiciled in the European Union, the assumption of jurisdiction by Spanish courts is determined pursuant to the Brussels Convention of 27 September 1968, otherwise it is determined pursuant to Article 22.3.7 of the Organic Law of Judicial Authority (Ley Orgánica del Poder Judicial - LOPJ).
The criteria contained in Article 22.3 of the LOPJ, and Article 5.1(a) of the Brussels Convention, differ with respect to determining the competent judicial forum. In accordance with Article 22.3 of the LOPJ, the Spanish courts will assume jurisdiction when the contractual obligations are created or fulfilled in Spain. Pursuant to Article 5.1 of the Brussels Convention, the judicial forum, of the place where the obligation which is the subject of the complaint is to be fulfilled, is competent to assume jurisdiction. In other words, jurisdiction is based on the main obligation arising from the contract. In addition, in Article 6.2, if the complaint is based on a guarantee obligation, it may be filed in the judicial forum competent to determine the action brought on the principal obligation.
Applicable law
In theory, based on the independent nature of a guarantee, the parties may freely select the applicable law, in accordance with the Rome Convention of 1980. When the parties do not select an applicable law, the law of the habitual residence of the contracting party rendering the most characteristic contractual performance will be applied. In the case of suretyship guarantees, this results in the application of the law of the residence of the guarantor, due to the guarantee´s independence from the underlying debt.
The International Chamber of Commerce (ICC) has published rules with respect to contractual guarantees, titled Uniform Rules for Contract Bonds (URCB). These rules attempt to establish a uniform framework, and will be applied when expressly selected by the parties. Article 8(a) of the URCB establishes the aplication of the lex fideussionis, failing which, the law of the principal contract will apply. The URCB treats guarantees as being accessory in nature, considering the principal contract as an integral part of the guarantee. In article 7 URCB, a guarantee is interpreted to be a joint undertaking with the underlying debt.
UNCONDITIONAL GUARANTEES (LAS GUARANTÍAS A PRIMERA DEMANDA)
Unconditional guarantees are guarantees of distinct legal significance. The objective of unconditional guarantees is to avoid the formality of standard subsidiary guarantees (fianzas). The Supreme Court, based on the freedom of contract principle embodied in Article 1.255 of the Civil Code, recognizes the validity of a guarantee based solely upon a contract, both substantively and procedurally.
Concept and Economic Function
The objective of an unconditional guarantee is to optimize the function of the suretyship guarantee (fianza), by allowing enforcement of the guarantee obligation based solely on the direct claim of the beneficiary. Thus, it is characterized by its features of abstraction and autonomy. The guarantor is generally a bank; the guarantor pays on its guarantee first, and then brings its claim for reimbursement (de solve et repete). The beneficiary is not required to establish the default of the principal debtor.
The risks associated with the guarantee contract and the guaranteed debt are minimized, and an advantageous procedural position is obtained as well. The principal debtor is not involved in the relationship between the bank and the beneficiary. Accordingly, it serves a credit function due to the liquidity provided to the beneficiary. The guarantor also receives an economic benefit, in the nature of its fee collected to issue the guarantee.
The Legal Framework Applicable to Unconditional Guarantees
ICC uniform rules regarding unconditional guarantees (URDG)
Scope of application
The URDG apply to guarantees of independant signficance. The success of the URDG is based on its use in international practice. The international nature of its application is derived the beneficiary, the principal and/or the guarantor being located in different countries. The rules establish two types of unconditional guarantees: documentary and counterguarantees. The URDG do not apply to international letters of credit.
Structure of the guarantee
At minimum, the guarantee should specify: (1) the indentity of the principal debtor, the guarantor, and the beneficiary; (2) the consideration for the issuance of the guarantee; (3) the maximum amount payable; (3) the currency; (4) the conditions for reducing its amount; (5) the due date and termination of the guarantee, and the conditions to claim payment under the guarantee. The guarantee should be set forth in writing. Absent agreement to the contrary, the guarantee is irrevocable.
Termination of the guarantee is generally based on payment, its expiration or release of the guarantor. Absent agreement to the contrary, the guarantee is nonassignable.
Judicial forum
Article 28 of the URDG establishes that, absent agreement to the contrary, the courts of the country of the establishment of the guarantor, or the principal debtor, as the case may be, shall have exclusive jurisdiction to determine issues; or, if the guarantor and the principal debtor have their establishments in different countries, the courts of the country where branch issuing the guarantee shall have jurisdiction. If the guarantee contains a jurisdiction selection clause, its terms will be dispositive.
Applicable law
Guarantees are subject to the same choice of law rules applicable to the rest of the contractual obligations. An issue arises when the parties do not specify the applicable law. In such case, Article 27 of the URDG establishes as an objective connection, the place of the establishment of the guarantor, or the principal debtor, or the place where the branch issuing the guarantee has its establishment, as the case may be.
ASSURANCE LETTERS
Concept and Economic Function
The use of assurance letters arises in banking relations and transactions within related corporate entities. The mother company approaches a bank located in the same country as the company´s headquarters, and of which it has an established business relationship, to initiate the negotiation and granting of a credit to another company, controlled by the mother company and located in a different country. The mother company makes a formal written presentation to the bank, containing a wide variety of information and declarations, for the purpose of conveying assurance with regard to the transaction to be financed. Assurance letters serve a guarantee function, the extent and legal effect of which depends directly on the type of letter issued. There are generally two types of assurance letters: weak and strong.
Strong assurance letters
Strong assurance letters are characterized by their high degree of formality, precision and clarity with respect to their purpose. They contain hightly-tailored information that is provided specifically for the bank´s reliance. Strong assurance letters typically contain a series of representations designed to function as a guarantee. The entity issuing the letter promises to maintain the status quo, thereby establishing an obligation to not withdraw its participation without the consent of the bank, or repay or guarantee the credit extended upon withdrawal, and promises to maintain the solvency of the beneficiary entity, assuring repayment of the credit and covenanting to hold the bank harmless from any loss by virtue of having issued, maintained or enlarged the credit. The essence lies in the great extent of the promissory nature of the declarations of the company issuing the letter, which facilitates the shifting of the risk associated with the issuance of the credit to the beneficiary company as a result of the various covenants and promises undertaken.
Weak assurance letters
Weak assurance letters are designed solely to communicate to the bank knowledge of the existence of the financed transaction, and its general conformity. Their objective is to convince the bank that the credit extension is not at risk. The letter does not convey that the company issuing the letter assumes any obligation previously assumed by the beneficiary company. The issuing company only represents that a certain result or objective is possible.
Legal Nature
Informative representations are distinguishable from affirmations by the issuing company which rise to the level of a promise or covenant, representations which are legally recognized as obligations creating liability in the event of their breach. Representations by which the issuing company assumes a legal obligation are obligations of a guarantee nature.
In practice, assurance letters are construed literally, within the context of the entire document and its intended purpose. When the information provided has been relied upon, and is proved misleading or false, the imposition of legal liability is imperative – in accordance with the lex contractus.
Assurance letters represent an atypical and unique type of guarantee, nevertheless legally binding. The conflictual principle of autonomy governs, and the applicable law selected by the parties will be recognized. In absence of an election, the law of the place of the entitiy issuing the assurance letter will be applied.
RESERVATION OF TITLE CLAUSES
Concept and Economic Function
Reservation of title clauses represent a separate agreement within a sales contract extending credit to the purchaser, which makes payment of the goods a condition precedent to the seller´s transfer of title to the goods to the purchaser. This type of guarantee is based on the seller´s retention of title to the property.
Such clauses create a guarantee within the sales contract respecting personal movable property, which only binds the parties to the contract, and which only may be enforced against the property subject to the sales contract, to the extent it remains unchanged and identifiable. Subsequent disposition or transmutation of the property is impliedly prohibited, ie., the purchaser´s ability to resell the property is restricted.
Validity and Effects Inter Se
Validity of the agreement
Determined by the lex contractus
The validity of the contract from which the agreement arises is determined by the law governing contractual obligations (Article 10.5 Civil Code and the Rome Convention of 1980). As these clauses are normally incorporated into the main sales contract, the law governing the main contract will also determine the validity of the title retention clause. However, in accordance with the principle of contractual autonomy, the parties may designate a different law to govern the reservation of title clause. In addition, as it is possible for the title reservation clause to be agreed at a point in time separate from the conclusion of the main sales contract, it may have its own lex contractus.
When the lex contractus is Spanish law, it is important to take into account particular legislation establishing a domestic limitation, found in Article 4.5 of the Law 50/1965, of 17 July, with respect to the sale of movable property upon credit, which in particular excludes international commercial transactions from its application - import-export transactions - except in cases involving goods flowing in commerce within the European Union.
Inapplicability of the lex contractus
Certain issues related to the validity of title reservation clauses are outside the scope of the lex contractus, such as:
(1) The capacity of the parties: governed by the law of each party´s country (Article 9.1 Civil Code) subject to the national interest exception (Article 10.8 Civil Code);
(2) Observance of sufficient formalities: with respect to which the favor negotii and Article 11.1 Civil Code establish three alternative connections: the law of the place of execution, the lex contractus, and the common national law of the parties. Nevertheless, as many legal regimes apply a ab solemni tatem formula required by the lex contractus, in such cases this method will be dispositive according to Article 11.2 Civil Code.
Validity as a Guarantee
Application of the lex rei sitiae
The reservation of title constitutes a guarantee based on contractual title, the validity of which is determined in accordance with the lex contractus. However, the validity of guarantee rights is also governed by the law of the place where the assets subject to the guarantee are located (Article 10.11 Civil Code). The lex rei sitiae determines the exact moment and the necessary conditions under which the reservation of title constitutes a valid guarantee. Nevertheless, the lex rei sitiae is not determinative in the following circumstances:
(1) When the lex contractus is applicable; and
(2) With respect to the capacity to contract reservation of title.
Transitory problem
With regard to rights created in movable personal property, there is unanimity in the application of the law of the place where the property is located at the time the sales contract respecting the property is concluded (the law of the place of exportation or shipment of the property). Once established, the law applicable to the validity of the contract is unaffected by the subsequent transfer of the property to its ultimate destination.
The problem of incomplete adquisition
The European jurisprudence recognizes the validity of foreign guarantee rights containing irregularities, as long as the meet the validity requirement established in the lex rei sitiae.
Transformation of rights/problem of content recognition
The traditional approach has been to apply the lex rei sitiae to determine the content of the guarantee rights, as well as their effects between the parties and versus third parties. Still, the various legal systems differ greatly with respect to the determination of content; the majority recognizes the seller´s right of appropriation and reclamation, while other systems only attribute to the seller the right to recover the value of its claim through the auction of the property.
A flexible approach is the norm encountered amongst the various guarantee legal frameworks. Reservation of title clauses, which give rise to guarantee rights in accordance with the lex rei sitiae, are typically transformed into a right of priority at auction pursuant to the particular lex rei sitiae, resulting in its lesser-effective transformation, yet maintaining the viability of the guarantee, with it changed content.
With respect to the relationship between the contracting parties, clearer lines are drawn. When the transaction involves property to be exported pursuant to the sales contract, the law applicable to the transaction or selected by the parties, which would govern their contractual relationship, has stronger connection which approximates the lex rei sitiae of the final destination of the property, as opposed to merely having a transitory and insignificant lex rei sitiae at the moment of contract conclusion.
INTERNATIONAL DOCUMENTARY CREDITS
Concept and Economic Function
The documentary credit is a payment mechanism carried out between banks which function as payment guarantors/intermediaries.
It is necessary to design a secure payment mechanism which meets the needs of parties to international business transactions. The purchaser desires verification that the goods will be delivered; while the seller wants to assure payment collection. In order to meet both needs, the parties agree to use the banking system as an intermediary, which assures payment by the purchaser upon verification of documents respecting the goods. The banks do not involve themselves in verifying the actual condition and quality of the goods, limiting their involvement to the administration of payments based on specified documents. Assuming the documents comply with the instructions of the purchaser, the bank issues payment via documentary credit – a secure and expedient payment process.
The general advantages of documentary credits are their security, financial swiftness and flexibility. Disadvantages typically encountered are processing delays and transaction costs (1 to 1.5% of the transaction value).
This payment method can be carried out in a three or four-sided transaction. The three-sided structure involves three legally-distinct parties. Under an agreement between the issuing bank and its client, the bank agrees to make payment to a third party (beneficiary), based on instructions received from the client, and upon the beneficiary´s presentation of documents set forth in the sales agreement which satisfy the credit requirements. The intervention of the bank is the element which fundamentally distinguishes the documentary payment credit from payment against documents.
The transaction can also take on a four-sided structure resulting from th intervention of a second intermediary bank which can function as: (1) an advising bank with respect to the status of the credit, (2) a payor bank, and/or (3) a confirming bank. The bank serves the second function when the issuing bank is unable to effectuate payment in the country of the seller due to its lack of a financial structure in that country. This four-sided structure allows the beneficiary to deliver documents and receive payment of the credit in its own country, thereby enhancing the security of the payment, as a result of a second bank´s assumption of an independent obligation to pay the credit.
The issuing bank assumes risk in the issuance of the credit. Its obligation to pay the credit is independent of the client´s subsequent obligation to repay the issued funds. The bank typically opens a line of credit on behalf of the client up to a specified limit, which is generally only issued to trusted clients or clients who can collateralize the line of credit.
Private International Law and the Documentary Credit
In the context of private international law, the standard issues of competent judicial forum and applicable law arise. The former generally involves application of the Brussels Convention of 27 September 1968, and when its application is excluded, Articles 21 and 22 of the Organic Law of Judicial Authority are applicable. The norm is for the parties involved to select the competent forum. Forum-selection clauses in the main sales or transaction agreement do not encompass the documentary credit transaction. Courts competent to determine issues documentary credit issues generally apply the private international law system of the country where they are located. Lacking international uniformity, judicial resolutions vary from country to country.
Inasmuch as the legal relationships arising under a documentary credit are typically carried out by private international parties, the are generally subject to private international law analysis, in lieu of a particular domestic law. The jurisprudence developed in some countries has created specific guidelines, however in Spain the development of specific conflictual framework is lacking. Under the Spanish private international law system, there is no substantive and directly applicable regimen, nor regimens applicable by extension. Nevertheless, since 1 September 1993, the law applicable to legal relations arising in documentary credit transactions is determined in accordance with the Rome Convention of 1980, regarding the law applicable to contractual relationships, with non-contractual relationships governed by Article 10.9.1 Civil Code.
Choice of Law Framework
The law applicable to each component of the documentary credit transaction is determined contract by contract, due to the independent legal significance of the collective contracts constituting the transaction. Furthermore, the Rome Convention requires application of choice of law rules on a separate, contract by contract basis. With regard to non-contractual obligations, Article 10.9.1 Civil Code determines the applicable law. As the Rome Convention does not contain special rules for each type of contract, the general concepts are applied to each separately.
Law selected by the parties
With regard to the applicable law, the following legal relationships generally arise in separate contracts: (1) the main sales or transaction agreement, (2) the agreement between the purchaser/client and the issuing bank, and (3) the relationship between the issuing bank with any intermediary bank involved in the documentary credity transaction. The applicable choice of law regimen is the Rome Convention. The applicable law is determined on a contract by contract basis, permitting the parties to each separate transaction to choose amongs the several legal regimes which may be applied in whole or in part.
Applicable law in absence of selection
In absence of an applicable law selected by the parties, the applicable law will be determined pursuant to Article 4 of the Rome Convention, which contains a series of objective criteria in determining the law applicable to the subject contract.
Non-contractual relationships
The relationship between the issuing bank and the beneficiary, as well as between the intermediary bank and the beneficiary, are based on unilateral promises to pay which create a non-contractual obligation to which the applicable law cannot be selected by the parties, this obligation being governed by Article 10.9.1 Civil Code.
FIDUCIARY TRANSFERS
Concept and Validity
This arrangement consists of a fiduciary transfer by the debtor to the creditor of assets which the debtor possesses, for the purpose of guaranteeing a preexisting debt, in the amount of the pending debt plus interest. The debtor remains in possession of the asset and contracts with the creditor for the reconveyance of the creditor´s fiduciary interest upon satisfaction of the debt. The holder of this type of gurantee obtains a fiduciary interest in the asset, while the debtor retains registered title. Thus it operates in function similar to a deed of trust, but its use is not limited to real property.
Comparative law considerations
Certain legal systems do not recognize or prohibit this type of guarantee arrangement. However, the following two basic considerations exist in all systems:
(1) It is a common and customary practice; and
(2) All systems endeavor to prevent fraud and shams in its use.
Classification issues
The classification process pursuant to the lex contractus will always be required to determine whether a valid and enforceable guarantee has been established, creating legally recognizeable rights, or on the contrary, to nullify fraudulent or sham transactions, or transactions of similar effect.
Enforceability
The enforceability of the reservation of title against third parties is a fundamental consideration. Standard choice of law concepts are applied to determine the applicable law to the enforceability of the guarantee.
Adquisition by third parties
Enforceability is generally determined by the law of the place where the asset is located at the time of its acquisiton by the third party. The guarantee will only be enforceable against third parties acquiring title in lack of good faith, on the assumption that the guarantee has not transferred complete title to the creditor. If the transaction results in the complete adquisition of the asset by the creditor, it is enforceable against any third-party claimant, acting in good or bad faith.
Competing claims
In the event of the insolvency of the fiduciary-creditor, the grantor-debtor maintains a position separate and above competing claimants. In the event of the insolvency of the grantor-debtor, satisfaction of the claim of the fiduciary is generally given special recognition within the group of competing claimants, without any right of separation.
Notice limitations
An ad hoc registry for purposes of registering fiduciary transfers does not exist, therefore it constitutes a hidden guarantee. With respect to this problem, two possible solutions exist: (1) to permit registration of the guarantee in the registry of pledged property without release of possession, or (2) permit registration in the registry of sales financed by installment loans.
