Jurisdiction - China
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China – Supreme Court Strengthens Its Interpretation On Respecting The Independence Of Refund Guarantees.

14 July, 2014

 

Legal News & Analysis – Asia Pacific – China – Shipping Maritime & Aviation

 

The Chinese Supreme Court in November 2013 circulated a draft judicial interpretation dealing with cases in relation to independent guarantees [最高人民法院关于审理独立保函纠纷案件若干问题的规定 (征求意见稿)] (the “Draft Interpretation”).

 

This appears to be the court’s official response to an increasingly used tactic amongst shipyards in China whereby a local party (e.g. a Chinese shipyard) seeks to secure claims that they have brought in China (typically based on fraud or other tortious grounds to circumvent the arbitration clauses usually found in shipbuilding contracts) by freezing funds payable under a refund guarantee and/or seeking to prohibit Chinese banks as guarantor from making payment under guarantees the banks have issued.
 
The court seems to have recognised the danger of frivolous allegations of fraud as well as the importance of maintaining the market’s confidence in bank guarantees issued by Chinese banks. Prior to publication, the court circulated this Draft Interpretation and invited discussions and debate among representatives from various industries, including banks, shipyards, and other stakeholders.
 
Although it must be noted that the Draft Interpretation has not been formally issued, and is therefore not binding at present, it contains a set of important principles and provisions which aim to clarify the court’s stance on how these cases should be dealt with.
 
The Draft Interpretation gives clear definition to independent guarantees, namely “a written promise issued, on the instruction of the Applicant, by the Guarantor under which the Guarantor undertakes to pay the Beneficiary in the event of complying presentation of a demand and/or agreed set of documents within the maximum amount as specified in the guarantee”.
 
The traditional view taken by the court has been that the concept of an independent guarantee only applies to underlying transactions that have foreign elements (under the Chinese system, unlike English Law, it is not always possible to separate a security document like a refund guarantee from the underlying contract). It is therefore important that the Draft Interpretation has confirmed the “principle of independence”, i.e. a Chinese Court should not accept a guarantor’s defence which is solely based on the underlying disputes.
 
The Draft Interpretation sets out circumstances in which a demand by the beneficiary may be deemed as a fraud. Generally, where a party claims that there has been a fraud, this claim must be supported by evidence before an injunction to suspend payment may be issued. Furthermore, when the court hears cases where the cause of action is fraud, or cases where one party is applying for an injunction, the court is entitled to undertake a limited examination on the underlying disputes (i.e. the court does not need to wait until the underlying claim is finally litigated to make a determination of whether the facts of the case support an injunction).
 
There is also a positive clause in the Draft Interpretation which provides that, if the basis for one party to apply for an injunction (e.g. to prohibit the Guarantor from making payment) is merely a breach of contract or that the underlying disputes have been submitted for arbitration, the court must refuse to grant such application. If the other party has submitted any judgment or arbitral award issued by a competent court or tribunal which can prove the beneficiary has grounds to make demands under the relevant refund guarantees, then the court shall timely dismiss the application for an injunction. 
 
It is not clear when the court will formally issue this Interpretation – hopefully in the second half of 2014.
 
Ince & Co
 
For further information, please contact:
 
Jason Lemann, Ince & Co
 

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