First demand guarantees

1. Background

Corporation “A” (judicially declared bankrupted) is a rental car company, leasing cars without driver.

Assisted by its official receiver, Corp. A agreed into a rental car agreement with Corporation B (the “Agreement”). Corp. A provided to Corp. B two letters of credit upon first demand as a guarantee of its obligations.

Both letters of credits are bank guarantees stating: “a guarantee of the obligations assumed by [A] on the basis of the [Contract], a copy of which is attached to this guarantee (…) against the simple and prior request addressed to [the Bank] by the beneficiary [B]”.

Later on, Corp. A (under liquidation) returns all the cars to Corp. B, minus one, under repair, that B refused to receive.

Corp.A’s liquidator sued Corp.B and the guarantor Bank requesting to be released of the warranty once the cars have been returned.

The claim was accepted at first and second instance Courts, considering that:

“The guarantee was not autonomous, being part of a contractual package, concluded by a company in bankruptcy, assisted by its bankruptcy administration”.

2. The Supreme Court’s decision

Corp. B appealed into the Supreme Court, resolving the case on April 5th 2019 (217/2019) as follows:

a) Letter of credit upon first demand as a Guarantee

The SC begins its sentence by making a brief analysis of this type of guarantee:

“In this contractual modality, the guarantor assumes an abstract and independent obligation to pay the secured obligation, from the moment is required by the creditor and without opposing exceptions of any kind, not even the nullity of the secured obligation”.

It points out that, unlike the ordinary guarantee, the first-demand guarantee: “does not require a breach of the principal obligation, since these guarantees can be made effective upon simple request”.

It is a non-accessory guarantee. In other words, to be effective, there is not need to prove a breach of the guaranteed obligation. Debtor’s claim would be enough for this purpose.

The guarantor cannot defend different arguments against the beneficiary claiming payment, than those arising from the guarantee itself. To do it  would be to misrepresent the guarantee’s nature.

First demand guarantees are immediate guarantees, independent of the secured obligation and the original contract. And these characteristics do not prevent from possible subsequent actions such as the following ones:

• Those derived from the payment of the guarantee; or
• Those to determine the degree of performance of the guaranteed obligation.

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b) Resolution of the case under analysis:

In view of the foregoing, the SC considered that the terms included in these types of guarantees are of essential importance.

The document has to be interpreted following its literal clauses. Only when literal interpretation proves to be insufficient, will the rules of the Civil Code be taken into account.

The Supreme Court considers that the literal nature of the guarantees discussed deviates from the characteristics of a guarantee at first request. In particular:

“They do not limit themselves to establishing the abstract and autonomous enforceability of a guarantee at first request, but rather they make the guarantee effective by expressly linking it to the [Contract], which is incorporated by means of a copy in the guarantees. Thus, we are faced with a guarantee that is accessory to a principal contract, which is more similar to an ordinary guarantee than to a first demand guarantee.

The very terms of the guarantees were the ones excluding the independence of the trust relationship from the guaranteed contractual relationship”.

The appeal was, therefore, dismissed.

3. Conclusions

We cannot conclude that the analyzed Judgment is the beginning of the end for guarantees at first request: The specific text of the guarantee must be considered to determine whether or not the guarantee works.

However, this ruling opens uncertainties regarding the abstract character of guarantees upon first demand:

• Must the secured contract be incorporated to the letter of credit?
• Is it enough a reference to the secured contract in the letter?
• What should be included in the letter to prevent its invalidation?

We will need to wait for future case law in order to properly answer those questions.

If this article has been of interest, we also suggest you to read the following article published on our website:

Total Breach and Defective Performance (Misconduct in Spanish Law).