An Iraqi Perspective on Bank Guarantees

Banking & Finance / Iraq

This Article aims to address the basic principles of bank guarantees and compare the Iraqi statuary position and practice with international best practices.Contents

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Law Update: Issue 370 - From Africa to Asia: Legal Narratives of Change and Continuity

An Iraqi Perspective on Bank Guarantees

Ali Al-Dabbagh
Senior Associate,
Banking & Finance

Nawar Al-Ameri
Trainee Lawyer,
Banking & Finance

IntroductionThis Article aims to address the basic principles of bank guarantees and compare the Iraqi statuary position and practice with international best practices. A bank letter of demand guarantee (hereinafter “Bank Guarantee”) is an undertaking, issued by a bank at the request of one of its customers (hereafter “Principal”) to pay a sum of money up to a specified amount to a named beneficiary (hereafter “Beneficiary”) on demand if the Beneficiary requests payment within the validity period of the Bank Guarantee. All jurisdictions regulate Bank Guarantees, however it is never satisfactory to all parties and can sometimes cause problems due to the lack of uniform rules, standardised practice, and internationally harmonised model guarantee forms; traditionally Bank Guarantees had to be negotiated and drafted from scratch for each new contract. And as such, there was a need for a guideline to help facilitate issuing Bank Guarantees and from that need the Uniformed Rules for Demand Guarantees were born. Said rules underwent an amendment and were replaced by the Uniformed Rules for Demand Guarantees 758 (hereinafter “URDG”). The URDG 758 is a set of contractual rules that apply to Bank Guarantees and counter-guarantees, it is not legally mandatory but rather applied through a agreement with the banks. General Understanding of Bank Guarantees Bank Guarantees are a tool that offers risk management in international trade transactions and can provide Employers in construction contracts or other payees with some security. Bank Guarantees play a great role in building the confidence needed for the parties to enter into these types of agreements. Below we set out an outline of Bank Guarantees’ elements:

Parties to The Bank Guarantee: A Bank Guarantee consists of three parties, and three distinct relationships:

Between the Principal and the Beneficiary: it is the contractual relationship that preceded the issuance of the Bank Guarantee, on which the Bank Guarantee was issued.
Between the Principal and the Bank: it is the contractual relationship on which the Principal asked the bank to issue the Bank Guarantee.
Between the Beneficiary and the Bank: it is the contractual relationship that stems out of the Bank Guarantee itself under which the bank agreed to pay a certain amount of money to the beneficiary when asked and during a specified amount of time.

Purpose: The purpose of the Bank Guarantee under which the Bank Guarantee was issued and based on the contractual relationship between the Principal and the Beneficiary must be specified on the face of the Bank Guarantee.

Obligations: The obligation of the bank towards the Beneficiary is a direct and primary obligation and it is independent from the obligation of the bank in front of the Principal.

Credit Coverage: A Bank Guarantee is a type of non-cash credit and a bank may choose to cover it by asking for a personal guarantee or assets to pledged as collateral.

A Bank Guarantee is categorized based on its purpose, and every Bank Guarantee serves a purpose based on the contractual relationship between the Principal and the Beneficiary, to name a few:

Advance Payment Guarantee;

Non-Performance Guarantee;

Good Performance Guarantee;

Payment Guarantee;

Warranty Guarantee;

Customs Guarantee; and

Shipping Guarantee.

A Comparative Look into Bank Guarantees Between Iraqi Laws and International Standards Bank Guarantees are regulated in the Code of Commerce No. 30 of 1984 (hereinafter “Code of Commerce”) and the instructions issued by the Central Bank of Iraq. The Code of Commerce restricted the issuance of this type of guarantees by non-banking entities, while the URDG provides that it may be issued by any entity or person. The Code of Commerce stipulations mostly align with the URDG’s stipulations regarding Bank Guarantees, but the URDG is vastly more comprehensive, and it provides better guidance to all parties as it is more frequently updated and used by banks globally. The URDG regulate conditional Bank Guarantees, unlike the Code of Commerce that prohibits this kind of Bank Guarantees. The Code of Commerce has also stipulated that a Bank Guarantee is an irrevocable obligation but did not provide any authority for the issuing banks to review the reason of a demand to pay or liquidation in accordance Bank Guarantee, this power was referred to courts. Currently, if a beneficiary decided to enforce a Bank Guarantee, regardless of whether such an enforcement is valid or not, the issuing bank may not refuse the enforcement of the Bank Guarantee. Instead, the parties must refer their dispute to courts, only then the validity of the enforcement will be reviewed, and a judgment will be obtained. Courts have further confirmed this procedure by issuing orders on applications without lengthy proceedings requiring the issuer of the Bank Guarantee to enforce it. The Code of Commerce separates the bank as a guarantor from the relationship between the principal and the beneficiary when it came to liquidation and payment under the demand guarantee because it obliged the bank to enforce the Bank Guarantee if it is presented with a demand before the date of expiration, and penalizes the banks that couldn’t or wouldn’t fulfil their obligation on the basis of disputes between the beneficiary and the principal. The URDG also took this position when it came to unconditional Bank Guarantees, and it went further in explaining that if there are any conditions to enforce a Bank Guarantee, then the issuing bank will deal with documents only, the only condition that does not require a specific document to indicate compliance is the date for the lapse of a period. Conditional Bank Guarantees are not allowed under the Code of Commerce, Bank Guarantees do not have any conditions or restrictions. Usually the parties to a Bank Guarantee include conditions of liquidation in the underlying commercial contracts, which provides the principal some protection by restricting the liquidation indirectly, this way a Bank Guarantee cannot be liquidated by the Beneficiary without breaching the commercial contract, which would give rise to a claim in accordance with said contract even if not the bank guarantee itself.

The Iraqi judiciary has maintained the same position on restricting Bank Guarantees, namely is that it is unlawful to restrict liquidation in the Bank Guarantee itself. This is evidenced by the decision of the Presidency of the Risafa Federal Court of Appeal in its cassation capacity decision No. 932//2016 which states that “The Ex Parte Order and the grievance against it to stop the liquidation of the letter of guarantee is contrary to the provisions of the law”. This was not the only decision to reaffirm the enforceability of Bank Guarantees. Letters of Guarantee Under the URDG 758: The URDG 758 is more detailed than the Iraqi Code of Commerce and oriented around minimizing irregularities in banking practice and the difficulties that are frequently encountered during cross-border transactions. The URDG 758 is an improvement on its predecessor the URDG 458. Some highlights of the URDG 758 offers include the following:

Standardization: the URDG 758 offers a standardized set of definitions and terminology

Global Acceptance: the URDG 758 is recognized and accepted by banks, businesses, and governments worldwide

Cost Efficiency: the URDG 758 can lower the costs of issuing Bank guarantees by eliminating the need for parties to negotiate and agree on terms for each individual transaction

Technical Clarity: the URDG 758 specifies the requirements of a Bank Guarantee both the form and content

Legal Clarity: the URDG 758 paints a clear picture for liability and indemnification and the extent of liability and indemnification

Risk Management: since the URDG 758 sought after minimizing the difficulties that are frequently encountered during cross-border transactions, it was successful in offering it

ConclusionBank Guarantees are an essential part of international trade transactions as they facilitate these agreements, reduce the risk, and provide security offering confidence in all parties of the transaction. Bank Guarantees needed to be regulated properly on an international level, the URDG was drafted to satisfy the need for such a standard; to guide parties and guarantors and help them in what used to be an exhaustive process.

For further information,
please contact Ali Al-Dabbagh and Nawar Al-Ameri

^{Published in}^{September 2024}