This content is from: Local Insights

Switzerland

Performance bonds are contracts of guarantee commonly used in international trade. Their commercial purpose is to secure the performance of a primary obligation through assured and prompt payment in case of default. No dispute arising out of the underlying agreement between the principal and the beneficiary of the guarantee ought to interfere with the independent undertaking of the guarantor. Hence, performance bonds invariably include an absolute undertaking by the guarantor to pay 'on first demand'.

However, under Swiss law a principal who presents persuasive if not definitive evidence of fraud on the part of the beneficiary may require the guarantor not to honour the guarantee. The fraud has to be evident and manifest vis-à-vis the bank at the time of the actual calling of the guarantee. In addition, Zurich injunctions are granted (or refused) on urgent applications. The standard of proof in such proceedings is somewhat eased: the party seeking an injunction needs only to show that the manifest fraud is convincingly likely. The standard of proof resulting from differing substantive and procedural law requirements as set out above causes much legal uncertainty. Furthermore, restraining or delaying payment through urgent applications may adversely affect the reputation of local banks as guarantors.

Interestingly, the courts in Zurich seem more hesitant to grant injunctions restraining the guarantor from paying under the guarantee in the case of a so-called counter-guarantee.

Essentially, a counter-guarantee is an independent undertaking by a bank in the country of the principal in favour of a local bank in the country of the beneficiary, and not to the beneficiary directly. The local bank in turn guarantees payment on first demand to the beneficiary.

The Supreme Court of Zurich upheld recently the decision of a single judge who had declined to grant interim relief on an urgent application concerning a counter-guarantee. On review the Court of Appeal confirmed its standing practice mainly for the following reasons.

In the case of a counter-guarantee an injunction is not granted because the applicant (principal) establishes to the satisfaction of the court that the beneficiary has called for payment in a fraudulent manner. For exclusively the bank located in the country of the beneficiary is entitled to demand performance under the counter-guarantee and only fraud on its part may lead to an injunction. Therefore, the applicant needs to show either:

  • that the local bank in the beneficiary's country called the counter-guarantee fraudulently ie without the beneficiary itself having called the direct guarantee; or
  • that the local bank and beneficiary conspired in demanding payment.

In the second case the opportunity or duty of the local bank to refuse payment has to be determined according to the foreign law governing the contract of guarantee between the beneficiary and the local bank. This can be especially relevant in two circumstances. First, according to foreign law, fraud may not at all constitute a ground to refuse payment. Second, the foreign law may require a qualified degree of unfairness by the beneficiary to justify non-compliance with the guarantee on the part of the bank.

Once the foreign legal position between the foreign bank and the party to the underlying agreement is established, the implications for the counter-guarantee have to be determined. In this respect the domestic law of the bank in the principal's country applies. Similarly, the question of fraud or conspiracy and its consequence in respect of the counter-guarantee are governed by the domestic law of the bank issuing the counter-guarantee.

The burden of proof of all the above rests entirely with the applicant. The defendant (bank) issuing a counter-guarantee is not obliged to ascertain whether a counter-guarantee is not obliged to ascertain whether a serious basis for the allegation of fraud or conspiracy exists. The issuing bank is merely concerned with the formalities for a valid demand.

From the above follows that, before granting relief, the courts in Zurich require a person in whose favour a counter-guarantee has been procured to present a strong and well argued case. This is conducive to increased legal certainty, which is indispensable in international trade.

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