Perspective | Examining the Application Rules for Standby Letters of Credit with Guarantee Functions and the Criteria for Determining Fraudulent Conduct in Independent Guarantees Through Cases from the Supreme People’s Court
Published:
2025-12-15
In international commercial trade, independent guarantees and standby letters of credit—important forms of international security—provide beneficiaries with robust protection thanks to their “pay-on-demand” independence. As international trade continues to expand, these instruments have become widely adopted; however, this widespread use has also led to a growing number of disputes involving independent guarantees and standby letters of credit in China. In 2016, the Supreme People’s Court issued the “Provisions of the Supreme People’s Court on Several Issues Concerning the Adjudication of Disputes over Independent Guarantees,” thereby clarifying the legal application of independent guarantees. Yet, under China’s current legal framework, no explicit rules govern the legal application of standby letters of credit. A judgment rendered by the Second International Commercial Tribunal of the Supreme People’s Court has filled this gap by, for the first time, clearly defining the legal rules applicable to standby letters of credit. This article will analyze this landmark case to interpret the legal application of standby letters of credit and to elucidate the criteria for determining “guarantee fraud” committed by the beneficiary of a counter-guarantee.
In international commercial trade, independent guarantees and standby letters of credit, as important forms of international guarantees, are characterized by their... Pay on demand The independence of such instruments provides solid protection for beneficiaries. As international trade continues to expand, independent guarantees and standby letters of credit have become widely used; however, this has also led to a growing number of disputes involving these instruments in China. In 2016, the Supreme People’s Court issued the “Provisions of the Supreme People’s Court on Several Issues Concerning the Adjudication of Disputes over Independent Guarantees,” which clarified the legal application of independent guarantees. Yet, under China’s current legal framework, there are still no explicit rules governing the legal application of standby letters of credit. A judgment rendered by the Second International Commercial Court of the Supreme People’s Court has filled this gap by, for the first time, clearly defining the legal rules applicable to standby letters of credit. This article will analyze this landmark case to interpret the legal application of standby letters of credit and... Counter-guarantee letter Standards for Determining “Guarantee Fraud” by the Beneficiary.
I. Basic Facts of the Case
In December 2011, Company A entered into a project contract with Philippine companies B and C, under which Company A was required to provide a standby letter of guarantee equal to 10% of the contract amount. In June 2012, as the contractor, Company A applied through the Beijing Branch of Bank Y to issue a standby letter of guarantee to secure the performance of the Project Engineering Contract it had signed with Company B and others. Bank Y then instructed the Manila Branch of Bank Z to issue the standby letter of guarantee, with the beneficiary being Company B, and simultaneously issued a counter-guarantee standby letter of guarantee. In November 2015, Company B submitted a full claim against the standby letter of guarantee to the Manila Branch of Bank Z. The Manila Branch of Bank Z promptly filed a conforming claim under the counter-guarantee with Bank Y. However, Bank Y paid only USD 7.3135 million; the remaining USD 15.6661 million remained unpaid because Company A had filed an application for a payment stop order with the Fourth Intermediate People's Court of Beijing on the grounds of fraud. Concurrently, Company A initiated litigation, and Company B also lodged a complaint with the Central Bank of the Philippines. From May to September 2017, the Manila Branch of Bank Z reached a settlement with Company B for USD 6 million, and Company A and Company B also reached a settlement (Company B refunded USD 7.3135 million and withdrew its claim). After Company A withdrew its lawsuit, the court lifted the payment stop order in May 2019. In July 2019, the Manila Branch of Bank Z filed a claim against Bank Y for USD 6 million plus interest under the counter-guarantee. Company A subsequently brought a lawsuit against the Manila Branch of Bank Z, alleging that the branch had engaged in fraud and requesting Bank Y to issue a payment stop order. (The specific facts of this case are illustrated in the figure below.)
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II. The focal point of the dispute in this case
(1) The nature of the legal relationship in this case and the applicable law
The court held that standby letters of credit with a guarantee function should be governed by the “Regulations on Independent Guarantees.” According to the “Regulations on Independent Guarantees,” the primary function of an independent guarantee is that, in the event of a breach of the underlying contract, the beneficiary can obtain payment under the independent guarantee simply by submitting a valid claim accompanied by documents that conform to the terms of the guarantee. If the underlying contract is performed and completed normally, the independent guarantee remains unused and serves merely as a backup. This “backup” characteristic of the independent guarantee is entirely identical to that of a standby letter of credit, and is distinctly different from the nature of a commercial documentary credit, which functions as a payment instrument during the performance of the underlying contract. Therefore, standby letters of credit with a guarantee function should be recognized as independent guarantees.
(2) Whether there was fraud at the Manila Branch of Bank Z under the counter-guarantee standby letter of credit.
1. Does the Manila Branch of Bank Z have any fraudulent circumstances as described in Article 12, Paragraph 4 of the “Regulations on Independent Guarantees”?
Article 12 of the “Regulations on Independent Guarantees” provides: “Where any of the following circumstances exists, the people’s court shall determine that fraud involving an independent guarantee has occurred: … (4) The beneficiary confirms that the underlying transaction debt has been fully performed or confirms that the payment due event stipulated in the independent guarantee has not occurred;…”
Under this provision, fraud in the counter-guarantee letter can occur in two scenarios: First, the beneficiary of the counter-guarantee letter—the issuer of the independent guarantee—knows that the beneficiary of the independent guarantee has engaged in fraudulent conduct yet still makes payment and files a claim under the counter-guarantee letter, thereby constituting a doubly fraudulent claim. Second, the beneficiary of the counter-guarantee letter does not base its claim on the fraudulent claim made by the beneficiary of the independent guarantee; rather, relying solely on its status as the beneficiary of the counter-guarantee letter, it files a fraudulent claim under the counter-guarantee letter itself. In this case, Company B submitted a claim and presented documents under the standby letter of credit, and Z Bank’s Manila Branch submitted a claim and presented documents under the counter-guarantee standby letter of credit, asserting that it had received a complying claim under the standby letter of credit. However, there is no evidence in this case to show that, at that time or prior to it, either Company B or Z Bank’s Manila Branch made any statement indicating that they had confirmed “the underlying transaction debt had been fully performed” or that “the payment maturity event stipulated in the independent guarantee had not occurred.” Therefore, this case does not involve the fraudulent scenario described in Article 12, Paragraph 4 of the Regulations on Independent Guarantees, and the subsequent events occurring after the claim under the counter-guarantee standby letter of credit cannot be used to determine whether the claim itself constitutes fraud.
2. Does the Manila Branch of Bank Z have any fraudulent circumstances as described in Article 12, Item 5 of the “Regulations on Independent Guarantees”?
Article 12, item 5 of the “Regulations on Independent Guarantees” stipulates: “If the beneficiary knowingly abuses its right to payment despite being aware that it does not have such a right, the people’s court shall determine that this constitutes fraud in connection with an independent guarantee.”
According to this provision, if a beneficiary submits a payment request knowing full well that it has no right to do so, such submission constitutes an abuse of the right to make a payment request and amounts to fraud. In this case, the Settlement Agreement addresses claims under the Standby Letter of Credit rather than those under the Counter-Guarantee Standby Letter of Credit. The independence of the Counter-Guarantee Standby Letter of Credit means that Bank Y’s payment obligation under the Counter-Guarantee Standby Letter of Credit is not discharged by the repayment arrangement under the Standby Letter of Credit. Moreover, the Settlement Agreement is not one of the matters that the Counter-Guarantee Standby Letter of Credit expressly stipulates must be reviewed. Given the documentary nature and independence inherent in standby letter of credit transactions, Bank Y is not entitled to rely on the Settlement Agreement as a defense against its payment obligations under the Counter-Guarantee Standby Letter of Credit.
III. Summary
By hearing this case, the Second International Commercial Court of the Supreme People’s Court has provided crucial guidance for cross-border guarantee practice. First, the judgment clarifies for the first time in legal application that standby letters of credit with guarantee functions should be recognized as independent guarantees under Chinese law, and they are uniformly subject to the “Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Disputes Involving Independent Guarantees,” thereby resolving the long-standing ambiguity in their legal characterization. Second, the judgment further clarifies the boundaries of the independence of counter-guarantees, explicitly stating that the act of a counter-guarantee beneficiary reaching a settlement with relevant parties to resolve underlying disputes and thereby waiving certain rights does not, in itself, constitute fraud against an independent guarantee. This provides judicial protection for banks’ good-faith conduct in international transactions, while also reminding issuing banks that they must bear a stricter burden of proof when asserting their rights. The judgment also reflects the stance of Chinese courts—respecting international commercial rules and equally protecting the rights and interests of both domestic and foreign parties—which plays a positive role in fostering a stable and predictable rule-of-law environment for international trade.
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