First demand guarantees

Written on 18 Dec 2015

The Supreme Court judgment passed on 17 July 2014 reinforces the independent and unconditional nature of first demand guarantees.

Both the First Instance Court and the Provincial Court have agreed on the legitimacy of suspending the payment of a first demand guarantee. The debtor was granted the right to suspend payment of part of the purchase price stated in a land purchase agreement and such payment obligation had been secured with the first demand guarantee referred above.

The Supreme Court judgment of 17 July 2015 makes reference to the Judgment of 17 February 2000 and points out that a first demand guarantee is a type of an unusual security characterized by its unconditional, non-ancillary, independent and personal nature. It also highlights that “the fact that a first demand guarantee is regarded as an independent agreement implies that a first demand guarantee stands in opposition to a joint and several guarantee as its validity and effectiveness is not dependent on the validity and effectiveness of the underlying business. As it provides unconditional security, the guarantor can only raise the defences provided for in the first demand guarantee itself and in its relations with the beneficiary”.

As the doctrine of the Supreme Court has long recognized, and in order to comply with the principle of good faith in contractual relations, the judgment also states that the guarantor can raise the exception doli, that is to say, the guarantor can avoid any abusive exercise by the beneficiary of the rights arising from the first demand guarantee by suspending the payment of the obligation secured by the principal debtor. In this respect, although the first demand guarantee is considered to be a non-ancillary, independent and unconditional guarantee of the underlying obligation, the doctrine of the Supreme Court provides the guarantor the right to oppose to its enforcement by raising counterclaims arising from the underlying relationship.

However, in this particular case, the Court establishes that the suspension of the enforcement of the first demand guarantee necessarily changes its nature and function and concludes that a confrontation arising from the underlying obligation should not result in the ineffectiveness of the first demand guarantee. In this regard, it seems that the enforcement of such first demand guarantee by the beneficiary would not be regarded as an abuse of the rights under the first demand guarantee and, therefore, the guarantor cannot rely on the suspension of the underlying obligation to object to the payment. Furthermore, the suspension of a payment obligation granted by a court is not a sufficient reason to raise the exception doli.

Nevertheless, pursuant to the judgment issued on 17 July 2014, the Supreme Court is inflexible about the nature of first demand guarantees, which in fact represent an independent and unconditional guarantee regarding the underlying obligation they are securing, to the extent that, even though the payment obligation was suspended by a court, the guarantee that secures such obligation remains fully in force and is, therefore, enforceable.

The stance adopted by the Supreme Court through its judgement of 17 July 2014 reinforces and emphasises the pre-eminence of this type of guarantee in commercial transactions, particularly in certain deals, such as leases or works contracts. Moreover, the judgment of 17 July 2014 highlights the importance of negotiating the content of first demand guarantees, since any discussion regarding their scope and enforceability will be bound by its own terms and conditions.