Do bank guarantees provide security for underlying legal relationship?

In the Netherlands, bank guarantees are common financing arrangements and are used to obtain (nearly absolute) security for the underlying legal relationship.This security sometimes creates unusual situations. Such an unusual situation was brought before the Dutch Court in this case. Dutch corporate lawyer Sander Schouten explains.

Dutch law: no specific requirements for bank guarantees

There are no bank guarantees in Dutch law. This means that there are no specific requirements that bank guarantees must fulfil. It depends on the circumstances whether or not there is a bank guarantee. The parties to a bank guarantee are the Principal, the bank, and the Beneficiary.

‘Abstract’ or ‘independent’ bank guarantees

A particular form of the bank guarantee is the commonly used ‘abstract’ or ‘independent’ bank guarantee. With this form, the bank needs to pay the beneficiary upon first request, irrespective of the circumstances. For this reason, in the case of an abstract or independent bank guarantee, it comes down to strict grammatical interpretation.

Dutch Supreme Court about abstract bank guarantees

The Dutch Supreme Court has recently confirmed the above: it follows from the nature and function of abstract bank guarantees that the explanation of the guarantee attributes great weight to the terms (read strictly) (HR 13 March 2015 (ABN AMRO Bank/Amstelpark Tennis Promotions et al)). In this case, it came down to strict grammatical interpretation and also immediately introduced a problem: how should a bank position itself in the case of a grammatical bank guarantee if a party invoking a bank guarantee is not a party to the underlying legal relationship.

Bank guarantee for three months’ rent

In this case, the tenant was obliged to issue a bank guarantee for three months’ rent. If the tenant fails to pay the rent, the landlord would be entitled to the bank guarantee and get paid without problems. The problem was that not the landlord but the parent company of the landlord was included in the bank guarantee. When the parent company laid a claim on the bank guarantee, the bank did not pay after the tenant objected. The fact was that the tenant had indicated that the payment was going to be made to the wrong party (the parent company).

Parent company: there is an abstract bank guarantee

The parent company held the view that the bank should pay the required amount because there was an abstract bank guarantee. As soon as a beneficiary lays a claim on the bank guarantee, the bank is obliged to pay. In the case of a bank guarantee, one can also say: ‘pay first, talk later.’

Dutch Court: underlying legal relationship between parties

However, the Dutch Court did not agree with this and stated that the purpose of a bank guarantee is to ensure the underlying legal relationship. Because the wrong party had been included, there was also no question of an underlying legal relationship between the parent company and the tenant.

Not paying bank guarantee in reasonableness and fairness?

Moreover, at the time of preparation of the bank guarantee, the landlord and the parent company appeared to be aware that incorrect parties had been included. Therefore, the Court held the view that the appeal that not paying would be unacceptable according to the standards of reasonableness and fairness, did not hold.

In most cases, payments are made with bank guarantees

With bank guarantees, it is important to proceed very precisely. After all, a bank must pay (in principle) when requested by the beneficiary. It is only possible to deviate from this in very exceptional cases, such as the present case. AMS Advocaten is happy to assist in (international) disputes concerning bank guarantees or other banking issues.