United Nations Convention on Independent Guarantees and Stand-by Letters of Credit

The United Nations General Assembly adopted the Convention on Independent Guarantees and Stand-by Letters of Credit on 11 December 1995, with the aim of facilitating the use of independent guarantees and stand-by letters of credit in international transactions. The Convention reconciles the legal and practical differences between independent bank guarantees arising from European laws and stand-by letters of credit based on United States law. (1)

Definition of Independent Guarantees and Stand-by Letters of Credit

The Convention provides a detailed definition of independent guarantees and stand-by letters of credit, stating that both constitute an independent obligation issued by a bank, another institution, or a natural person referred to as the guarantor or issuer, and this obligation is called an “undertaking.” The effect of this obligation is that the guarantor or issuer pays the beneficiary a specified or ascertainable sum upon the presentation of a simple demand or a demand accompanied by specified documents evidencing entitlement to payment due to a failure to perform an obligation, the occurrence of a contingency, repayment of borrowed funds, or payment of any debt owed by the applicant or another person. (2)

Objectives of the Convention

The explanatory memorandum to the Convention sets out several objectives, including:

1. Facilitating the use of independent guarantees and stand-by letters of credit, particularly in countries that rely on only one of these instruments.
2. Establishing a set of harmonized rules governing independent guarantees and stand-by letters of credit, thereby providing greater legal certainty in their use in daily commercial transactions and reducing uncertainty when used in international trade.
3. Providing legislative support for the parties to the Convention in applying certain agreed-upon rules in this regard, including the Uniform Customs and Practice for Documentary Credits issued by the International Chamber of Commerce or any other rules that may be developed for dealing with independent guarantees and stand-by letters of credit.

Scope of Application of the Convention

The scope of application of the Convention includes the guarantees and letters of credit defined under Article (2) of the Convention, provided that the undertaking (the guarantee or letter of credit) is international. This applies in the following situations:

1. If the place of business of the guarantor or issuer of the undertaking is located in a State Party to the Convention.
2. If the rules of private international law lead to the application of the law of a State Party, unless the undertaking excludes the application of the Convention. (3)

The undertaking is deemed international if the places of business of any two of the following parties are located in different States: the guarantor or issuer, the beneficiary, the applicant, or the confirmer. (4)

The scope of the Convention also extends to any international letter of credit that does not fall under the definition set out in Article (2) of the Convention, where it explicitly stipulates that it is subject to the provisions of the Convention. (5)

Form of the Undertaking (Guarantees and Letters of Credit) under the Convention

The form of the undertaking in the Convention includes the mechanism of its issuance, its form, and its amendment, as follows:

• Issuance, form, and irrevocability of the undertaking

The Convention provides that the undertaking is deemed issued once it leaves the “sphere of control” of the issuer. The expression “sphere of control” under Article (7) of the Convention confirms the complete departure of the undertaking from the control of the issuer, and includes, for example, situations where the undertaking is retained at the time of issuance by an agent or attorney of the issuer.

The Convention does not require a specific form for issuing the guarantee or stand-by letter of credit, so long as such form preserves a full record of the text of the undertaking and provides authentication of its source by customary means or in a manner agreed between the guarantor or issuer and the beneficiary.

Once issued, the undertaking may not be revoked unless it expressly provides otherwise. (6)

• Amendment of the undertaking

The Convention confirms the fundamental rule that the undertaking may not be amended except in the manner set out in the undertaking or by agreement between the guarantor or issuer and the beneficiary. In cases other than these, the undertaking is deemed amended upon issuance of the amendment only if the beneficiary had previously consented to the amendment; otherwise, the undertaking shall not be amended until the guarantor or issuer receives written notice from the beneficiary accepting the amendment. (7)

Substance of the Undertaking (Guarantees and Stand-by Letters of Credit) under the Convention

The Convention provides several principles governing the substance of independent guarantees and stand-by letters of credit, including:

• Transfer of the beneficiary’s right to demand payment

The beneficiary has the inherent right to demand payment from the guarantor or issuer pursuant to the undertaking. Accordingly, the Convention provides that the beneficiary’s right to demand payment may not be transferred unless the undertaking permits such transfer. (8)

• Assignment of proceeds

The Convention permits the beneficiary to assign to another person any proceeds to which the beneficiary is entitled under the undertaking, unless the undertaking provides otherwise or the parties agree otherwise. (9)

• Extinguishment of the right to demand payment

The beneficiary’s right to demand payment under the undertaking is extinguished in the following cases:

• Receipt by the guarantor or issuer of a statement from the beneficiary releasing him from the obligation to pay.
• Agreement between the parties to terminate the undertaking.
• Payment of the amount specified under the undertaking, unless the undertaking provides for renewal of the amount or its automatic increase.
• Expiration of the validity period of the undertaking.

It may be agreed that the document containing the undertaking be returned to the guarantor or issuer as a security, or as a fundamental condition for extinguishing the right to demand payment. (10)

• Expiration of the validity period of the undertaking

The validity period of the undertaking expires under the Convention in the following situations:

• Upon the occurrence of the expiry date specified in the undertaking.
• Upon the occurrence of the event or act upon which the undertaking stipulates expiration.
• After six (6) years from the date of issuance of the undertaking if no expiry date is stated and no expiration event is specified. (11)

What was the primary motivation for the United Nations General Assembly to adopt this Convention in 1995?

The primary motivation for the United Nations General Assembly to adopt the Convention in 1995 was to facilitate the use of independent guarantees and stand-by letters of credit in international transactions.

According to the sources, the Convention was designed to achieve several key objectives:

Reconciling Legal Traditions:   It seeks to bridge the legal and practical differences between independent bank guarantees, which are largely rooted in European laws, and stand-by letters of credit, which are based on United States law.

Harmonization and Legal Certainty:   By establishing a set of harmonized rules, the Convention aims to provide greater legal certainty in daily commercial transactions and reduce the uncertainty often associated with international trade.

Support for Diverse Markets:   It facilitates the use of these financial instruments specifically in countries that may currently rely on only one of the two types.

Legislative Support:   The Convention provides a legislative framework to support parties in applying agreed-upon international rules, such as the Uniform Customs and Practice for Documentary Credits issued by the International Chamber of Commerce.

Which two distinct legal traditions regarding independent guarantees and stand-by letters of credit does the Convention seek to reconcile?

The Convention specifically seeks to reconcile the following two distinct legal traditions:

Independent bank guarantees originating from European laws.

Stand-by letters of credit based on United States law.

By bridging these different legal and practical frameworks, the Convention aims to facilitate international transactions and provide greater legal certainty for parties using these financial instruments, regardless of which tradition they typically follow.

Overview of the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit

This text outlines the United Nations Convention designed to standardize the usage of independent guarantees and stand-by letters of credit across international borders. By bridging the gap between diverse legal systems, the framework provides legal certainty and a unified set of rules for global commercial transactions. The text defines these financial undertakings as autonomous obligations that require payment upon the presentation of specific documentation or proof of default. It further clarifies essential operational aspects, including the criteria for internationality, the irrevocability of issued documents, and the procedures for amending or transferring rights. Finally, the document specifies how these obligations are terminated, whether through payment, mutual agreement, or the passage of a designated expiry period

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Sources:

1. James Byrne and Harold Burman, United Nations Convention on Independent Guarantees and Stand-by Letters of Credit, Cambridge University Press, 27 February 2017, “United Nations: UN Convention on Independent Guarantees and Stand-by Letters of Credit | International Legal Materials | Cambridge Core”.
2. Article (2) of the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit, adopted by the United Nations General Assembly on 11 December 1995 and entered into force on 1 January 2000.
3. Paragraph (1) of Article (1) of the Convention.
4. Article (2) of the Convention.
5. Paragraph (2) of Article (1) of the Convention.
6. Article (7) of the Convention.
7. Article (8) of the Convention.
8. Article (9) of the Convention.
9. Article (10) of the Convention.
10. Article (11) of the Convention.
11. Article (12) of the Convention.