Kazakhstan: Unconditional Bank Guarantees Issued Under Kazakhstan Law: Practical Difficulties Which Foreign Creditors Should Be Aware Of.

Introduction

A guarantee, as a means of securing the performance of a commercial obligation, is widely applied among businesses operating within the territory of Kazakhstan and abroad. In our practice, we come across many instances where domestic Kazakhstani companies obtain guarantees to secure the performance of their obligations to foreign creditors. Generally, foreign creditors prefer a guarantee to be issued by a reliable bank in Kazakhstan. It is also important for foreign creditors that the bank guarantee is unconditional, i.e. payable on first demand. On a number of occasions, we have seen that guarantees issued under Kazakhstan law were not as effective as expected by foreign creditors – they were not always payable on first demand. In this article, we would like to share some thoughts on the legal aspects of unconditional bank guarantees (hereinafter "UBG") issued under the laws of Kazakhstan and practical difficulties associated with their use which foreign creditors should be aware of.

It is generally envisaged that a bank which issued a UBG must satisfy a creditor's demand without raising any counter conditions to a beneficiary (creditor) demanding the payment. Under the UBG, the bank should not examine existence of grounds for payment under the UBG. In order for payment under the UBG to be made a creditor's written demand to the bank would be sufficient. In the case of the UBG, a creditor does not bear the burden to prove that a default under the main obligation has occurred. It is, therefore, presumed that the UBG is less risky to creditors willing to receive payment under a guarantee, as compared to an ordinary bank guarantee.

Practice shows, however, that the UBG contains substantial risks to creditors to receive payment quickly - this is not always possible. In a number of situations, UBGs proved to be insufficiently effective under the laws of Kazakhstan which effectively means that, in practice, UBGs issued by banks in Kazakhstan do not materially differ from ordinary bank guarantees. This may come as a surprise to foreign creditors not accustomed to a situation when recovery of funds under the UBG, in a number of situations, can only be ensured following protracted and costly litigation, provided that at the end of it, the demand for payment is recognized by court as being legitimate. In our opinion, these practical difficulties with the exercise of creditors' rights derive from inadequacies in the Kazakhstani laws of civil procedure.

Below, we briefly discuss the regulation of the UBG under Kazakhstan law and international experience, providing examples of cases in Kazakhstan, and propose possible modifications of the law which could improve the situation. 

Legal Regime of UBG in Kazakhstan

Kazakh law does not distinguish the UBG as a separate category of guarantee. General rules governing the issuing of a guarantee are set forth in Chapter 18 "Security of Obligations" of the RK Civil Code (the "Civil Code"). Requirements applicable to a bank guarantee are provided for in "Regulations Governing Issue of Bank Guarantees", as approved by Resolution of RK Financial Monitoring and Supervision Agency dated April 28, 2008 No. 55. Given that laws of Kazakhstan do not distinguish the UBG as a separate category of a guarantee, UBGs offered by banks in Kazakhstan are a product of contractual agreement.

Article 333(2) of the Civil Code contains a provision which serves as a legal basis for the UBG under Kazakhstan law. According to this provision "[a] guarantor [bank] may raise objections against a creditor's demand [to honour a guarantee] which [objections] a debtor may present,  except to the extent provided for by a guarantee agreement" (emphasis added).  A commentary to this provision of the Civil Code (ed. by Prof. Suleimenov M.K. and Basin Y.G.) reads that: "[l]imitation of guarantor's right to raise objections against creditor's demand may ensue from the terms of a guarantee agreement only,  e.g. if terms of guarantee agreement envisage unconditional performance of creditor's demand upon first request." (emphasis added). Nevertheless, as the Commentary to the Civil Code expresses the opinion of its authors and it is not always taken into account by courts, creditors secured by the UBG are advised to ensure that the UBG clearly reads that a guarantor (bank) may not raise objections against creditor's demand to pay; the UBG should specify the time frame within which the bank must honor the guarantee, and that the UBG is payable upon a written demand of a creditor and presentation of other documents (terms) which parties may select at their own discretion. It is worth mentioning that, under Kazakhstan law, if the UBG does not mention a time frame within which it must be performed, the default rule is that the payment is due within seven days following the receipt of a creditor's demand.

International Business Practices vs. Kazakhstan laws

Bank guarantees are often selected by parties to be governed by the Uniform Rules for Demand Guarantees approved by the International Chamber of Commerce ("URDG Rules"). URDG Rules apply whenever there is a reference in a guarantee agreement that it is subject to URDG Rules. URDG Rules also do not distinguish unconditional guarantees, however, the unconditional nature of a guarantee is recognized by the latest edition of URDG Rules No. 758. These Rules provide that a guarantor shall perform an obligation under guarantee upon a creditor's presenting specific documents referred to in the guarantee, without the obligation to verify whether the underlying secured obligation has been performed. Article 5(a) of URDG Rules provide that: "the [o]bligation of a guarantor to honour the guarantee does not depend upon claims and objections which ensue from any relations other than those between a guarantor and a beneficiary." Article 6 of URDG Rules provides that: "[g]uarantors deal with documents and not with goods, works or services to which documents relate." Thus, URDG Rules recognize that a creditor's written demand may be sufficient to honour the guarantee. However, a guarantor may refuse to honour the guarantee, if there are inconsistencies in documents provided by a beneficiary.

The Uniform Customs and Practice for Documentary Credits ("UCP Rules") also apply to a UBG in practice. UCP Rules, although formally intended to apply in payments, from the practical point of view, the payment mechanism provided for in UCP Rules is analogous to that of a UBG. UCP Rules are also governed by a mechanism where money is transferred upon the presentation of documents; a guarantor (bank) is not obliged to examine a debtor's performance of the underlying obligation.

Creditors should bear in mind that, although a UBG issued by a bank in Kazakhstan is governed by URDG or UCP, it does not mean that the rules of URDG and UCP would fully apply. Under Kazakhstan law, URDG and UCP rules would apply to the UBG in so far as they do not contradict Kazakhstan law. Thus not all of the internationally accepted principles applicable to UBG would work. For example, under Kazakhstan law, a guarantee is viewed as a so-called "accessory" obligation, and the validity of a guarantee depends on the validity of the main obligation which the guarantee aims to secure. In other words, a guarantee would be terminated, if, among other things, the main secured obligation is terminated. This is unlike a more widely accepted practice where a guarantee is viewed as an independent undertaking, effective regardless of the validity of the underlying transaction secured by the guarantee. Practical implications like this should be borne in mind whenever foreign creditors are offered a guarantee governed by Kazakhstan law.

Practical Application of UBG in Kazakhstan

Although Article 333(2) of the Civil Code allows parties to issue guarantees where a guarantor may not raise objections which a debtor could raise, (i.e. a guarantor must honour a guarantee when presented with the creditor's demand), certain Kazakhstan rules of civil procedure prevent the practical implementation of these substantive provisions. This is why, in practice, a creditor may be unable to promptly receive funding under a UBG where a debtor actively resists this.    

According to Article 333(1) of the Civil Code: "[a] guarantor, prior to satisfying a creditor's demand, must notify the debtor thereof, and in the event that an action is filed against a guarantor, the guarantor must involve the debtor as a party to the proceeding . . . ." Thus, after a bank receives a creditor's demand to honour the UBG, the bank must notify the debtor of the demand. In practice, immediately upon the receipt of notice from a bank about the creditor's demand, the debtor may bring a lawsuit against the creditor seeking the invalidation of the demand and claiming that the underlying secured obligation was properly performed and there was no grounds for raising the demand under the UBG. Sometimes, claims like this may be frivolous.

Along with filing a lawsuit, a debtor would apply for a motion seeking an order of injunctive relief prohibiting the guarantor (bank) from performing any obligation under the UBG to the creditor while judicial proceedings are pending. If a motion seeking injunctive relief is filed simultaneously with a statement of claim, according to Article 160 of the RK Code of Civil Procedure ("Code of Civil Procedure") "[j]udge would decide on a motion for injunctive relief . . . without giving notice to the respondent and other parties to a case . . . ." It effectively means that a creditor has no means of objecting to the taking of injunctive relief while the court is deliberating on the injunctive relief. A creditor would become aware of the injunctive relief after the order is issued. A respondent may object to the order of injunctive relief thereafter or if the claimant applies for the order in the course of the main proceedings.

According to Article 21(2) of the Code of Civil Procedure "[o]rders of court . . . which entered into effect . . . are binding on all parties with no exception, and such orders must be immediately executed within the territory of Kazakhstan." Immediately after an order of injunctive relief is issued by the court, a debtor would immediately send a copy of the order to the guarantor (bank) and apply to a court bailiff to initiate the enforcement of the order. If all relevant procedures are observed, the guarantor would, in turn, refuse to perform the creditor's demand to honour UBG, at least, until the debtor's lawsuit is reviewed on its merits and a binding judgment is issued or the injunctive relief is cancelled. In such litigation, the creditor must prove that the order of injunctive relief is redundant or that the claim or the injunctive relief is  without proper grounds. This may take several months.

Later in the proceedings, if the court, upon hearing a creditor's (respondent's) objections to the order of injunctive relief, rules to cancel the order, such cancellation may take a long time to enter into effect and get actually removed, provided the debtor acts quickly to file relevant appeals. According to Article 164(4) of the Code of Civil Procedure: "[f]iling of an appeal. . . against the ruling of a court cancelling injunctive relief suspends the execution of the court's ruling". Alternatively, even if the court does not cancel its order of injunctive relief, according to Article 164(3) of the Code of Civil Procedure: "[f]iling of an appeal against a court ruling which orders injunctive relief does not suspend execution of the order." Thus, the order would remain effective while the appeal against the order is reviewed. If the appeal is rejected, the creditor would have to wait until the judgment on merits enters into effect and only then can the creditor try to remove the injunction.

If the debtor appeals the judgment further, the withdrawal of the injunction may be delayed further. Delays could also be possible in the course of physical removal of injunctions, because the removal of the injunction follows a special enforcement procedure which may also get delayed, if proper techniques are applied by the debtor.

In addition to the above, it is worth mentioning that filing a lawsuit seeking invalidation of a creditor's demand to honor UBG will cost a debtor very little, because, under Kazakhstan civil procedure law, a claim is considered a non-property claim, and the court fees applicable to filing non-monetary claims would be minimal. This is unlike monetary claims (claims seeking recovery of funds) which a creditor would have to file against guarantor (bank), if he (she) wishes to recover the amounts payable under the UBG. In order to file a monetary lawsuit, a creditor's court fees would equal three per cent of the amount sought (when filed by legal entities, or one per cent when filed by individuals). This is a very considerable amount compared to a nominal fee payable by the debtor. Although there is a possibility for the creditor to also file a non-monetary claim (e.g. to obligate the bank to perform the guarantee), in practice, this category of claims is not easily enforceable.

If a debtor sees that the creditor is prevailing in court, he (she) may file another lawsuit, for example, seeking a declaration of the secured underlying obligation as invalid, and again, the debtor may seek injunctive relief prohibiting the guarantor (bank) from honouring the UBG while proceedings are pending, regardless of the merits of the case, just to delay payment. Under Kazakhstan law, the guarantee is not considered independent of the underlying secured obligation. According to Article 336(1) of the Civil Code: "[g]uarantee ceases to be effective upon termination of the underlying obligation secured by the guarantee." Thus, any potential challenge to the effect of the underlying obligation may bring into question the validity of the guarantee which, therefore, would give a debtor grounds to seek injunctive relief to suspend payments under the guarantee.

The examples provided above illustrate how serious legal and financial uncertainties may arise out of a UBG, despite its appearing to be an effective means of securing obligations. Practical difficulties like this occur not only because of the nature of procedural law, but also due to the fact that, in practice, the threshold is high to bring a debtor to liability for frivolous claims. As a result, debtors file all sorts of claims, whether grounded or not, to delay payment under a UBG.

Proposals

Currently, probably the most effective means of avoiding the risks mentioned above would be to obtain  a UBG from a foreign bank, according to the laws of a foreign jurisdiction which does not permit delays under a UBG. However, such UBGs are too expensive to make them available to the majority of businesses in Kazakhstan. For this reason, in our view, in order to make UBGs more effective under Kazakhstan law, relevant procedural laws of Kazakhstan may need revision.

In order to ensure that UBGs are effectively enforced in Kazakhstan, in our view, the Code of Civil Procedure should be amended so as to establish additional criteria which must be satisfied prior to ordering injunctive relief prohibiting banks from honouring a UBG. Establishing restrictions for claiming injunctive relief in relation to UBGs would develop greater trust in UBGs. In the meantime, the Normative Resolution of the Kazakhstan Supreme Court dated January 12, 2009 No.2 "On Provisional Remedies In Civil Cases" could be modified accordingly.     

In addition, the possibility of introducing the main principles of UCP/URDG Rules into the Civil Code and laws on payments and transfers should also be carefully studied. These amendments would require, among other things, reconsidering some of the principles currently underlying a guarantee, for example, that guarantees are viewed as an accessory obligation, not as an independent one. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.