FORECLOSURE OF

MORTGAGE - REDEMPTION
Category: Obligations and Contracts

FORECLOSURE
> Remedy available to the mortgagee by which he subjects the mortgaged property to the
satisfaction of the obligation to secure which the mortgage was given
> Denotes a procedure adopted by the mortgagee to terminate the rights of the mortgagor on the
property and includes the sale itself

VALIDITY AND EFFECT OF FORECLOSURE

> The right to foreclose the mortgage and to have the
property seized and sold with a view to applying the proceeds to the payment of the principal
obligation
> A mortgage contract may contain an acceleration clause—
on occasion of the mortgagor’s default, the whole sum remaining unpaid automatically becomes
due and payable
> Essence of mortgage contract—property has been
identified and separated from a mass of the property of
the mortgagor to secure the payment of a principal obligation
> Once the proceeds have been applied to the payment of
the principal obligation, the debtor cannot anymore be asked to pay unless there is deficiency

KINDS OF FORECLOSURE

1. Judicial
2. Extrajudicial

AN ACT TO AUTHORIZE THE MORTGAGE OF PRIVATE REAL PROPERTY IN FAVOR OF

ANY INDIVIDUAL, CORPORATION, OR ASSOCIATION SUBJECT TO CERTAIN CONDITIONS

Section 1. Any provision of law to the contrary notwithstanding, private real property may
be mortgaged in favor of any individual, corporation, or association, but the
mortgagee or his successor in interest, if disqualified to
acquire or hold lands of the public domain in the
Philippines, shall not take possession of the mortgaged property during the existence of the
mortgage and shall not
take possession of the mortgaged property except after
default and for the sole purpose of foreclosure,
receivership, enforcement or other proceedings and in no
case for a period of more than 5 years from actual possession and shall not bid or take part in
any sale of such real property in case of foreclosure: Provided, that said mortgagee or successor in
interest may take possession of said property after default in accordance with the
prescribed judicial procedures for foreclosure and
receivership and in no case exceeding 5 years from actual
possession.

Section 2. All laws, orders, or regulations, or parts thereof inconsistent with the provisions of this Act,
are repealed or modified accordingly.

Section 3. This Act shall take effect upon its approval.

NOTES ON RA 133:

1. You can mortgage to a foreigner. RA 133 sanctions this. Ownership is not equivalent to
mortgage. Nonetheless, he can only institute judicial proceedings and not
extrajudicially foreclose the mortgage. Furthermore, he cannot bid or take part in the sale of the real
property.
2. The foreigner may not take possession of the property during the mortgage. He could only
possess the same as a lessee.
3. The foreigner may only take possession of the mortgaged
property after default, and for the sole purpose of
foreclosure, enforcement or other proceedings. This
should not exceed the period of 5 years from actual possession.

JUDICIAL FORECLOSURE UNDER RULE 68, RULES OF

COURT

1. The mortgagee should file a petition for judicial foreclosure in the court which has jurisdiction over
the area where the property is situated
2. The court will conduct a trial. If, after trial, the court finds merit in the petition, it will render
judgment ordering the mortgagor/debtor to pay the obligation within a period not
less than 90 nor more than 120 days from the finality of judgment.
3. Within this 90 to 120 day period, the mortgagor has the chance to pay the obligation to
prevent his property from being sold. This is called the EQUITY OF REDEMPTION PERIOD.
4. If mortgagor fails to pay within the 90-120 days given to him by the court, the property shall be sold
to the highest bidder at public auction to satisfy the judgment.
5. There will be a judicial confirmation of the sale. After the confirmation of the sale, the purchaser
shall be entitled to the possession of the property, and all the rights of the
mortgagor with respect to the property are severed or
terminated. The equity of redemption period actually extends until the sale is confirmed. Even after
the lapse of the 90 to 120 day period, the mortgagor can still redeem the property, so long as there has
been no confirmation of the sale yet. Therefore, the equity of redemption can be
considered as the right of the mortgagor to redeem the property BEFORE the confirmation of the
sale.

a. After the confirmation of the sale, the mortgagor

does not have a right to redeem the property anymore. This is the general rule in judicial
foreclosures – there is no right of redemption after the sale is confirmed.

The proceeds of the sale of the property will be disposed as follows:

a. First, the costs of the sale will be deducted from the price at which the property was sold
b. The amount of the principal obligation and interest will be deducted
c. The junior encumbrances will be satisfied
d. If there is still an excess, the excess will go back to the mortgagor. In mortgage, the mortgagee
DOES
NOT get the excess (unlike in pledge).
i. If there is a deficiency, the mortgagee can ask for a DEFICIENCY JUDGMENT which
can be imposed on other property of the mortgagor. The rule on extrajudicial
foreclosure is different. The mortgagee must go to court and file another action for the collection of
the deficiency.
ONE WOULD SHY AWAY FROM A JUDICIAL FORECLOSURE:

1. Judicial foreclosure is costly, since the parties would need to hire lawyers. But then again, the
present rules provide that court fees are needed to be paid in extrajudicial proceedings also.
2. The parties have very little control over the sale because there is court intervention.

3. More susceptible to stalling/dilatory tactics by the mortgagor, since he can file all sorts of
motions in court to prevent the sale.
4. It is more efficient to have extrajudicial proceedings since for judicial proceedings, there is a
minimum lapse of time of 6 years.
EXTRAJUDICIAL FORECLOSURE

(UNDER ACT 3135/4118 AND SC ADMINISTRATIVE CIRCULAR)

WHERE SHOULD AN EXTRAJUDICIAL FORECLOSURE SALE BE

DONE?

> Sale cannot be made legally outside the city or province

wherein the property sold is situated. In case the place
has been stipulated, it shall be made in the municipal building of the said place
NOTICE OF THE SALE

1. POSTING of the notices of the sale FOR NOT LESS THAN 20 DAYS in at least 3
public places of the municipality or city where the property is situated
2. IF THE PROPERTY IS WORTH MORE THAN P400, such
notice shall also be published once a week at least 3 consecutive weeks in a newspaper of
general circulation in the municipality or city. (You don't need to count 6 days between publications.)
NOTE: there is jurisprudence, which held that there is sufficient notice when there is publication.
PUBLIC AUCTION/SALE

1. Time shall be between 9AM and 4PM. It shall be made in

the direction of the sheriff of the province, the justice or auxiliary justice of the peace of the
municipality, or of the notary public of the municipality, who shall be
compensated with P5 for each day of actual work or performance in addition to his expenses.

2. Anyone may bid at the sale, unless there are stipulations in the agreement.

POSSESSION
> Upon foreclosure, if the mortgagor is in possession of the
property, he will retain possession during the redemption period—1 year from the date of sale
> If the winning bidder wants possession during the redemption period, he may execute a bond
in the amount equivalent to the use of the property for 12 months, to indemnify the debtor in case
it be shown that the sale was made without violating the mortgage or without complying with the
requirements of the Act. Upon approval, a writ of possession will be issued in his favor.
> If the winning bidder is able to secure possession, the mortgagor may petition that the sale is
set aside and the writ of possession be cancelled on the ground that he
wasn't in default or that the sale wasn't made in
accordance with Act 3135. This must be filed within 30 days from issuance of the writ of
possession.

RIGHT OF REDEMPTION

> The debtor, his successors-in-interest, or any judicial creditor or judgment creditor of said debtor,
or any person having a lien on the property subsequent to the mortgage
or deed of trust under which the property is sold, may
redeem the same at any time WITHIN THE TERM OF 1 YEAR FROM AND AFTER THE DATE
OF THE SALE and such will be governed by the Rules of Court
> When the property is redeemed after the purchaser has been given possession, the redeemer is
entitled to deduct from the price of redemption any rentals that said purchaser may have
collected in case the property or any part thereof was rented. If the property was used as his own
dwelling, it being town property, or used it gainfully, it
being rural property, the redeemer may deduct from the
price the interest of 1% per month provided in the Rules of Court.
RULES OF COURT, RULE 39, SECTIONS 29 TO 31, AND 35

Sec. 29. Effect of redemption by judgment obligor, and a

certificate to be delivered and recorded thereupon; to whom payments on redemption made.
If the judgment obligor redeems, he must make the same
payments as are required to effect a redemption by a redemptioner, whereupon, no further
redemption shall be allowed and he is restored to his estate. The person to whom the
redemption payment is made must execute and deliver to him a
certificate of redemption acknowledged before a notary public or other officer authorized to
take acknowledgments of conveyances of real property. Such certificate must be filed and recorded in
the registry of deeds of the place in which the property is situated, and the registrar of deeds must note
the record thereof on the margin of the record of the certificate of sale. The payments mentioned in this
and the last preceding sections may be made to the purchaser r redemptioner, or for him to the officer
who made the sale.

Sec. 30. Proof required of redemptioner.

A redemptioner must produce to the officer, or person from whom he seeks to redeem, and serve with
his notice to the officer a copy of the judgment or final order under which he claims the right to redeem,
certified by the clerk of the court wherein the judgment or final order is entered; or, if he redeems upon a
mortgage or other lien, a memorandum of the record thereof, certified by the
registrar of deeds; or an original or certified copy of any
assignment necessary to establish his claim; and an affidavit
executed by him or his agent, showing the amount then actually due on the lien.

Sec. 31. Manner of using premises pending redemption; waste restrained.

Until the expiration of the time allowed for redemption, the court
may, as in other proper cases, restrain the commission of waste on the property by injunction, on
the application of the purchaser or the judgment obligee, with or without notice; but it is not waste for a
person in possession of the property at the time of the sale, or entitled to possession afterwards, during
the period allowed for redemption, to continue to use it in the same manner in which it
was previously used; or to use it in the ordinary course of husbandry; or to make the necessary
repairs to buildings thereon while he occupies the property.

Sec. 35. Right to contribution or reimbursement.

When property liable to an execution against several persons is sold thereon, and more than a
due proportion of the judgment is satisfied out of the proceeds of the sale of the property of one of
them, or one of them pays, without a sale, more than his
proportion, he may compel a contribution from the others; and when a judgment is upon an
obligation of one of them, as security for another, and the surety pays the amount, or any part thereof,
either by sale of his property or before sale, he may compel repayment from the principal.

GENERAL BANKING LAW OF 2000, SECTION 47

Sec. 47. Foreclosure of Real Estate Mortgage. - In the event

of foreclosure, whether judicially or extra-judicially, of any
mortgage on real estate which is security for any loan or other
credit accommodation granted, the mortgagor or debtor whose
real property has been sold for the full or partial payment of his obligation shall have the right
within one year after the sale of the real estate, to redeem the property by paying the amount due
under the mortgage deed, with interest thereon at rate specified in the mortgage, and all the costs and
expenses incurred by the bank or institution from the sale and custody of said property less the
income derived therefrom. However, the purchaser at the auction
sale concerned whether in a judicial or extra-judicial foreclosure
shall have the right to enter upon and take possession of such
property immediately after the date of the confirmation of the auction sale and administer the same
in accordance with law. Any petition in court to enjoin or restrain the conduct of foreclosure
proceedings instituted pursuant to this provision shall be given due
course only upon the filing by the petitioner of a bond in an
amount fixed by the court conditioned that he will pay all the
damages which the bank may suffer by the enjoining or the
restraint of the foreclosure proceeding.

Notwithstanding Act 3135, juridical persons whose property is being sold pursuant to an
extrajudicial foreclosure, shall have the
right to redeem the property in accordance with this provision
until, but not after, the registration of the certificate of foreclosure sale with the applicable Register of
Deeds which in no case shall be more than three (3) months after foreclosure, whichever is earlier.
Owners of property that has been sold in a foreclosure sale prior to the effectivity of this Act shall retain
their redemption rights until their expiration.

NOTES:
1. For judicial foreclosure, the redemption period is within
one year. For extrajudicial, its 90 days from sale or registration.
2. The purpose is to give concession to the banks. Banks
cannot get properties mortgaged by those in financial distress.
3. The redemption price would be the mortgaged obligation
plus the interest as stipulated in the original obligation. Compare this with judicial foreclosure
wherein the redemption price is the original price. In this case, you have to pay more when
redeeming from a bank.
4. There is immediate possession
5. A motion to enjoin would not be entertained unless secured by a bond.
6. Court will fix the amount of the bond. Normally, this
would be the liability of the bank plus costs. This remedied the loopholes in Act 3135—
protect the bank during foreclosures. This makes it hard to secure injunctions and it
shortens the redemption period.

LETTERS OF CREDIT
Category: Law on Negotiable Instruments

LETTERS OF CREDIT- Negotiable Instruments

NATURE AND IMPORTANCE

> A letter of credit is a financial device developed by merchants as a convenient and relatively
safe mode of dealing with sales of goods to satisfy the seemingly irreconcilable interests of the seller,
who refuses to part with his goods before he is paid, and a buyer, who wants to have control of
the goods before paying
> To break the impasse, the buyer may be required to contract a bank to
issue a letter of credit, the issuing bank can authorize the seller to
raw drafts and engage to pay them upon their presentment simultaneously with the tender of
documents required by the letter of
credit. The buyer and seller agree on what documents are to be
presented for payment, but ordinarily they are documents of title evidencing or attesting to the
shipment of the goods to the buyer
> Once the letter of credit is established, the seller ships the goods to the buyer and in the
process secures the required shipping documents
and documents of title. To get paid, the seller executes a draft and presents it together with the
required documents to the issuing bank
> The issuing bank redeems the draft and pays cash to the seller if it
finds that the documents submitted by the seller conform with what the letter of credit
requires. The bank then obtains possession of the documents upon paying the seller. The transaction
is completed when the buyer reimburses the issuing bank and acquires the documents entitling
him to the goods. The seller gets paid only if he delivers the
documents of title over the goods while the buyer acquires the said
documents and control over the goods only after reimbursing the bank.

INDEPENDENCE PRINCIPLE
> What characterizes letters of credit, as distinguished from other
accessory contract, is the ENGAGEMENT OF THE ISSUING BANK TO
PAY THE SELLER ONCE THE DRAFT AND THE REQUIRED SHIPPING
DOCUMENTS ARE PRESENTED TO IT. In turn, this arrangement
ASSURES THE SELLER OF PROMPT PAYMENT, INDEPENDENT OF ANY BREACH OF THE
MAIN SALES CONTRACT.

LAWS GOVERNING A LETTER OF CREDIT TRANSACTION

> Uniform Customs and Practice for Documentary Credits (UCP) issued by the International
Chamber of Commerce

PARTIES TO A LETTER OF CREDIT TRANSACTION

1. Buyer—procures the letter of credit and obliges himself to reimburse the issuing bank upon
receipt of the documents of title. He is the one initiating the operation of the transaction as buyer of
the merchandise and also of the credit instrument. His contract with the bank which is to issue
the instrument and is represented by the Commercial Credit Agreement form which he signs,
supported by the mutually made promises contained in the agreement
2. Opening bank—usually the buyer’s bank which issues the letter of
credit and undertakes to pay the seller upon receipt of the draft and proper documents of titles to
surrender the documents to the buyer upon reimbursement. As it is the one issuing the
instrument, it should be a strong bank, well known and well regarded in international trading
circles.
3. Seller—in compliance with the contract of sale, ships the goods to
the buyer and delivers the documents of title and draft to the issuing bank to recover
payment. He is also the beneficiary of the credit instrument because the instrument is addressed to him
and is in his favor. While the bank cannot compel the seller to ship the goods and avail of the
benefits of the instruments, however, the seller may recover from the bank the value of his shipment is
made within the terms of the instrument, even though he hasn’t
given the bank any direct consideration for the bank’s promises contained in the instrument
4. Correspondent bank/advising bank—to convey to the seller the
existence of the credit or a confirming bank which will lend credence to the letter of credit issued
by the lesser known issuing bank or paying bank which undertakes to encash the drafts drawn
by the exporter. Furthermore, another bank known as the
negotiating bank may be approached by the buyer to have the draft discounted instead of going to
the place of the issuing bank to claim payment

RESPONSIBILITIES OF BANKS IN COMMERCIAL CREDIT

TRANSACTIONS
> If the beneficiary is to be advised by the issuing bank by cable, the services of an ADVISING
OR NOTIFYING BANK must always be utilized

> The responsibility of the NOTIFYING BANK is merely to convey or

transmit to the seller or beneficiary the existence of the credit. However, if the beneficiary
requires that the obligation of the issuing bank shall also be made the obligation of the bank to himself,
there is what is known as a CONFIRMED COMMERCIAL CREDIT and the bank
notifying the beneficiary of the credit shall become a CONFIRMING BANK. In this case, the
liability of the confirming bank is primary and it is as if the credit were issued by the issuing and
confirming banks jointly, thus giving the beneficiary or a holder for value of drafts drawn under the credit,
the right to proceed against either or both banks, the moment the credit instrument has been breached.

> The paying bank on which the drafts are to be drawn it may be the
issuing bank or the advising bank. If the beneficiary is to draw and
receive payment in his own currency, the advising bank may be indicated as the paying bank
also. When the draft is to be paid in this
manner, the paying bank assumes no responsibility but merely pays
the beneficiary and debits the payment immediately to the account
which the issuing bank has with it. IF THE ISSUING BANK HAS NO ACCOUNT WITH THE
PAYING BANK, the paying bank reimburses itself by drawing a bill of exchange on the issuing bank, in
dollars, for the equivalent of the local currency paid to the beneficiary, at the buyeing
rate for dollar exchange. The beneficiary is entirely out of the transaction because his draft is
completely discharged by the payment, and the credit arrangement between the paying bank and
issuing bank
doesn’t concern him.
> If the draft contemplated by the credit instrument, is to be drawn on
the issuing bank or on other designated banks not in the city of the
seller, any bank in the city of the seller which buys or discounts the
draft of the beneficiary becomes a negotiating bank. As a rule, whenever, the facilities of an
advising or notifying bank are used, the
beneficiary is apt to offer his drafts to the advising bank for
negotiation, thus giving the advising bank the character of a
negotiating bank becomes an endorser and bona fide holder of the
drafts and within the protection of the credit instrument. It is also
protected by the drawer’s signature, as the drawer’s contingent
liability, as drawer, continues until discharged by the actual payment of the bills of exchange.

LIABILITY IN COMMERCIAL CREDIT TRANSACTIONS

> A commercial bank which departs from what has been stipulated under the letter of credit, as when it
accepts a faulty tender, acts on its own
risk, and it may not thereafter be able to recover from the buyer or
issuing bank, as the case may be, the money thus paid to the beneficiary
> In the case of a discounting arrangement, wherein a negotiating bank pays the draft of a beneficiary of
a letter of credit in order to save such beneficiary from the hardship of presenting the documents directly
to the issuing bank, the negotiating bank can seek reimbursement of
what has been paid to the beneficiary who as drawer of the draft
continues to assume a contingent liability thereon. Thus, the negotiating bank has the ordinary
right of recourse against the seller or beneficiary in the event of dishonor by the issuing bank.

PROTOTYPE EXPORT TRANSACTION

1. PROFORMA INVOICE—all the particulars for the proposed shipment which are then known
to the buyer

2. PRICE QUOTATION FAS AND CIF—FAS stands for “free along side”
which means that the seller will be responsible for the cost and
risks of the goods “along side” an overseas vessel at the stated location: the buyer bears the
costs and risks from that point. CIF on the other hand means “cost, freight and insurance”, that in
exchange for this stated price, the seller undertakes not only to
supply the goods but also to obtain and pay for insurance and bear the freight charges to the
stated pointy.

3. BUYER’S PURCHASE ORDER

4. LETTER OF CREDIT
a. One way for a seller to be assured of payment is to ship goods under a negotiable bill of lading and
arrange for a bank in buyer’s city to hold the bill of lading until the
buyer pays the draft in the usual foreign sale this
arrangement for securing payment of the price is not adequate
b. In some situations, sellers may need assurance of payment even before the time of
payment. This problem arises in contracts which call for the manufacture of goods to the buyer’s
specifications.
c. Although the proforma invoice may not specify, the seller
will expect the letter of credit to be confirmed by the
local bank in its location. But why does a local bank
confirm rather than issue a letter of credit? The bank that issues the letter of credit needs
assurance that it will be reimbursed by the buyer, on whose behalf it pays the
seller. The buyer’s bank can take steps to minimize or
remove the hazards. It will receive the negotiable bill of
lading controlling the goods which will provide security
for the customer’s obligation to reimburse the bank; in addition, the buyer’s own bank can judge in
the light of its knowledge of his financial standing whether added security is needed and can insist
on such security before it issues the letter of credit
d. To meet the seller’s letter of credit requirements, the buyer will request its bank to arrange for
the issuance of a letter of credit which will comply with the terms of the
proforma invoice. The buyer will then sign a detailed
application and agreement for commercial credit prepared by the bank. The issuing bank,
after approving the buyer’s credit standing transmits a letter of credit by
cable to the confirming bank. This confirming bank will then deliver to seller a document advising
the latter that the issuing bank opened a letter of credit in its favor and
adding the confirming bank’s confirmation. In this arrangement, the seller is assured of payment of
its sight drafts drawn on the confirming bank in the amount of the
total amount of the sale, provided it presents the
documents called for in the letter of credit. An examination of the letter of credit will also
reveal that the bill of lading is to be consigned to the order of the buyer’s
bank, thereby giving the bank control over the goods,
with the consequent security for its claim against the buyer.

5. ACCEPTANE; SHIPMENT
a. On the receipt of the confirmed letter of credit, the seller will send the order acknowledgment. This
document will repeat the description and price of the goods which has
also appeared on the proforma invoice and states the number and expiration date of the letter of
credit.
b. Further, the arrival of the letter of credit is the go-signal for the seller to send the goods. The seller
then prepares the COMMERCIAL INVOICE which provides a complete
record of the transaction and is an important source of
information to such interested parties as a bank
discounting a draft or an underwriting extending issuance.
c. As the time of shipment approaches, the seller will contact its forwarder and give its shipping
instructions. It will inform that to comply with the requirements of the
letter of credit, the bill of lading must be made to the order of the issuing bank. It will also send
copies of the commercial invoice, a packing list, and a Shipper’s export
declaration. When the forwarder receives these
documents, he takes over all further documentation as
the agent of the shipper, the latter merely has to
dispatch the goods from the factory in accordance with the forwarder’s instructions.
d. The seller will then send the truck to the pier where they
are delivered to the ocean carrier’s receiving clerk who
signs the dock receipt. The dock receipt is a form supplied by the ocean carrier which contains
information relevant to the shipping of the bearings such as the number of the pier, and the name
of the ship. The dock receipt is NON-NEGOTIABLE and serves as a temporary receipt for the
goods until they are loaded on board.
e. The ocean carrier is soon ready to receive the cargo. When the goods are loaded on board,
the steamship line issues a bill of lading which, to comply with the letter of credit, is CONSIGNED TO
ORDER OF THE ISSUING BANK. The bill of lading is initially prepared by the forwarder on
a form supplied by the ocean carrier, it sets forth the
markings and numbers of the packages, description of the goods, and the number and weight of the
packages. On its dorsal side, it will state that the goods are received
for shipment, but a statement FREIGHT PREPAID ON
BOARD is initiated by a representative of the steamship line after loading. The forwarder then
delivers the bill of lading and the commercial invoice to the seller.
6. INSURANCE

7. PAYMENT; THE DRAFT.

a. The confirming bank stated in their letter that the estimated CIF price would be “available by
your drafts on us at sight” when accompanied by the listed documents

b. Seller accordingly draws a sight draft on the confirming

bank. The sight draft together with the commercial
invoice, insurance certificate, full set of bills of lading,
and the packing list are presented to the confirming
bank. When the bank receives these documents, it
issues its bank draft to seller’s order and transmits the
documents by air mail to issuing bank, which will
reimburse the confirming bank.
c. The documents, sent by airmail, will reach the buyer’s
bank well ahead of the ocean shipment. The time for release of the documents to buyer and
reimbursement to the bank will depend upon the arrangement which was
made between the bank and buyer when the letter of
credit was initially established.
d. If the buyer plans to resell the goods, he may not be able
to reimburse the bank until the goods arrive and he
resells the goods. In this event, the issuing bank may need to take further steps to secure its
claim against the buyer.

STANDBY LETTERS OF CREDIT OR GUARANTEES

HISTORY AND PURPOSE

> Sometime ago, it is common in international dealings to require the
furnishing of a cash deposit as security, but with the expansion of
international trade this became prohibitively expensive for the
counterparty and in due course gave way to a more convenient safeguard, the provision of a
written undertaking by a bank in favor of the buyer or employer payable on demand
> Demand guarantees as substitute for cash are designed to provide the
beneficiary with a speedy monetary remedy against the counterparty
to the underlying contract and to that end are primary in form and documentary in character.
> The demand guarantee is expressed to be payable solely on presentation of a written
demand and any other specified documents. Accordingly, any demand within the maximum amount
stated must in principle be paid by the guarantor, regardless whether the underlying
contract has in fact been broken and regardless of the loss actually suffered by the beneficiary

A CONCISE DEFINITION: DEMAND GUARANTEES

> Undertaking given for payment of a stated or maximum sum of money
on presentation to the party giving the undertaking of a demand or
payment and such other documents as may be specified in the
guarantee within the period and in conformity with the other conditions of the guarantee
> Procured by the seller in favor of the buyer for the latter to be paid in case the seller doesn’t comply
with contract provisions. The economic burder is upon the party who breaches the contract

> Employed typically in construction contracts and contracts for international sale of goods

> Demand guarantees are intended to safeguard the other party against non-
performance or late or defective performance by the supplier or contractor

GUARANTEE STRUCTURES AND TERMINOLOGY: DI

RECT (3RD PARTY) GUARANTEES
> Involves a minimum of three parties
1. Account party/principal—party to the underlying contract
whose performance is required to be covered by the guarantee and who gives instruction for
its
2. Issuer/guarantor—the bank or other party issuing the guarantee on behalf of the customer
the principal
3. The beneficiary—the other party to the underlying contract, in whose favor the guarantee is issued
> Usually the guarantee in the 3-party structure is the principal’s bank and carries on business in
the same country as the principal, whilst the beneficiary carries on business in a foreign country
> Known as direct guarantees because the guarantee is issued to directly
by the principal’s bank, not by the local bank in the beneficiary’s country

PRINCIPAL TYPES OF DEMAND GUARANTEES

1. Tender or bid guarantee
a. Where tenders are invited it is often a condition of consideration of the tender that the
tenderer undertakes to sign the contract if its awarded to him, to procure the issue of any performance
or other guarantee required by the guarantee and not to modify or withdraw his tender in the meantime
b. Purpose—safeguard the beneficiary against breach of such an undertaking
c. If the tenderer is successful and fails to sign the contract
and to furnish the requisite performance or other guarantee, or withdraws his tender before its
expiry, the beneficiary can call upon the guarantor to pay a specified
sum designed to compensate him for the trouble and
expense he suffered in reawarding the contract, as well as any additional cost of the contract

2. Performance guarantee
a. Guarantee of the central performance of the contract from commencement to completion
b. Given for a specified percentage of the contract sum
c. But there are stages in the relationship between the
parties which precede and follow the central
performance, and there may be distinct segments of liability to be covered within that performance

3. Advance payment or repayment guarantee

a. Underlying contract may entitle the principal to payment of stated sums in advance of performance
b. The advance payment guarantee is designed to secure the beneficiary’s right to repayment of
the advance if the performance to which it relates is not furnished
4. Retention guarantee
a. Construction contracts usually provide for stage payments against architect’s or
engineer’s certificate and for a specified percentage of the amount certified in each certificate to be
retained by the employer for a specified period of time as safeguard against defects
b. The employer may be willing to release such retention
moneys against a retention guarantee securing
repayment of the released retention moneys if defects are later found or if the contractor fails to
complete the contract
5. Maintenance or warranty guarantee
a. Construction contracts usually provide that on completion
part of the retention moneys are to be retained for a specified period to cover the cost of any
defects or malfunction which become manifest during that period

GUARANTEES NOT GUARANTEED BY UNDERLYING

CONTRACT
> Not all guarantees are meant to be in favor of a party in the underlying contract
> For example are customs guarantees which are issued to the customs
to cover any duty that may become payable when imported goods which would be exempt from
duty if reexported within a specified time are not in fact reexported within that time

THE LEGAL NATURE OF A DEMAND GUARANTEE

> A demand guarantee is an abstract payment undertaking that is, a
promise of payment which, though intended to preserve the
beneficiary from loss in connection with the underlying transaction is
detached from the underlying contract between principal and
beneficiary and is in form a primary undertaking between the guarantor and beneficiary which
becomes binding solely by virtue of its issue
> A secondary guarantee is both secondary in form and intent. The intention of the parties is that
the guarantor will be called upon to pay
only if the principal defaults in performance, and then only to the extent of the principal’s liability
and subject to any defenses available to the principal
> A documentary credit is both primary in intent and form. The parties to the underlying contract intend
that the bank issuing the credit is a
to be the first port of call for payment, and this is the effect of the
agreement between them. Whereas in the case of a suretyship
guarantee, the beneficiary cannot look to the guarantor without
establishing default by the principal, the reverse is true of the
documentary credit. The parties have designated payment by the bank as the primary payment
method and only if it fails without fault on the part of the beneficiary is entitled to >
DEMAND GUARANTEE STANDS BETWEEN THE SURETYSHIP
GUARANTEE AND THE DOCUMENTARY CREDIT—SECONDARY IN
INTENT AND PRIMARY IN FORM. Performance is due in the first
instance from the principal, and the guarantee is intended to be resorted to only if the principal
has failed to perform. But though this is the intent of the parties, the guarantee isn’t in form linked to
default under the underlying contract, nor there is any question of
performance to hold the beneficiary harmless up to the agreed maximum; and the sole condition of
the guarantors payment liability is
the presentation of a demand and other documents specified in the guarantee in the manner of
and within the period of the guarantee
> THE GUARANTOR HAS NO CONCERN WITH THE UNDERLYING CONTRACT AND IF
DEMAND IS DULY PRESENTED, PAYMENT MUST BE
MADE DESPITE ALLEGATIONS BY THE PRINCIPAL HAS FULLY
PERFORMED THE CONTRACT—IN THE ABSENCE OF ESTABLISHED
FRAUD OR OTHER EVENT CONSTITUTING GROUND FOR NON-PAYMENT

STANDBY LETTERS OF CREDIT

> Undertaking primary in form but intended to be used only as a fallback in the event of default by the
principal under the underlying contract

> Standby credit in legal perspective is simply another term for demand guarantees
> The standby credit has developed into an all-purpose financial support
instrument embracing a much wider range of uses than the normal
demand guarantee. Thus, standby credits are used to support financial and non-
financial obligations of the principal and to provide credit enhancement for the primary financial
undertaking

KEY ELEMENTS IN A DEMAND GUARANTEE

1. The parties
2. A reference to the underlying contract
3. The amount or maximum amount of the guarantee and any agreement for reduction or
increase
4. The currency of payment
5. The documents, if any, to be presented for the purpose of a demand or of reduction or
expiry
6. The expiry date or other expiry provisions as well as any agreement for extension
> Where it is intended that the guarantee shall not commence until presentation of a particular
document, this fact should be specified
> Direct guarantee: principal, guarantor, and beneficiary should be identified
> Indirect guarantee: principal, instructing party, beneficiary, and counter-guarantee
> Central to the demand guarantee is its documentary character: the rights and obligations it
creates are to be determined solely from the
terms of the guarantee and from any document presented in accordance with the guarantee,
without the need to ascertain external facts

DISTINCT NATURE OF CONTRACTUAL RELATIONSHIPS

> Guarantor’s commitment to the beneficiary arises solely by virtue of the issue of the guarantee
and his duty to pay is conditioned only on
presentation of demand and other specified documents in conformity with the terms and within the
duration of the guarantee
> Principal is not concerned with the contract between the guarantor and beneficiary
> Beneficiary has no concern with the contract between the principal and guarantor
> The relationship of principal and guarantor has an internal mandate—
the guarantor is obliged to act in accordance with the terms of the
contract, failing which he may forfeit his right to reimbursement but
those terms are of no concern to the beneficiary, whose right to payment depends solely on his
acting on conformity with the terms of the guarantee
> In indirect contracts, there is an additional mandate which has 2 facets—the mandate from the
instructing party to the guarantor as to
the issue of the guarantee, which the guarantor as mandatory must
comply with if he accepts the instruction; and two, the counter-guarantee which the guarantor
exacts from the instructing party as a precondition of issuing the guarantee and which is separate from
the mandate
1. Abstract character of the payment undertaking—binding
solely by virtue of issue of the guarantee, subject to the beneficiary not rejecting it
2. Independence of the guarantee from the underlying transaction
> Guarantee is separate from that contract and the
rights and obligations created by the guarantee are
independent of those arising under the underlying contract
> In the absence of established fraud by the
beneficiary, the guarantor is not entitled to refuse
payment and the principal is not entitled to have
payment restrained merely because of a dispute between the principal and beneficiary
3. Independence of the guarantee from the principal-guarantor relationship—
the guarantee is separate from the contract
between the principal and the guarantor is not entitled to invoke a breach of that contract
4. Documentary character of guarantee—amount and duration of the duty to pay, the conditions of
payment and termination of payment obligation depend solely on the terms of the guarantee itself
and presentation of required documents
5. Requirement of compliance of the demand with the terms of the guarantee
6. Guarantor’s duty of examination limited to apparent good order of the document
7. Guarantor’s duty limited the exercise of good faith and reasonable care
8. Independence of counter-guarantee from guarantee
9. Independence of counter-guarantee from mandate received from instructing party