Covid-19 and trade finance: demand guarantees, Standby & Documentary Letters of Credit

Posted: 20/03/2020

The Covid-19 pandemic may affect different instruments commonly used in the finance of trade transactions worldwide. Here we provide a brief overview of the ways in which the virus could make an impact.

Frustration

Historically, the bar for arguing that a particular contract governed by the laws of England and Wales has been frustrated has always been very high; it must be impossible for the parties to carry out their obligations as set out in the contract. The outbreak of Covid-19 is, therefore, unlikely by itself, to render a letter of credit (LC) or demand guarantee frustrated.

Force Majeure

Unlike in countries such as France, Belgium, Germany and other civil law jurisdictions (where “force majeure” provisions are often enshrined in domestic codes and regulations), force majeure terms, under English law, will not automatically be implied into the terms of letters of credit or demand guarantees. Accordingly, unless suitable force majeure circumstances are expressly referred to and included in such documents (which they are generally not) it is very unlikely that the outbreak of Covid-19 will, of itself, relieve or postpone a party’s obligation to pay.

Notwithstanding the above, where an LC or a demand guarantee subscribes to a particular set of ICC Rules (either (1) Uniform Customs and Practice for Documentary Credits (UCP600), (2) International Standby Practices (ISP98) or (3) Uniform Rules for Demand Guarantees (URDG 278), these rules provide assistance as to how – if indeed at all – the concepts of force majeure are to apply to the particular instrument.

Standby and documentary letters of credit

Letters of credit may be governed by either the articles contained in UCP600 (documentary LCs) or rules in ISP98 (standby LCs).

UCP600 may provide some limited protection to an issuing bank in such circumstances.  In particular, Article 36 expressly stipulates that the bank will not assume any “liability or responsibility for the consequences arising out of the interruption of its business by Acts of God…or any other causes beyond its control.” Article 36 goes further to provide that upon resuming its business the bank will also have no obligation to “honour or negotiate under a credit that expired during such interruptions of its business.” It is important to note, however, that in order to rely on the provisions of Article 36, the issuing bank will need to prove that a force majeure event within the terms of Article 36 has occurred.

By contrast, where a standby LC is governed by ISP98, Rule 3.14 provides that the beneficiary of the LC may present the requisite documents to the issuing bank within 30 days of the bank’s re-opening after a closure by reason of a force majeure event.

Demand guarantees

URD758 contains terms relating to force majeure events in demand guarantees similar to those in ISP98 relating to Standby LCs (ie if a guarantor faces closure due to a force majeure situation arising when the demand guarantee expires, the beneficiary is granted a 30 calendar days’ extension to the guarantee by virtue of Article 26).

Difficulties in arguing force majeure – issuing banks

Public policy: whilst Covid-19 has caused much disruption, governments worldwide have been keen to ensure that it does not affect bank payment networks - the majority of which currently still remain operative. There is an increasing push by regulators to oblige financial institutions to be prepared for and address the effects of Covid-19 with effective disruption mitigation plans such that payment operations remain functional.

Autonomy: although recent English law cases have challenged the concept, the autonomy of the payment obligation under the LC (and in most cases the demand guarantee) from the underlying transaction remains a principle supported under English Law – the banks are to consider if presented documents comply and not concern themselves with the underlying transactions. Accordingly, where the underlying trade transaction is affected by Covid-19 disruption events, the seller and the issuing bank will have an “uphill struggle” under English law if they are seeking to argue that force majeure event has occurred that releases them from the obligation to pay under the LC if a valid demand (with conforming documents) has been presented.  

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