International bank guarantees and bankruptcy proceedings

The figure of international bank guarantees is usual in the context of international trade where the contracting parties agree to issue them to insure their business. Some of the most common doubts or fears that arise during the negotiation of international bank guarantees are What happens if one of the parties is declared bankrupt? and How are bank guarantees issued?

In many international contracts, such as in the sale or supply of goods or the execution or installation of work, the contracting party (also called the buyer) usually requires the contractor (also called the seller) to make a bank guarantee available as a condition for the realization of the contract. In this way, the contracting party ensures compliance (at least in part) of the contractor’s principal obligation.

For greater clarity, it should be noted that the bank guarantee is also referred to as the collateral or bond. In this sense, the person who orders the issuance of a guarantee is also referred to as the originator, and the beneficiary of the guarantee is the beneficiary or the endorsed. The person who issues the guarantee and is obliged to pay in the case of incompliance of the originator is the guarantor (which is usually a banking entity).

Let us consider a brief example: a Spanish company (the buyer) presents an offer to buy equipment from a foreign manufacturer (the seller) through a sales contract. Given the high cost of manufacturing the goods, the buyer agrees to pay the supplier a part of the price in advance (35% of the total price). In turn, the buyer requires that a bank guarantee is made available in advance, given that the seller is located in a foreign country. Additionally, the buyer asks the seller to issue an execution guarantee for the remaining 65% of the contract.

What would happen if the contractor is declared bankrupt?

The consequences would be the following.

What would happen if the contracting party is declared bankrupt?

It must be assumed that the activation of a bank guarantee mainly depends on the underlying legal business (unless it is a guarantee at first request). Therefore, when we talk about the effects of the declaration of bankruptcy on guarantees, we must first talk about the effects that bankruptcy has on contracts in general.

The effects of bankruptcy on contracts in general

For these purposes, art. 61.2 of Law 22/2003, of July 9, Bankruptcy (hereinafter, LC) states that the bankruptcy declaration, by itself, will not affect the validity of contracts with reciprocal obligations (such as those of international sales), pending compliance on part of both the insolvent and the other party. Moreover, art. 44.1 of LC gives legal security to economic traffic by establishing that the bankruptcy declaration will not interrupt the continuation of the debtor’s professional activity.

Notwithstanding the above, it should be noted that the second paragraph of art. 61.2 of LC enables the debtor or, if applicable, the bankruptcy administrator (hereinafter, the BA) to urge the resolution of the contract. The decision is ruled by the bankruptcy judge, always watching over the interest of the same, agreeing to, where appropriate, the appropriate refunds and compensation to be paid by the estate.

In the case at hand, if the BA of the contracting company rescinds the contract in accordance with the above, the bank guarantee will not have a purpose. As a long as the contractor complies with its contractual obligations, nothing will prevent cancellation.

The action for reimbursement, ex art. 71 LC

Art. 71 LC regulates the infamous reintegration action. In essence, this provision serves to say that the detrimental acts for the active estate carried out by the debtor within the two years prior to the date of the bankruptcy declaration will be voided, even if there was no fraudulent intention.

However, the same provision establishes a series of assumptions that cannot be subject to rescission in any case, such as the assumption that ordinary acts of the debtor’s professional activity are performed under normal conditions, among others.

On the other hand, following the same line of argument as in the previous section, if the seller does not breach any of its contractual obligations, the bank guarantee cannot be executed by the insolvent buyer.

The Royal Decree-Law 5/2005

Art 15 of RD 5/2005 offers legal certainty to contracting parties by expressly establishing that the opening of a bankruptcy procedure or administrative settlement cannot be grounds for nullification or rescission of a financial guarantee agreement or the provision of a guarantee itself, provided that the resolution of said opening is subsequent to the formalization of the guarantee agreement or to the contribution of the guarantee.

The same art. 15 of LC in section 5 stipulates that bank guarantees can only be rescinded or contested under the provisions of article 71 LC, just as we have seen before. In addition, the BA will have to demonstrate that they have been made in creditors’ fraud.

Conclusions

In light of the above, it can be observed that the Spanish bankruptcy law is focused on providing legal security to companies that intend to start commercial relationships with companies in economic difficulties. In this sense, the current LC is inspired by the principle of continuity of the debtor’s activity in order to keep the contracts with reciprocal benefits in place to the highest extent possible. As a general note, consequence of the above is that the international bank guarantees will remain in force in the same way without having the bankruptcy declaration influence its content.

This article is not considered as legal advice

Luis Trigueros Von Korff

Luis Trigueros Von Korff graduated from ESADE with a Law degree. He specializes in commercial law, specifically in the areas of corporate law and bankruptcy law. For any further enquiries please Contact us