Means of Performance Guarantee
Anatoly Didenko, Professor, Doctor of Law
The principal methods of performance guarantee are well known. Unlike the previous revision, the new list of the methods provided by clause 292 of the Civil Code is not comprehensive, which is why new approaches have to be borrowed from other legal systems.
I would like to focus on guarantee, a well known and widely accepted method of performance guarantee, and compare it with suretyship, pledge and other means.
This method is very popular and, albeit not as topical as other legal problems faced by the oil and gas sector, such as subsoil use or land regime, it is still worth being discussed.
Unfortunately, we cannot accept theory and practice of guarantee developed by other former SU countries, first of all Russia, because Kazakhstan’s legislation is quite different.
We should note the difference in defining the guarantee and suretyship as methods of performance guarantee by laws of Kazakhstan and Russia. The Russian Civil Code includes both methods in the definition of suretyship and establishes the general principle of the joint and several liability of the guarantor and debtor. However, parties to a contract may agree otherwise. The term “guarantee” in Russian laws is also used to define special relations between the bank, other lending institution or insurance organization (guarantor) on the one part and the principal on the other, regarding payment by the principal to the creditor of the principal amount against the issued guarantee. In accordance with the law, guarantor’s liability to pay an agreed amount does not depend on the liability backed up by the bank guarantee. The Civil Code of Kazakhstan has differentiated guarantee from suretyship which caused a lot of unnecessary complexities in the legal practice and impossibility to make any logic interpretation of a number of the provisions of the Civil Code.
Laws regulating guarantee and suretyship have repeatedly changed over a short period of time. Lawmakers replaced the two definitions and what had earlier been “guarantee” was called “suretyship”, and vice versa. A reasonable question arose—what is the purpose of changing the traditional meaning of these concepts?
Before amendments to the Civil Code, the difference in application of the terms “guarantee” and “suretyship” was minimum due to the fact that in most cases one of the party to a guarantee or surety agreement was the bank and these relations were regulated by banking laws. In case of any discrepancies between the banking laws and the Civil Code, the former prevailed.
The civil legislation required that the creditor should address to the principal debtor before he demanded payment from the guarantor. Under the banking laws, the creditor could have the debt repaid by the guarantor without recourse to the principal debtor. This last provision negated the secondary nature of the guarantee as well as the relevant provisions of the Civil Code.
Thus, the Civil Code was adapted to the normal banking practice where the guarantor was a joint debtor. Government guarantees also provided for joint and several responsibility of the state for the debtor’s liabilities.
Therefore, lawmakers decided to bring the terms used in the Civil Code in line with the banking terminology. Later, they also cancelled the prevalence of the banking laws over the provisions of the Civil Code for civil cases. In 1998 a number of legal acts were amended as regards authorities given to different legal entities (institutions mostly), including the authority to issue guarantees and suretyship, and the kind of responsibility for such liabilities. Afterwards, various individual provisions on guarantees and suretyship were amended as well.
As a result, the terms used in the laws are often misleading not only for laymen, but, most importantly, professional lawyers. For example, pledge agreements involving foreign capital frequently contain representations and warrantees of the parties, which are essential in case of any dispute. In this section, the pledger represents and warrants that it has a full right to dispose of the pledged property, the pledged property is movable, the pledger has obtained all permits and approvals required for the pledge registration, the property is free of any liens, each piece of the pledged property is in good and working condition, and that the list of the pledged property is exact and complete. Of course, it is obvious for the lawyer that such warrants have nothing to do with performance guarantee.
Here is another situation, where it is necessary to distinguish between two essentially different methods of performance guarantee—suretyship and suretyship for property. Suretyship is an individual method of performance guarantee, while suretyship for property is a type of pledge security. In case of suretyship, the guarantor bears secondary liability to the value of its entire property; in case of suretyship for property, the guarantor bears joint responsibility with the principal debtor but within the value of the property pledged on behalf of the principal debtor.
Sometimes, courts do not take into account this difference and do mistakes. Almaty Merchant Bank raised a claim against three persons and demanded recovery of the pledged property. The court established that one of the defendants had received money under a loan agreement and two others acted as guarantors for the borrower and pledged their apartment. The Supreme Court of the Republic of Kazakhstan ordered to re-investigate the case. It stated that in accordance with articles 332 and 357 of the Civil Code, the lending bank should have demanded repayment from the debtor before making claims against joint sureties, and the inferior court should verify whether the borrower had refused to fulfill the bank’s request.
In this case, the Supreme Court equated the status of guarantors for property with that of ordinary guarantors. This approach is also taken by some researchers who believe that the guarantor for property bears a secondary responsibility, suretyship norms may be applied, and the creditor should first demand payment from the principal debtor.
However, the above-stated approach does not take into account the following circumstances. In case of suretyship, the guarantor’s liability covers all of its proprietary rights. In case of pledge, the surety allocates a part of its property as its liability. In the first case, the creditor may recover any assets of the guarantor which may be recovered. In the second case, only the pledged property may be recovered and this is done on preferential terms. Thus, it is impossible to combine these methods.
When involving a third person as a pledger, the pledgee expects easy and quick repayment of the debt in the form of the pledged property instead of using it as an extra way to claim the debtor’s property.
In accordance with Article 331, clause 2, of the Civil Code, guarantee and surety agreements should be made in writing and any verbal guarantee or surety agreements will be considered void and null. A guarantee or surety agreement is considered valid when made in writing by the guarantor and debtor and accepted by the creditor (this may be done later in the absence of the guarantor).
A notification in writing issued by the surety or the guarantor to the creditor to confirm the responsibility for performance of the debtor’s obligation and absence of the creditor’s objections (article 331 of the Civil Code) can be accepted as a written guarantee or surety agreement. Guarantee and surety agreements can be made as a separate document or be an integral part of the principal agreement signed by three parties—the creditor, the debtor and the guarantor (surety). The option of drawing up a separate guarantee agreement is provided so that the guarantor and creditor could sign it without approval by and notification of the debtor and even against it will.
The laws differentiate guarantee and suretyship by several aspects (cause, character, scope and order of responsibility, kinds of secured obligations, etc.). The most discussible issues are the character and scope of responsibility assumed by the guarantor or surety.
The guarantee relations may be created by act of law. For example, clause 9-2 of the Decree of the President of the Republic of Kazakhstan On Subsoil and Subsoil Use reads that the authorized body has no right to decline a transfer of the subsoil use right to an affiliated company provided that the parent company has provided to the authorized body a guarantee of complete performance of the contractual obligations jointly with the affiliated company.
This regulation helped settle a problem faced by large foreign investors who wished to assign their obligations to small-sized affiliated companies and thus minimize responsibilities under a subsoil use contract.
The laws may set certain requirements to the parties and the procedure of issuing a guarantee, and a failure to fulfill such requirements may result in invalidity of the guarantee agreement. For example, according to clause 4 of Article 331 of the Civil Code, second-tier banks may issue bank guarantees and suretyship on the basis of licenses given by the National Bank in accordance with the provisions of the Civil Code and requirements of the legal acts of the National Bank regulating such transactions. In a number of proceedings where guarantor banks were defendants, the court refused to satisfy claims of creditors explaining their decisions by the absence of endorsement of the National Bank on the guarantee agreement certifying acceptance of the guarantee and the license for issue of guarantees.
Guarantees (suretyship) issued by the bank in KZT or foreign exchange for the amount exceeding 5 million tenge should be registered with the National Bank (resolution of the Board of the National Bank dated November 28, 2000).
This provision doubts validity of a guarantee which is not registered with the National Bank. A question then arises whether Article 155 of the Civil Code may be applied, which states that a transaction subject to registration is considered complete upon registration only. The answer to this question will be negative, since this article covers only transactions whose obligatory registration is required by relevant legal acts. The law of the Republic of Kazakhstan On Regulatory Legal Acts, dated March 24, 1998, does not classify banking acts as legislative documents. Therefore, registration of guarantees and surety agreements with the bank is rather formal and a failure to register them does not influence their validity.
This, however, does not apply to transactions carried out by governmental organisations. Article 44 of the Civil Code provides for obligatory registration of civil transactions concluded by official bodies. The resolution of the Government of the Republic of Kazakhstan On Measures Preventing Increase in Accounts Payable by Governmental Organizations, dated December 25, 1998, states that transactions entered into by official bodies at the expense of the state budget are considered concluded upon their registration with local treasury authorities.
As the laws may require a guarantee to be issued, they may also impose certain limitations on the number of guarantors. Such limitations, as it was already noted, are directly imposed on banks which do not hold licenses to issue guarantees.
Article 44 of the Civil Code provides for different forms of transactions which can be carried out by governmental and other organizations and various forms of responsibility for relevant liabilities. Civil transactions (including guarantee) carried out by official bodies must be registered, while transactions entered into by other organizations are not subject to registration. A governmental organization bears responsibility for contractual obligations within the limits of the approved budget for this organization, while other organizations are responsible for their liabilities to the value of their assets or, if such assets are insufficient, the property of their founders. We believe the limitation of the governmental bodies’ liability to the approved budget contradicts Article 6 of the Constitution of the Republic of Kazakhstan which ensures equal protection of the state and private property.
As regards the right of governmental organizations to issue guarantees and suretyship, this issue, which has been pending for a long time, has been settled finally. Governmental organizations may not issue guarantees or suretyship for obligations of third persons (Article 200, clause 1, subclause 4, of the Civil Code).
A special procedure is established for issuing guarantees on behalf of the state. The Law of the Republic of Kazakhstan On the Government and Government-Guaranteed Borrowing and Debt, dated August 2, 1999, states that residents of Kazakhstan may take non-government borrowing of any size, in any currency and form, subject to limitations established by laws of Kazakhstan.
Governmental organizations may not borrow funds for non-government purposes.
Legal entities can obtain non-government loans against government guarantees of the Republic of Kazakhstan. Such loans must be obtained under a loan agreement.
Government guarantees are provided to creditors as guarantee of performance of obligations by residents of the Republic of Kazakhstan under non-government loans obtained by them.
The Government of the Republic of Kazakhstan has an exclusive right to issue guarantees on behalf of the Republic of Kazakhstan for such loans.
The National Bank of the Republic of Kazakhstan and local executive bodies have no right to issue guarantees for loans on behalf of the Republic of Kazakhstan. The Ministry of Finance of the Republic of Kazakhstan issues government guarantees on behalf of the Government of the Republic of Kazakhstan.
Government guarantees can not be provided as security for loans from local executive bodies.
Government guarantees are issued on the basis of a resolution of the Government of the Republic of Kazakhstan for each investment project.
Government guarantees are issued on condition that the borrower must redeem budget funds spent by the Government when performing the guarantor’s obligations.
Legal entities applying for a government guarantee under loan agreements where such legal entities act as borrowers must meet the following requirements: they must be residents of the Republic of Kazakhstan who are engaged in business activity; implement projects included in the state investment program of the Republic of Kazakhstan for a given period; have a counter-guarantee from a second-tier bank of the Republic of Kazakhstan, etc.
A government guarantee must be issued in the form of a written guarantee agreement executed by Ministry of Finance and the creditor, or in the form of a written notification to the creditor confirming that Ministry of Finance accepts obligations of the guarantor under a non-government loan (guarantee obligation).
Only documents which meet this requirement can be recognized as government guarantees. No acts or other documents issued by government bodies of the Republic of Kazakhstan and their officials have legal force of a government guarantee.
A guarantee agreement comes into force on the date of its signing by the parties, unless otherwise stipulated by the agreement.
Guarantee agreements, guarantee obligations under each investment project and suretyship for each obligation of the borrower shall be signed by Minister of Finance of the Republic of Kazakhstan.
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