Letters of guarantee have come to prominence with the increase in the variety and size of commercial transactions. With bigger transactions, as the non-performance of the obligations undertaken may cause non-compensable damages to the obligee, it became necessary for a reassurance to be obtained for the compensation of damages that may arise from such non-performance by a third party. Letters of guarantee, and especially bank letters of guarantee, are demanded in commercial transactions because they are payable immediately and unconditionally upon demand, provide fast compensation and because any defense and obligations that the obligor may have against the obligee may not be raised by the issuer of the letter of guarantee against the addressee of the letter. The objective is to reassure the addressee of the letter of guarantee as an incentive for entering into a transaction.
Legal Characteristic and Elements of Letters of Guarantee
Although the legal characteristic of letters of guarantee has been subject to discussion for a long time, today it is widely accepted to be a guarantee agreement.
The Court of Appeal's Decision of Joint Chambers dated 13.12.1967 and numbered E.1966/16, K.1967/7 describes bank guarantee letters as guarantee agreements. According to said decision, the bank's undertaking with the addressee is completely separate and independent from the main agreement and the relationship between the parties to such agreement. The decision qualifies guarantee agreements as the undertaking of a third party's performance. However, practice with respect to the characteristics of letters of guarantee continued to be uncertain. As a result, the Court of Appeal issued a second Decision of Joint Chambers in 1969. Pursuant to the 1969 decision, the clause included within letters of guarantee setting forth that immediate and unconditional payment shall be made upon the written demand of the obligee under the main agreement shows that letters of guarantee are a type of guarantee agreement which is the undertaking of a third party's performance as regulated under article 110 of the old Code of Obligations ("old CO") No. 818. The undertaking of a third party's performance has been regulated in line with the old CO under the new Code of Obligations No. 6098 ("new CO") in its article 128.
In practice, letter of guarantee agreements are required to include certain elements in order to be deemed as a guarantee agreement.
First, the risk that is undertaken must be predetermined. The guarantee must be given in order to induce the guarantee to act in a certain way and especially to enter into a commercial relationship with the beneficiary. The guarantor must be undertaking an independent obligation to the guarantee. The relationship between the guarantor and the guarantee and the relationship between the guarantee and the beneficiary, who is the obligor under the main agreement, shall be completely independent from one another. The issuer of the letter of guarantee shall be undertaking a primary and independent obligation. Lastly, consideration for the letter of guarantee is subject to discussion.
Term and Prescription of Letters of Guarantee
As letters of guarantee are deemed to be guarantee agreements and there are no specific regulations for guarantee agreements, letters of guarantee shall be subject to the general prescription period of ten years as regulated under Art. 125 of the old CO and Art. 146 of the new CO.
Letters of guarantee may have an expiration date. An expiration date bears importance in respect of the determination of the responsibility of the issuing party.
In order for the issuing party to be held liable, the undertaken risk must be realized within the term as well as the demand of payment.
Letters of guarantee that do not include an expiration date do not have a term of validity and remain in effect indefinitely. The issuer is liable for the risk starting as of the date of realization of the risk until the end of the term of prescription. Liability arising from a letter of guarantee which does not include an expiration date shall begin at the date of maturity which is the date of the realization of the risk. If the date of realization of the risk, and therefore the date of maturity, cannot be determined and more than ten years has passed as of the date of issuance, the issuer may object on the grounds of prescription. If the guarantee objects, the date of the realization of the risk shall be proven by the issuer.1
It should be noted that pursuant to Art. 26 of State Procurement Law No. 2886, letters of guarantee provided for works that fall within the scope of said law shall not include an expiration date.
Where letters of guarantee include a date of expiration, the letter of guarantee shall be terminated if the risk is not realized or demand for compensation is not made within the period of expiration.
The Court of Appeals accepts within its jurisprudence that payment may be demanded during the ten year prescription period if it is proven that the risk was realized within the term of expiration. Art. 128, par. 2 of the new CO, which corresponds to Art. 110, par. 2 of old CO sets forth that in agreements for the undertaking of a third party's action, clauses stating that the agreement shall become invalid if a written demand of payment is not made to the guarantor within the expiration term shall be valid. The Court of Appeals applies this rule. Therefore, in order for a letter of guarantee including an expiration date to actually become invalid at the end of its term, it must include specific wording stating that it shall become invalid if a written demand of compensation is not made within the term. However, it must be noted that wording only stating that the demand for compensation must be made within the term of the letter of guarantee is not sufficient to render the letter of guarantee invalid at the end of the term.
This is affirmed with the decision of the Court of Appeals dated 24.01.2013 and numbered 2012/798 E., 1542 K. According to this decision, in order for a letter of guarantee to become invalid at the end of its term if no demand for compensation is made, this must be stated explicitly within the letter. The letters of guarantee subject to said decision stated a date of expiration but did not include a clause specifically stating that they would become invalid if a written demand of compensation was not made before the end of the term. The Court of Appeals deems that, in such cases, even if the term of the letter of guarantee ends, the letter of guarantee shall remain in effect for ten years as of the date of expiration.
Issues with respect to the term and prescription of letters of guarantee, which are frequently used in commerce, require attention. Letters of guarantee with a fixed term may be subject to execution during the ten year prescription period, starting from the end of the term of the letter of guarantee, unless it is specifically stated within the letter that it shall become invalid at the expiration date unless a demand for compensation is made before the end of its term. The consistent opinion of the Court of Appeals affirming this may be seen in its recent judgments.
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.