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Can letters of guarantee cause international trade disputes?

On Behalf of | Sep 20, 2023 | International Trade Litigation |

When engaging in international trade, letters of guarantee and letters of credit are often used to provide security against potential breaches of contract. These financial instruments aim to foster trust and ensure compliance between entities involved in a trade. However, there are times when they can also inadvertently give rise to disputes.

Letters of guarantees vs. letters of credit

A letter of guarantee works like a letter of credit but with a unique twist. It ensures payment to either party even if the counterparty does not follow the transaction rules. A letter of guarantee may also allow for reimbursement without going to court if the shipper cannot prove delivery, making dispute resolution simpler.

Wrongful calls on letters of guarantee

Wrongful calls on letters of guarantee happen when the person who is supposed to get the money (usually the buyer) asks for payment, but it does not match the rules in the guarantee or the contract. Typically, these may be in the form of:

  • Noncompliance or disputed interpretation of contractual terms: Wrongful calls often occur when the beneficiary asks for payment without following the contract’s rules. For instance, they might say the other party did not do what they were supposed to but cannot prove it. Disagreements can also happen about what the contract terms really mean.
  • Expired or invalid guarantees: Sometimes, a beneficiary may try to use an expired guarantee or violate specific conditions outlined in the guarantee document.
  • Fraudulent claims: There may be instances when beneficiaries try to trick the system by making fake claims or changing things to get payment under the guarantee when there is no real reason for it.

These disputes can potentially result in financial losses for the issuer of the guarantee or the party bound to honor it.

Avoiding disputes

To minimize the risk of international trade finance disputes arising from letters of guarantee, parties should:

  • Ensure contract terms are precise and congruent with the letter of guarantee.
  • Establish open communication channels to resolve issues promptly.
  • Engage legal experts to draft comprehensive agreements.
  • Implement robust due diligence to assess the creditworthiness of the parties involved.

While letters of guarantee play a pivotal role in international trade finance, they must be managed diligently to prevent disputes. Clear contractual terms and vigilant oversight can help maintain the integrity of these financial instruments and ensure smoother international trade transactions.