This article examines the independence principle and manifest abuse in bank guarantees, and explains how payment can be stopped and wrongful calls recovered.
In construction, supply, EPC and public procurement contracts, bank guarantees are the employer's strongest form of security. That strength comes from the guarantee being independent of the underlying contract and, in most cases, payable "on first written demand, unconditionally". The same feature creates a serious risk for the contractor or seller: the guarantee can be called even where the contract has been fully performed, and the dispute then has to be fought while the money sits with the beneficiary. This article examines the legal nature and types of bank guarantees, what a first demand clause means, the URDG 758 rules, injunctions to stop payment in cases of manifest abuse, recovery after a wrongful call, and the points to address when negotiating the contract.
1. Legal Nature: A Guarantee, Not a Suretyship
Under Turkish law, a bank guarantee is an undertaking for the act of a third party, that is, a guarantee agreement under Article 128 of the Turkish Code of Obligations (TCO). The bank, as guarantor, undertakes to pay the beneficiary a specified amount if the applicant, the party to the underlying contract (the contractor, seller or debtor), fails to perform.
What distinguishes a guarantee from a suretyship is independence. A suretyship is accessory to the principal obligation, and the surety may raise the defences available to the principal debtor. Under a guarantee, the bank's obligation is independent of the underlying contract. As a rule, the bank cannot raise defences arising from the underlying relationship, such as that the contract has been performed or that the debt never arose or has been extinguished. The wording of the instrument is decisive in determining whether it is a guarantee or a suretyship. Phrases such as "on first written demand", "unconditionally" and "irrespective of any objection by the applicant" point to an independent guarantee.
2. Types of Bank Guarantees
- Bid bond: issued at the tender or offer stage to cover the risk that the bidder refuses to sign the contract.
- Performance guarantee: secures proper performance of the contract. This is the type most often in dispute.
- Advance payment guarantee: secures repayment of an advance paid by the employer. Its amount may be reduced as the advance is offset against progress payments.
- Warranty or maintenance bond: secures the remedying of defects arising during the warranty period after provisional acceptance.
- Payment guarantee: secures the payment obligation of the buyer or employer.
In Turkish public procurement, under Public Procurement Law No. 4734, a bid bond may not be less than 3 percent of the bid price and a performance guarantee may not be less than 6 percent of the contract price. In private contracts, the percentages are entirely a matter for negotiation.
3. The First Demand Clause and the Bank's Duty of Examination
Under a first demand guarantee, the bank's duty of examination is limited to whether the demand complies on its face with the terms of the guarantee. The bank checks whether the demand was made within the validity period, in the form required and by authorised persons, whether the amount claimed exceeds the guaranteed amount, and whether any documents or statements required by the guarantee are attached. It does not investigate whether the demand is justified. Conversely, no payment is made on a demand that does not comply with the guarantee's terms, so it is vital for the beneficiary to prepare its demand in strict conformity with the wording of the guarantee.
In international transactions, guarantees are often made subject to the ICC Uniform Rules for Demand Guarantees (URDG 758). These rules apply only where the guarantee expressly incorporates them, and they offer the applicant important protections:
- Unless the guarantee provides otherwise, the demand must be supported by a statement indicating in what respect the applicant is in breach of the underlying contract (Article 15).
- The bank has five business days from presentation to examine the demand and decide whether to pay or refuse (Article 20).
- Where the beneficiary demands that the guarantee be extended or else paid, the bank may suspend payment for a period, giving the applicant time to consider the extension (Article 23).
"Extend or pay" demands are a common pressure tactic in practice. With a guarantee about to expire, the beneficiary may announce that it will call the guarantee unless it is extended, even where there is no genuine breach. The applicant must then decide quickly whether to extend, accept payment, or seek an injunction on the ground that the demand is abusive.
4. Manifest Abuse and Injunctions to Stop Payment
The only significant exception to the independence principle is manifest abuse of rights. Under Article 2(2) of the Turkish Civil Code, the legal order does not protect the manifest abuse of a right. In Turkish Court of Cassation practice, an injunction stopping payment under a guarantee is granted only in exceptional cases where the abuse is manifest and established largely by documents, so that it is apparent at first sight. The mere existence of an ordinary dispute under the underlying contract, such as a disagreement over whether performance was proper, is not considered sufficient.
Typical situations that may be treated as manifest abuse in practice include:
- Full performance of the secured obligation is clearly established, for example by a final acceptance certificate or by progress payment documents showing that the advance has been fully offset.
- The underlying contract has been terminated by mutual agreement and the beneficiary has undertaken to return the guarantee.
- The demand concerns a claim outside the risk the guarantee secures, for example where an advance payment guarantee is called for a performance claim.
- Documents establish that the applicant could not perform because the beneficiary failed to perform its own obligations under the underlying contract.
Applications for interim injunctions are assessed under Articles 389 et seq. of the Code of Civil Procedure. The injunction is usually framed as an order that the guarantee not be paid out to the beneficiary, and it is notified to the bank. The court requires the applicant to provide security against the loss the other side may suffer if the injunction proves unjustified. The main action must be filed within the statutory period after the injunction; it typically seeks a declaration that no debt is owed to the beneficiary and the return of the guarantee.
An arbitration clause in the underlying contract does not prevent an application to the state courts for an interim injunction (Article 414 CCP, Article 6 of the International Arbitration Law). The underlying dispute is then heard in arbitration. We discussed the drafting of arbitration clauses and the arbitration objection in our previous article.
In counter-guarantee structures common in international projects, where a Turkish bank issues a counter-guarantee to a foreign bank and the foreign bank issues a direct guarantee to the beneficiary, an injunction obtained in Türkiye may not prevent the foreign bank from paying. In such structures, the injunction strategy must take into account the law governing the guarantee and the country where payment is to be made.
5. Recovery After a Wrongful Call
Payment under a guarantee does not resolve the dispute under the underlying contract; it only determines who holds the money while the dispute continues. Where a guarantee has been called wrongfully, the applicant may claim repayment of the amount paid, with interest, from the beneficiary on the basis of the underlying contract and the rules on unjust enrichment, together with compensation for any further loss. Where the amount paid exceeds the beneficiary's actual claim under the underlying contract, the difference may also be recovered.
As between the applicant and the bank, the non-cash credit becomes a cash credit once the guarantee is paid. The bank will claim the amount paid, with interest and costs, from the applicant under the general credit agreement. A wrongful call therefore creates both a cash loss for the applicant and a significant burden on its credit lines and banking relationships.
Where a contract provides for both a bank guarantee and a contractual penalty, a further question arises as to whether the amount paid is to be set off against the penalty or against actual loss. We examined the nature and reduction of contractual penalties in this article.
6. Guarantees in Public Procurement
In public procurement contracts, the forfeiture of the performance guarantee depends on the circumstances set out in Public Procurement Contracts Law No. 4735. For example, where the contractor fails to perform in accordance with the contract and tender documents and the breach continues despite notice, the contract is terminated and the performance guarantee is forfeited. The lawfulness of the forfeiture and of the ground for termination is disputed in the civil courts as a matter of contract performance. Obtaining an interim injunction against a public authority is more difficult than in private contracts, so documenting the notice process from the outset and raising objections in time are decisive.
7. Practical Recommendations at the Contracting Stage
For the applicant (contractor, seller):
- Where possible, negotiate a conditional guarantee under which payment depends not only on a written demand but on a statement of breach, an independent determination or an arbitral award.
- In international transactions, ensure that the guarantee incorporates URDG 758 and that the statement of breach requirement is preserved.
- Provide for the guarantee to expire automatically on a fixed date or on events such as provisional and final acceptance, and for an advance payment guarantee to reduce in proportion to the offsets.
- Include in the contract an obligation to return the guarantee within a set period after completion, with a sanction for breach.
- Document every stage of performance with acceptance certificates, progress payments and correspondence. Manifest abuse can only be proven with documents.
For the beneficiary (employer, buyer):
- Define clearly the wording of the guarantee, the form of demand, who may make it and the documents to be presented.
- Make the demand within the validity period and in strict conformity with the wording; a deficient demand may be refused.
- Use the guarantee only for the risk it secures and only where there is a genuine claim. Abuse exposes the beneficiary to injunctions, repayment and damages.
8. Conclusion
Bank guarantees provide strong security because they are independent of the underlying contract, but that independence significantly weakens the applicant's position against unjustified demands. The key points can be summarised as follows:
- A bank guarantee is a guarantee agreement; as a rule, the bank cannot raise defences arising from the underlying relationship.
- Under a first demand guarantee, the bank examines only whether the demand complies on its face with the guarantee's terms.
- URDG 758 offers important protections, such as the statement of breach and the examination period, but only applies where expressly incorporated.
- An injunction stopping payment is available only in cases of manifest abuse established by documents; an ordinary performance dispute is not enough.
- An arbitration clause does not prevent an application to the state courts for an interim injunction.
- Repayment and damages can be claimed after a wrongful call, but the most effective protection is proper drafting of the guarantee and the underlying contract at the outset.
For advice on negotiating bank guarantees and guarantee structures, injunctions against unjustified calls, repayment and damages claims, and disputes arising from construction, supply and EPC contracts, please contact us at info@guzeloglu.legal.