The Issue of Legitimacy in the Use of Bank Guarantees in the Context of a Precedent Decision

One of the main goals of public procurement is to obtain the maximal quantity of the procurement subject while saving material resources. Today, public procurement is one of the largest sectors and encompasses almost every direction. Accordingly, disputes arising from public procurement are very topical.
In the context of public procurement relationships, several types of guarantees are used, whose goal is to ensure the supplier’s fulfillment of obligations. The legitimacy of claims arising from these guarantees has frequently become the subject of disputes.

The Appellate Court issued an interesting ruling on the issue of the legitimacy of using a bank guarantee.

On August 17, 2017, a public procurement contract was concluded between the Georgian Non-Profit Legal Entity Tbilisi Early Childhood Education Agency and the supplier. Under this contract, the supplier was to provide the purchaser with nourishment and catering services for preschool children in accordance with the contract terms and the attached meal menu. Due to the supplier’s alleged non-performance of the contract, an unconditional, irrevocable bank guarantee was submitted by the respondent party. The respondent argued that the supplier violated the contract terms and provided the purchaser with a product that did not conform to the contractual requirements. The purchaser identified non-compliance of the goods with tender specifications based on the product description and composition indicated on the product label, while the National Food Agency did not conduct a laboratory analysis of the product itself, nor was there any evidence in the case confirming non-compliance of the product itself with the contract requirements.

The Chamber found that the respondent did not present specific and substantiated objections based on the norms that allow the purchaser to exercise rights in case of deficient performance.

The Chamber clarified that the primary purpose of a bank guarantee for contract performance is to compensate damages caused by non-fulfillment or improper fulfillment. Such a guarantee serves to ensure that the customer receives full service in accordance with the contractual price and compensates losses that may arise from inadequate contract performance. It also covers risks connected to defects found in the supplied products. Thus, the performance bank guarantee is a means of compensating damages caused by inadequate performance, and its use as a penalty or sanction contradicts the purpose of the bank guarantee. According to the Appellate Chamber’s opinion, the mere existence of a claim right arising from a contract such as a bank guarantee does not entitle the beneficiary to unconditionally claim the amount; in this case, the beneficiary must display conscientious behavior towards the other party’s property (Article 316, Part 2 of the Civil Code). In this specific case, the deficiency in performance (expressed monetarily as several dozen GEL) is so insignificant relative to the primary obligation that treating it as improper performance is legally unfounded. The Chamber considered the use of the bank guarantee for this violation as unlawful and ordered the beneficiary to return the amount unduly received under the bank guarantee to the supplier.

The Appellate Court’s decision was upheld by the Supreme Court of Georgia. The Cassation Chamber agreed that evaluating improper performance takes into account the contract’s volume, the complexity of the work to be performed, timely fulfillment by the contractor, and the severity of the deficiency... In this case, the deficiency (in monetary terms, several dozen GEL) is so insignificant compared to the main obligation that considering it improper performance is legally unjustified... Accordingly, the use of the bank guarantee was inadmissible for the specific case. According to Article 991 of the Civil Code of Georgia, a person who without the basis enriches themselves at the expense of another by means other than those provided for in this chapter is obliged to return what was received... Article 991 of the Civil Code was recognized as the legal basis for the beneficiary’s obligation to return the funds received under the bank guarantee.
This decision is important for protecting suppliers’ interests. In hundreds of cases, performance bank guarantees had been used when suppliers committed minor contract breaches. Due to the same violation, purchasers would demand penalties stipulated by the contract alongside the bank guarantee.

By this decision, the Appellate Court established significant practice regarding bank guarantees that lawyers had discussed for years. It is hoped that purchasers will adopt this practice and, considering suppliers’ interests, will refrain from disproportionate penalty sanctions.

Author:

Mariam Sichinava
Georgian Lawyers for Independent Profession