Opinion: Fighting fraud allegations

Foreign companies regard independent bank guarantee letters as an important and relatively safe method to ensure contract performance and mitigate economic losses in cross-border transactions. However, they are finding that independent bank guarantee letters issued by Chinese banks are not being enforced in China.

A number of Chinese companies have been using fraud actions to challenge a foreign company's demand for payment under a guarantee. Before commencing formal fraud proceedings, Chinese companies may request a court order to suspend payment under the bank guarantee until the claim is litigated. If the Chinese company prevails in its fraud action, the foreign company will be unable to recover damages based on bank guarantees in China.

Order to suspend payment

Chinese companies are entitled to submit ex parte applications for interim property preservation and ask the court to order the bank to suspend payment under a guarantee letter. Generally, these applications are reviewed by the court docketing department and not by the judge in the civil division. The court docketing department is inclined to make quick procedural decisions and grant interim orders as long as appropriate security is provided from the applicant. In other words, these interim orders are being granted based entirely on the allegations of fraud before any substantive evidence is heard.

Jurisdiction over fraud claims

Generally, foreign companies include in transaction contracts and bank guarantees dispute resolution clauses that submit disputes to foreign arbitration (for example, Singapore International Arbitration Centre) or foreign courts. The selection of a foreign venue is for the express purpose of preventing Chinese courts from intervening in disputes. Despite this, Chinese courts may still assert jurisdiction over a dispute when a party alleges fraud. Chinese law classifies fraud as a tort, and Chinese courts can assert jurisdiction if the infringement takes place in China or is connected to China. A Chinese company can bypass an otherwise binding dispute resolution clause simply by asserting fraud in the cause of action submitted to the court.

Unenforceable overseas interim orders

While the Chinese company initiates its fraud action in China, the foreign company generally begins the foreign arbitration or court proceeding outside of China. Unfortunately, doing so has no effect on the litigation in China even if a foreign interim order is granted to stop or suspend the litigation in China. Chinese courts do not recognise foreign court interim orders or foreign interim arbitral awards.

Court practice

The court will apply Chinese law even if the parties have selected a different governing law in the bank guarantee and transaction contract. Choice of law provisions do not apply to fraud claims in China.

In addition, the court will step into the underlying transaction to determine whether the Chinese party breached the underlying contract. Although Chinese law considers bank guarantees as independent legal instruments that do not require examination of the underlying transaction for payment disputes, Chinese courts have carved out fraud as an exception and will examine the underlying transaction for a potential breach.

Some Chinese courts may also shift the burden of proof by requesting the foreign company to prove that the Chinese company has breached the contract. If the foreign company fails to satisfy the burden of proof, the court may rule against the foreign company.

In general, Chinese courts have broad discretion when deciding the applicable law, the underlying issue and the burden of proof, rendering the outcome of these cases unpredictable.

Dispute resolution strategy

Foreign companies should review, and, if appropriate, rewrite the dispute resolution clauses used in their transaction contracts and bank guarantees. Selecting an arbitration institution within China (for example, China International Economic and Trade Arbitration Commission) for both the transaction contract and the bank guarantee is recommended. This entitles the foreign company to seek assistance from the Chinese court or arbitration institution in order to prevent the Chinese company from filing a fraud action challenging the demand under the bank guarantee, including requesting an enforceable non-litigation order.

Alternatively, if a foreign company objects to having China as the venue for dispute resolution, the company should select an overseas venue where the Chinese guarantor bank has assets.

If a foreign company is named in a guarantee fraud litigation in China, devising an overall strategy that accounts for the parallel proceedings and the risks related to the fraud action in China is critical.


Peng Shen and Ying Wu, Baker & McKenzie, Beijing