Enforcement of a first-demand guarantee and exceptio doli
The first-demand guarantee is an increasingly common instrument in commercial contracts, yet it conceals pitfalls that can prove decisive in the event of a dispute.
Imagine entering into an important contract and having to provide (or receive) a guarantee to your business partner. A “first-demand” guarantee works like a blank cheque: if the beneficiary requests payment, the guarantor — usually a bank or an insurer — must pay immediately, without discussion. It cannot say: “Hold on, let us first verify whether the debt actually exists”. This is the fundamental difference from a traditional guarantee: here the guarantor pays, full stop.
What is the exceptio doli and when does it apply
There is, however, a limit.
If the party requesting payment is acting in bad faith — for example, they know perfectly well that they have no right to payment, or they are concealing decisive facts which, if disclosed, would reveal that the amount claimed is not due, such as that it has already been paid — the debtor may invoke the so-called exceptio doli, namely the fraud exception.
It is the only shield available, but it has a very stringent requirement: the abuse must be evident, proved by clear and incontrovertible documents.
This is referred to as “liquid proof”, meaning immediate and overwhelming.
It is not sufficient, for example, to claim to have counterclaims to set off against the claim being enforced: one must demonstrate, in black and white, that the enforcement is fraudulent.
Two judges, two opposite decisions
The case recently discussed by our firm before the Court of Milan illustrates just how fine the line between considering the enforcement abusive and not abusive can be.
A principal had engaged a contractor to carry out certain works; the contract provided for the payment of a substantial advance on the fee, in exchange for the contractor providing an unconditional first-demand guarantee for repayment of that sum.
The performance of the works then became considerably more complicated than the parties’ original programme and the principal, after paying the amounts requested by the contractor for work performed, exercised the right of withdrawal provided for in the contract, requesting repayment of the advance which had, precisely, been secured by the first-demand guarantee.
Faced with the contractor’s refusal — who claimed entitlement to certain further payments — the principal called on the bank guarantee; to block this, the contractor brought urgent proceedings under Article 700 of the Italian Code of Civil Procedure.
The first decision: enforcement blocked
The single judge of the Court of Milan ruled in favour of the contractor.
The judge held, in fact, that the guarantee did not cover repayment of the advance, but only damages for breach of contract. In other words, according to the single judge, the principal had called on the guarantee for a purpose different from that for which it had been granted and therefore the call was abusive and the exceptio doli well-founded.
The second decision: enforcement legitimate
The order was appealed by our firm before the Panel of the Court of Milan.
The Panel overturned everything.
Reading the first-demand guarantee as a whole, the Panel concluded that the principal had called on it precisely for the purpose for which it had been issued (namely, repayment of the advance). As for the counterclaims asserted by the contractor, the Panel classified them as matters going to the merits — that is, disputes relating to the underlying relationship — incapable of founding the exceptio doli.
The Panel, in short, held that there was no fraudulent conduct on the part of the principal (in calling on the guarantee), of which, indeed, the contractor had not even succeeded in providing “liquid and incontrovertible proof”.
Why such different outcomes?
The divergence between the two decisions can be explained by two main factors
- The first is the interpretation of the guarantee: the single judge read it restrictively, drawing a clear distinction between the part governing relations with the beneficiary and the part regulating the relationship with the guaranteed debtor; the Panel instead adopted a unified reading of the document, holding that all the clauses contributed to defining its scope.
- The second factor concerns the level of proof required: the first judge assessed on the merits the costs incurred by the contractor, deeming them sufficient to demonstrate abuse; the Panel instead held that such an examination exceeded the bounds of the interim proceedings, in which only immediate and overwhelming proof may be evaluated.
How to block the enforcement of a first-demand guarantee
The case demonstrates just how powerful — yet difficult to wield — the exceptio doli is.
Anyone seeking to block the enforcement of a first-demand guarantee cannot simply raise disputes relating to the contractual relationship or claim, even if demonstrating prima facie, to have counterclaims: they must show, unequivocally, that the beneficiary is acting in bad faith.
If the proof is not immediate and incontrovertible, the guarantee operates exactly as intended: the guarantor pays and the disputes are dealt with afterwards, in ordinary proceedings.
In this particular case, the ordinary proceedings are ongoing … stay tuned.
