Counter-guarantees are an essential mechanism for facilitating cross-border commercial transactions involving Iraq. When a foreign contractor or company needs to provide a bank guarantee to an Iraqi beneficiary but its relationship bank is a foreign institution, the counter-guarantee structure allows the foreign bank to issue a counter-guarantee to an Iraqi correspondent bank, which then issues the local guarantee in favour of the Iraqi beneficiary. This structure bridges the gap between the Iraqi requirement for a local bank guarantee and the foreign company’s banking relationships outside Iraq. This article examines the counter-guarantee framework applicable to Iraqi transactions under URDG 758 and CBI requirements.

What is a Counter-Guarantee?

A counter-guarantee is an independent undertaking issued by a bank (the counter-guarantor typically the foreign company’s home bank) in favour of another bank (the guarantor, the Iraqi correspondent bank), securing the counter-guarantor’s obligation to reimburse the guarantor if the guarantor is required to pay under the local guarantee it has issued to the beneficiary. The structure creates two independent instruments: the local guarantee issued by the Iraqi bank in favour of the Iraqi beneficiary; and the counter-guarantee issued by the foreign bank in favour of the Iraqi bank. Both instruments are independent of each other and of the underlying commercial transaction.

URDG 758 Counter-Guarantee Framework

URDG 758 provides a comprehensive framework for counter-guarantees in its Articles 1-5 and throughout the rules. Key provisions include: the independence principle applies fully to counter-guarantees, the counter-guarantor’s obligation to reimburse the guarantor is independent of both the local guarantee and the underlying transaction; the guarantor that receives a compliant demand under the local guarantee is entitled to demand reimbursement from the counter-guarantor; the counter-guarantor has the same five business day examination period for demands received from the guarantor; and the counter-guarantee must comply with all applicable URDG 758 requirements regarding form, demand mechanics, and expiry.

CBI Requirements for Counter-Guarantees

Iraqi banks accepting counter-guarantees from foreign banks must comply with CBI requirements regarding: correspondent banking, the foreign bank issuing the counter-guarantee must be an approved correspondent of the Iraqi bank, meeting the CBI’s correspondent banking due diligence standards; credit limits the total exposure to a single foreign bank under counter-guarantee arrangements is subject to the CBI’s single counterparty exposure limits; AML requirements, the Iraqi bank must conduct AML due diligence on the foreign bank and the underlying transaction; capital treatment counter-guarantees backed by approved foreign bank counter-guarantees receive specified treatment for capital adequacy purposes; and reporting Iraqi banks must report their counter-guarantee exposures to the CBI.

The Practical Mechanics of a Counter-Guarantee Transaction

A typical counter-guarantee transaction involving an Iraqi project proceeds as follows: the Iraqi project owner requires a performance guarantee from the foreign contractor; the foreign contractor instructs its home bank to arrange the guarantee; the home bank (counter-guarantor) issues a counter-guarantee to the Iraqi correspondent bank (guarantor); the Iraqi correspondent bank issues the local performance guarantee in favour of the Iraqi project owner; the Iraqi project owner calls the local guarantee if it believes the contractor has defaulted; the Iraqi bank pays the project owner and calls the counter-guarantee from the foreign home bank; and the foreign home bank reimburses the Iraqi bank under the counter-guarantee and seeks reimbursement from the contractor under the counter-indemnity.

Risk Allocation in Counter-Guarantee Structures

Counter-guarantee structures create distinct risk allocation issues: the foreign counter-guarantor bears the risk that the Iraqi guarantor bank will pay under the local guarantee even where the demand was fraudulent or non-compliant because the Iraqi bank’s payment obligation is independent; the foreign counter-guarantor should therefore include provisions in the counter-guarantee allowing it to challenge non-compliant demands from the Iraqi bank; the Iraqi bank bears operational risk in the examination of the local demand if it pays against a non-compliant demand, it may not be able to recover from the counter-guarantor; and both banks face the risk of fraud in the underlying transaction.

Structuring Counter-Guarantees — Key Drafting Points

Effective counter-guarantee documentation should address: the independence of the counter-guarantee from the local guarantee and the underlying transaction; the demand requirements what the Iraqi bank must present to the foreign bank to obtain reimbursement; the examination period and preclusion rules aligned with URDG 758; expiry the counter-guarantee expiry must be at least as long as the local guarantee expiry, plus a reasonable period for the Iraqi bank to present its demand; governing law and jurisdiction English law and London arbitration are commonly used for counter-guarantees involving international banks; and the currency of payment under the counter-guarantee typically USD or EUR, matching the currency of the local guarantee.

How Etihad Law Firm Assists

Etihad advises foreign companies and their banks on structuring counter-guarantee arrangements for Iraqi transactions, reviews counter-guarantee documentation for compliance with URDG 758 and CBI requirements, advises Iraqi correspondent banks on their obligations and rights under counter-guarantee structures, and represents clients in disputes arising from counter-guarantee calls.