I. “One Strike and You’re Out” Risk in Invalidity Disputes under Independent Guarantees
At first glance, an independent guarantee seems to offer broader and more convenient protection, with lower costs. However, once a patent issued through the independent guarantee route is invalidated, it loses its effect across all signatory countries. While the applicant enjoys convenience, they also bear the risk of their patent being “struck down” with a single action by a competitor.
Patents granted under the independent guarantee system are subject to the exclusive jurisdiction of the Unified Patent Court (UPC). The decisions made by the UPC apply to all UPCA (Agreement on a Unified Patent Court) member countries. For the winning party, this system saves on litigation costs and improves efficiency. However, for the losing party, especially when the patent is invalidated, the patent will be considered invalid across all UPCA member countries, leaving no room for recourse.
II. The Coexistence of the Unified Patent System with the Traditional European Patent System Increases the Complexity of Filing and Maintenance Strategies
(A) Regarding Waiver of Patent Rights
With the independent guarantee, it is not possible to selectively abandon the patent rights in a specific country; patents must be fully abandoned. This system design removes flexibility for patent holders and increases the costs of patent maintenance and management.
Typically, companies may choose to abandon granted patents due to high maintenance costs, outdated technology, lack of market demand, or even commercial strategy considerations. In the traditional European patent application process, patent holders could selectively refrain from paying annual fees in specific countries, thus abandoning the patents in those countries. However, under the independent guarantee system, patent holders are constrained by the system and no longer have the option to selectively abandon patents. They must choose between maintaining or abandoning the patent entirely, increasing both the cost of maintenance and limiting the flexibility of their patent strategies.
(B) The Geographic Scope of Protection of the Unified Patent
According to Article 18(2) of Regulation (EU) No 1257/2012, the territorial scope of a specific independent guarantee depends on the UPCA member states at the time of the patent’s registration. Even if new countries join the UPCA, the geographic coverage of the patent will not extend to those new countries.
Currently, 25 countries are participating in the independent guarantee system, though some countries have yet to officially approve the UPCA. As of June 1, 2023, 17 countries had approved joining the UPCA. As more countries approve the UPCA, the geographical coverage of the Unified Patent will expand. However, since the territorial scope of protection for a specific patent is based only on the UPCA member states at the time of registration, applicants may find different territorial coverage for patents filed at different times, which could affect patent filing strategies and subsequent maintenance.
For example, an applicant may wish to register Patent A as an independent guarantee but also seeks protection in countries that have not yet approved the UPCA (e.g., Ireland). In this case, the applicant would need to file separately in Ireland through the traditional European Patent route, provide translated documents as required by the Irish Patent Office, and pay the subsequent maintenance fees. However, once Ireland approves the UPCA, if the applicant files Patent B as an independent guarantee, they would no longer need to file separately in Ireland and could directly benefit from the independent guarantee system.
III. The Legal Relationship Between Direct and Indirect Guarantees
In a direct guarantee, three entities and legal relationships are involved: the beneficiary (the project owner in the international engineering contract), the applicant (the contractor), and the guarantor (the bank or non-bank financial institution issuing the independent guarantee). The three legal relationships are as follows:
- The contractual relationship between the beneficiary (the owner) and the applicant (the contractor) under the engineering contract;
- The agreement between the applicant and the issuer (the bank or financial institution) for the issuance of the guarantee;
- The guarantee relationship between the issuer and the beneficiary.
In an indirect guarantee (often referred to as a “counter-guarantee” or “indirect guarantee”), it involves a “foreign counter-guarantee and domestic counter-guarantee” structure. For instance, a Chinese contractor may apply to a domestic bank to issue a counter-guarantee, which is then used by the foreign bank to issue an independent guarantee in favor of the beneficiary (the project owner).
The legal relationships in an indirect guarantee are more complex and involve four parties:
- The contractual relationship between the bank and the beneficiary (the project owner and the foreign commercial bank);
- The mandate relationship between the applicant and the domestic bank (the bank typically issues the guarantee based on the contract with the applicant and requires the applicant to pay a certain amount of deposit);
- The counter-guarantee contract relationship between the counter-guarantor and the guarantor (the foreign commercial bank and the domestic counter-guaranteeing bank);
- The fundamental contractual relationship between the applicant and the beneficiary (the project owner and the domestic contractor).
IV. Suspension of Payment under Independent Guarantees
“Sight payment upon request” means that the issuing bank is obligated to pay the beneficiary immediately upon submission of compliant documents. This often creates significant difficulties for contractors seeking to stop payment under the guarantee, as payment can typically only be stopped in extreme cases of “fraud.”
Due to the characteristics of independent guarantees, particularly the “independence” and “payment first, dispute later” nature, fraud risks and malicious claims by beneficiaries are more prevalent. Thus, stopping payment under the guarantee is necessary in such cases.
Currently, there are two paths to stop payment under a guarantee:
- Fraud litigation (including requesting a payment suspension ruling before initiating a lawsuit);
- Interim measures by the court or arbitration tribunal during the proceedings of the underlying legal relationship.
V. Conditions for Court Ruling on Suspension of Payment under Independent Guarantees
The “Supreme People’s Court’s Interpretation on Several Issues Concerning Independent Guarantee Disputes” (November 18, 2016, first revised on December 29, 2020) provides detailed rules on the conditions for stopping payment and fraud determination. Specifically:
To request a suspension of payment, the applicant must meet the “high likelihood” standard set forth in Article 12 of the Interpretation.
The Interpretation outlines fraud situations, including:
- Collusion between the beneficiary and the applicant or others to fabricate the underlying transaction;
- Fraudulent or false third-party documents submitted by the beneficiary;
- Court or arbitration rulings confirming that the underlying debtor is not liable for payment or compensation;
- Situations where the beneficiary knows they have no right to request payment but abuses this right.
VI. Strategies for Applying for Payment Suspension in Indirect Guarantees
Due to the complex legal relationships involved in indirect guarantees, applying for payment suspension in a domestic court can be very risky. For example, even if a suspension order is successful in China, the foreign beneficiary may not recognize the order and may file parallel litigation in their country.
The most viable strategy for indirect guarantees is to apply for suspension of payment simultaneously in both the foreign and domestic courts, or first obtain an interim injunction in the foreign court and then apply to the domestic court for suspension of the counter-guarantee.
Conclusion
When the project owner decides to claim against the independent guarantee, the contractor and the project owner are usually in an irreconcilable conflict. While requesting payment suspension is crucial, contractors should remain vigilant about fraud risks by strengthening their awareness in advance, being cautious when choosing business partners and negotiating guarantee terms, and focusing on preemptive risk prevention. The contractor should strive to resolve disputes early, such as through a Dispute Adjudication Board (DAB), to avoid escalation. During the construction process, contractors should also ensure they collect and preserve relevant evidence.
This article solely reflects the author’s personal views and should not be regarded as formal legal advice or conclusions issued by BZW Law Firm or its lawyers. Should you wish to reproduce or quote any content from this article, please contact us via email. If you are interested in further exchanging views or discussing this topic, you are welcome to leave a message.
