COMMENTS ON THE AUTONOMY OF DEMAND GUARANTEES AND IRREVOCABLE LETTERS OF CREDIT

1.???? Demand guarantees are often used in circumstances where they are the? equivalent of irrevocable letters of credit.[1] An irrevocable letter of credit is generally defined as an independent undertaking by a bank (or other guarantor) to pay a beneficiary a stipulated sum of money against the presentation of stipulated documents.[2] Letters of credit[3] are typically used to facilitate international trade while demand guarantees are typically found in the construction industry.

2.???? In Sztejn v J Henry Schroder Banking Corporation [4] ?Shientag J said in the New York Supreme Court that it was well established that a letter of credit was independent of the primary contract of sale between a buyer and a seller. The bank issuing the letter of credit undertook to pay upon presentation of documents and not of goods. The principle was essential to preserve the efficiency of the letter of credit as an instrument for the financing of trade. It would be

“a most unfortunate interference with business transactions if a bank, before honouring drafts drawn upon it, was obliged or even allowed to go behind the documents at the request of the buyer, and enter into controversies between the buyer and the seller regarding the quality of the merchandise shipped.”

3.???? The autonomy of demand guarantees, like irrevocable documentary letters of credit,[5] is sacrosanct. They are autonomous documents independent of the underlying agreement between the parties to a contract.

4.???? The guarantor is obliged to make payment when presented with complying documentation. The only question that arises from the point of view of the guarantor, is whether or not it is presented with complying documentation, and if it is then payment must be made.

5.???? Demand guarantees[6] are in law in the words of Lord Denning MR[7]

“…virtually promissory notes payable on demand…. the performance guarantee stands on a similar footing to a letter of credit.”

6.???? It is no exaggeration that the autonomy of demand guarantees and documentary letters of credit is a prerequisite for trade. Donaldson LJ remarked in Intraco Ltd v Notis Shipping Corporation (The Bhoja Trader)[8] that:

“Irrevocable letters of credit and bank guarantees given in circumstances such as that they are the equivalent of an irrevocable letter of credit have been said to be the lifeblood of commerce. Thrombosis will occur if, unless fraud is involved, the Courts intervene and thereby disturb the mercantile practice of treating rights thereunder as being the equivalent? of cash in hand.”

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7.???? In Coface SA Insurance Co Ltd v East London Own Haven t/a Own Haven Housing Association[9]?the Supreme Court of Appeal reiterated that a guarantor's obligation to perform in terms of a demand guarantee was wholly independent from an underlying construction agreement between a contractor and its employer and that disputes in relation to the underlying construction agreement were accordingly irrelevant to the guarantor's obligation to perform in terms of the guarantee.

8.???? The demand guarantee is therefore an autonomous document that creates an autonomous obligation. A guarantor does not exercise a discretion when making payment and the guarantee must be paid according to its terms. The guarantor evaluates the documents presented and if the documents conform, it makes payment. Liability is not affected by the underlying relationship.

9.???? Fraud uncovers all and payment on a guarantee can be resisted on the basis of fraud. This constitutes an exception to the rule that the demand guarantee, like a letter of credit, is autonomous. A court will therefore not go behind the demand guarantee in order to decide whether payment should be made.

10.? Disputes that arise relating to the fulfilment of obligations in terms of underlying agreements therefore do not affect the demand guarantee or letter of credit.

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J Moorcroft F A Arb

Advocate, member of the Johannesburg Bar, Fellow of the Association of Arbitrators and panellist of The Arbitration Foundation of Southern Africa

[1] ?? Intraco Ltd v Notis Shipping Corporation (the Bhoja Trader) [1981] 2 Lloyd's Rep 256 (CA) 257; Bombardier Africa Alliance Consortium v Lombard Insurance Co Ltd and Another 2021 (1) SA 397 (GP).

[2] ?? Moorcroft & Vessio Banking Law and Practice (LexisNexis) para 32.7.

[3] ?? Often in terms of the Uniform Customs and Practice for Documentary Credits, the UCP600. In practice most letters of credit are made subject to the UCP or eUCP. See Banking Law and Practice para 32.8, 32.20.

[4] ?? Sztejn v J Henry Schroder Banking Corporation (1941) 31 NYS 2d 631 at 633.

[5] ?? See Banking Law and Practice ch 32.

[6] ?? Also known as performance bonds, performance guarantees, demand guarantees, advance demand guarantees, or construction guarantees. A better description might be ‘documentary guarantees’ as performance depends on the presentation of the required documents as is the case with a ‘documentary [letter of] credit.’

[7] ?? Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] 1 All ER 976 (CA) (1977) 3 WLR 764.

[8] ?? Intraco Ltd v Notis Shipping Corporation (The Bhoja Trader) [1981] 2 Lloyd's Rep 256 (CA) 257. See also Power Curber International Ltd v National Bank of Kuwait SAK [1981] 3 All ER 607 (CA) 613b, Loomcraft Fabrics CC v Nedbank Ltd and Another?1996 (1) SA 812 (A) 816G-817A; [1996] 1 All SA 51 (A), Lombard Insurance Co Ltd v Landmark Holdings (Pty) Ltd and Others 2010 (2) SA 86 (SCA) para 20, Bombardier Africa Alliance Consortium v Lombard Insurance Company Limited and another [2020] JOL 48680 (GP), Compass Insurance Company Ltd v Hospitality Hotel Developments (Pty) Ltd [2011] JOL 27976 (SCA), Nedbank Limited and another v Procprops 60 (Pty) Limited [2015] JOL 33537 (SCA).

[9] ?? Coface SA Insurance Co Ltd v East London Own Haven t/a Own Haven Housing Association?2014 (2) SA 382 (SCA); [2014] 1 All SA 536 (SCA). The Supreme Court of Appeal held that the majority decision in Dormell Properties 282 CC v Renasa Insurance Co Ltd and others 2011 (1) SA 70 (SCA); [2011] 1 All SA 557 (SCA) that created an exception to the principle enunciated above, was wrong. The minority judgment by Cloete JA (Mpati P concurring) in Dormell was endorsed by the later judgement.