Article

Factual Summary: Contractor entered into a contract with the Saudi Ministry to service its F-5aircraft. Under the contract, Contractor was obliged to arrange for a performance bond described as "letter of guarantee for final deposit" to be issued by a Local Bank in the sum of SAR21,075,000.

To induce Local Bank to issue its bond, Contractor arranged for its Parent Company to issue a counter guarantee. The Parent/Counter Guarantor issued a "Deed of Guarantee and Indemnity" unconditionally undertaking to pay to the Local Bank on its first written demand any and all amounts which Contractor failed to pay Local Bank. Contractor also provided "guarantee application and counter indemnity" to the Local Bank undertaking to indemnify it for all sums paid to Saudi Ministry.

The local performance bond was extended from time to time but eventually the Saudi Ministry demanded payment. On receipt of demand, Local Bank informed the Counter Guarantor of the Saudi Ministry's demand and sought payment under the counter guarantee. Counsel for Counter Guarantor objected, claiming that any drawing was abusive since the underlying transaction had been performed. Local Bank honoured the performance bond and then formally claimed from Contractor under Contractor's counter indemnity and from the Parent under its Counter Guarantee.

When payment was not made, Local Bank sued Counter Guarantor and Contractor for wrongful dishonour of the counter guarantee, and moved for summary judgment. The trial court granted summary judgment to Local Bank.

Legal Analysis:

1. Independence; Guarantee; Undertaking; Fraud; Title: The court noted that "Despite the titles of these documents they are written in familiar international banking terms." The court cited a number of English cases and stated "Commitments of the kind contained in the Guarantee are, as is well known, autonomous payment obligations which are treated similarly to letters of credit and other documentary credits.... A beneficiary is entitled to be paid irrespective of any dispute about the underlying transaction except where the fraud exception applies.... The classic description of the approach is set out in Edward Owen in the words of Lord Denning MR at 171 A 'All this leads to the conclusion that the performance guarantee stands on a similar footing to a letter of credit. A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay in accordance to its guarantee, on demand, if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice'. There must be clear fraud of which the bank has notice, a requirement consistently imposed by this Court ever since."

2. Fraud: The Counter Guarantor argued that: a) Saudi Ministry's claim for payment under the performance bond was made dishonestly and without it having any entitlement to make such a claim; b) the Local Bank paid Saudi Ministry in circumstances where it knew or must have known that Saudi Ministry had no entitlement to make such a claim and, in so doing, the Local Bank was complicit in a dishonest scheme on the part of Saudi Ministry to defraud the Counter Guarantor of the amount paid under the Performance Bond; and c) the Local Bank is not entitled to reimbursement from Contractor for the amounts paid by it to Saudi Ministry and the Counter Guarantor is not liable to indemnify the Local Bank under the guarantee for those amounts either. These arguments were backed by the description of facts by Mr. Young, Vice President and General Council of the Counter Guarantor, stating: 1) the underlying contract was extended until 8 November 2000 by which date Contractor had successfully completed all its obligations; 2) Saudi Ministry had never disputed this and that from November 2000 the only outstanding issues concerned the amount of money that Saudi Ministry was obliged to pay to Contractor; 3) By April 2002 the Counter Guarantor through a Mr Wilson and Mr Suheimat knew that performance had been completed, and in April 2004 Mr Wilson was again told by Mr Young and a colleague from the Counter Guarantor company that performance had been completed.

Rejecting these arguments, the court noted that:

"An assertion that [Contractor] successfully completed performance, even if true, would not necessarily mean the performance bond would not remain in force for a period for example to support warranties by [Contractor]. ... There are allegations that [Local Bank] knew that [Contractor] had successfully completed performance, but it seems no more than the bank recording an understanding of what it had itself been told by representatives of [Contractor] and [Counter Guarantor]. There are further claims by [Counter Guarantor] that [Contractor] has performed its contractual obligations but not the beginnings of any evidence of fraud or dishonesty by [Local Bank]. There is no basis for a defence of fraud on the material currently available. ...There will accordingly be judgment for the [Local Bank]."

Comments by Professor Xiang GAO:

1. The fraud exception only applies before payment is made by the issuer of a letter of credit oran independent guarantee. In the instant case, even if fraud had been proved, the fraud exception should have had no role to play as the issuer had already made the payment.

2. There are three independent guarantees involved in the instant cases. Each is independent from the other. In principle, fraud in one should not be used against payment in the other. If the Counter Guarantor took the view that fraud was involved in the transaction between Saudi Ministry and Contractor, it should have applied for injunction against the payment by the Local Bank to Saudi Ministry, rather than having refused to pay its own guarantee.

3. The argument of the Counter Guarantor was that the Local Bank had paid Saudi Ministry in circumstances where it knew or must have known that Saudi Ministry had no entitlement to make such a claim and, in so doing, the Local Bank was complicit in a dishonest scheme on the part of Saudi Ministry to defraud the Counter Guarantor. This argument is smart, but not strong in law, as it has been accepted that issuers should be allowed to pay even if they have been notified that fraud is involved (e.g.,s109(a)(2) of 95' UCC Art 5). Reimbursement can be refused only if the issuer has conspired with the fraudster or has been a party to the fraud scheme.

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