Summarized by Prof. M. Kelly-Louw*

Topics: Independence Principle; Prescription; Limitations; Fraud; Expiry Date

Prior history: Casey v. First National Bank Ltd, 2013 (4) SA 370 (GSJ), noted in 2013 ANNUAL REVIEW 355-356 (Under the independence principle, a right to draw on an LC that required a statement that the applicant did not meet its obligations to the beneficiary turned on the required recital and is not fraudulent because the amount drawn was not owed or the right to enforce it had prescribed or came to an end.)

Note: First National Bank (Lender/Beneficiary) had granted a credit facility to a private company, Kimberly Roller Mills (Pty) Ltd (Principal Debtor) in 1998. The facility was increased and extended from time to time. The credit facility (principal debt) was secured inter alia by an irrevocable standby letter of credit, subject to UCP500, that was issued by NationsBank NA (now Bank of America) (Issuer) on behalf of Paul Casey (Applicant), a friend of Principal Debtor's director, in favor of First National Bank (Beneficiary). The standby letter of credit was also periodically increased (eventually to an amount of USD 420 000) and the expiry date regularly amended (latest date of expiry was 31 March 2011). Beneficiary decided not to extend the credit facility beyond 31 March 2007 and Principal Debtor was liable to settle the outstanding debt owed under the terms of the facility. The debt owed absent legal demand or interruption under the Prescription Act 69 of 1968 also meant that the debt by the Principal Debtor would prescribe on 1 April 2010.

In July 2010 without prejudice, negotiations took place between the Principal Debtor/Applicant and Beneficiary. Negotiations failed and during October 2010 Beneficiary indicated that it would present the letter of credit for payment. Applicant then sent a letter via his attorneys to Beneficiary on 26 October 2010 requiring an undertaking from it that it would not present the letter of credit for payment, since the claim against Principal Debtor had become prescribed. Applicant also threatened to apply for interdictory (interlocutory) proceedings should the undertaking not be given and alleged that a presentation of the letter of credit by Beneficiary would be unlawful. Beneficiary, however, ignored Applicant's threat and demanded payment on the letter of credit from Issuer. Issuer paid according to its terms. As a result, Applicant as well as Principal Debtor instituted proceedings against Beneficiary for an order that the debt owed by the Principal Debtor to Beneficiary had been prescribed. They also sought a mandamus directing Beneficiary to restore to Applicant's account at Issuer with the proceeds of the letter of credit as well as the costs incidental to the drawing upon the letter of credit (e.g., banking charges of USD 1050).

Applicant inter alia alleged that the letter of credit constituted security ancillary to the principal debt and when Beneficiary presented the letter of credit to the issuer it had falsely asserted that the debt was due when it knew that the debt had already prescribed. He also argued that the claim was fraudulently made because Beneficiary knew that the amount of interest on the capital advanced it was claiming contravened the in duplum rule.

It is trite law that the common-law in duplum rule which has its origins in Roman law and was later received into the Roman-Dutch law still forms part of the South African law. In short, the rule effectively restricts the interest recoverable in terms of a loan where a debtor is in default. The rule very simply provides that interest stops running when unpaid (or rather arrear) interest equals the outstanding capital amount. Where the total amount of unpaid interest (contractual as well as default), has accrued to an amount equal to the outstanding capital sum, the defaulting debtor must first start making payments on his loan again (and so decrease the interest amount), after which interest may once again accrue to an amount equal to the outstanding capital sum. The rule therefore prevents unpaid interest from accruing further once it reaches the unpaid capital sum. Even where the interest is capitalised (meaning interest is then charged on interest), the capitalised interest does not lose its character as interest and become part of the capital amount for purposes of applying the rule. It does not mean that a creditor (ie lender) is prevented by the rule to collect more than double the unpaid (or paid) capital amount in interest, provided that, he at no time allows unpaid interest to reach the unpaid capital amount.

The court of first instance (see Paul Casey and Another v First National Bank Ltd 2013 (4) SA 370 (GSJ), discussed in 2013 ANNUAL REVIEW 355-356) considered and confirmed the autonomy principle and the documentary nature of standby letters of credit. It said that in the case before it the letter of credit was utilised to secure the payment of money. It also highlighted the disastrous consequences if the payment of letters of credit were to be undermined and stressed that payment would only be prohibited in cases of clear fraud committed by Beneficiary. The court of first instance stated that the letter of credit was triggered if Principal Debtor did not meet its obligations to Beneficiary. It was not dependent on whether or not the amount was, in fact, due and payable to Beneficiary and Beneficiary did not have to authenticate that any amount was owed. Besides, it was common cause that Principal Debtor had not met its obligations. Regarding Applicant's allegation regarding prescription of the principal debt, the court relied on the principle of autonomy and found that the terms of the letter of credit was dependent only on its own terms for continued validity. In the court's view, these terms required no more than that Principal Debtor did not meet its obligations to Beneficiary and the letter of credit remains extant. The court of first instance also made the point that the extension of the letter of credit appears to have been the reason for Beneficiary to have continued with negotiations to settle the debt without presenting the letter of credit immediately. It found that the in duplum rule did not find application to the amount of interest claimed by Beneficiary on the capital advanced (principal debt (credit facility)). Applicant appealed against the ruling by the court of first instance.

The South African Supreme Court of Appeal agreed with the view expressed by the court of first instance and dismissed Applicant's appeal in this regard. The Supreme Court of Appeal stated that the prescription of Beneficiary's claim in terms of the underlying contract was irrelevant concerning the demand that was made on the letter of credit. It also added (para 16):

"To claim a draw-down on the letter of credit Firstrand [the beneficiary] simply had to state that Kimberley [the principal debtor] had not met its obligations in respect of the facilities granted to it by Firstrand and that a specified amount was due and payable to Firstrand. Firstrand complied with the letter of credit, obliging the Bank of America [the issuer] to honour its undertaking and make payment. . . . Whether the claim of Firstrand had prescribed . . . would only be of relevance if Firstrand acted fraudulently. It would have to be established that Firstrand presented the draw-down claim to the Bank of America, knowing that it contained material representations of fact upon which it would rely and which Firstrand knew were untrue. Mere error, misunderstanding or oversight on the part of Firstrand, however unreasonable, would not amount to fraud . . . . Counsel on behalf of Casey [the applicant of the credit] and Kimberley when asked eschewed any reliance upon fraud to challenge Firstrand's entitlement to draw-down on the letter of credit."

However, regarding the court of first instance's ruling that the in duplum rule did not find application to the amount of interest claimed by Beneficiary on the capital advanced (principal debt (credit facility)) the Supreme Court of Appeal upheld the appeal and overturned the judgment of the court of first instance in that regard.1



The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.

* Professor of Law, Department of Mercantile Law, School of Law, University of South Africa.

1. When the court of first instance had granted leave to appeal its judgment, it acknowledged that it had erred regarding the application of the in duplum rule. Prior to the appeal starting Beneficiary also conceded that the in duplum rule, in fact, applied to the amount it had claimed on the capital advanced (principal debt (credit facility)).