Article

Topics: Counter Guarantees; Interpretation; Independence Principle; Fraud Exception; Strict Compliance; Interdict/Injunction

Note: Denel Soc Ltd (Seller/Supplier), a South African State Owned Entity and a manufacturer and supplier of defence equipment, entered into a contractual relationship with the Union/Government of India (Purchaser) for the supply of defence equipment and ammunition. The sales contract contained warranty clauses concerning the goods sold and clauses concerning Denel's performance in terms of the contract.

The Union/Government of India required Denel to provide various performance and warranty guarantees (first demand guarantees) in respect of the goods that Denel sold. Denel (Applicant of the warranty and performance guarantees), through a South African Bank, ABSA Bank Ltd (First Respondent), requested two banks in India, the State Bank of India (Second Respondent) and the Bank of Baroda (Third Respondent), to provide the warranty and performance guarantees, respectively. These guarantees called for a written demand stating that the seller (Denel) had not performed according to the warranty obligations for the goods delivered under the said contract. These were the principal guarantees between the two parties to the underlying contract (i.e., Denel and the Union/Government of India) and they were governed by the laws of India. The two banks of India also required guarantees that Denel (Applicant) would pay them if and when they discharged their obligations under the principal guarantees (i.e., warranty and performance guarantees) to the Union/ Government of India (Purchaser/Beneficiary/Fourth Respondent). Therefore, Denel asked a South African bank, ABSA Bank Ltd (First Respondent) to provide counter-guarantees to the State Bank of India and the Bank of Baroda (Second and Third Respondents).

The counter-guarantees were governed by South African law (silent as to any governing ICC rules) and were first demand guarantees/independent guarantees. In terms of the counter guarantee, ABSA Bank (Guarantor) could draw upon Denel's bank account all the payment that it (ABSA Bank) had made in the discharge of its obligations under the counter guarantee. The counter-guarantees provided that ABSA Bank (Guarantor) would pay the Indian Banks on first written demand stating that they have been called upon to make payment under and in terms of the principal guarantees (performance and warranty guarantees).

On 25 May 2011, ABSA Bank Ltd advised Denel of its intent to make payment at 12:00 on 26 May 2011 in respect of the counter-guarantees since the Union/ Government of India (Beneficiary of the principal guarantees/Fourth Respondent) had made demands in respect of the principal guarantees (i.e., warranty and performance guarantees) issued by the two Indian Banks in favour of the Union/Government of India. The Union/Government of India (Beneficiary of the principal guarantees) stated in their written demand made on the Indian Bank that "the seller has not performed according to the contractual obligations for the goods delivered". On 26 May 2011, Denel obtained an urgent interim interdict (injunction) on an ex parte basis against ABSA Bank (First Respondent/ Guarantor of counter-guarantee) restraining the Bank from making payment to the two Indian Banks (Beneficiaries of counter-guarantee/Second and Third Respondents) in respect of the counter-guarantees that ABSA Bank had issued pending the finalisation of this application before the court. Denel (Applicant of the counter-guarantee/Client of ABSA Bank/Plantiff in case before court) applied, specifically, for an order interdicting ABSA Bank from making payment to the two Indian Banks in respect of such counterguarantees pending the finalisation of arbitration proceedings, already instituted and pending in India, in respect of the aforesaid principal guarantees. Denel also sought interdictory relief in India to restrain the Union/Government of India (Beneficiary of principal guarantees) from calling up or making demands in respect of the principal guarantees pending resolution of a dispute that had arisen between Denel and the Union/Government of India (i.e., parties to contract of sale (underlying agreement to the principal guarantees) in arbitration proceedings in India. The two Indian banks were also parties to the proceedings in India as respondents.

The application for the interdict concerning the counter-guarantees was heard by the South Gauteng High Court, Johannesburg. Denel (Applicant) based its application on the following two grounds:

- The demands made by the Union/Government of India (Beneficiary of principal guarantees) against the two Indian Banks in terms of the principal guarantees were not strictly compliant and in turn the demands made by the two Indian Banks against ABSA Bank (Guarantor of counterguarantee) in terms of the counter-guarantees, which were identical to the first mentioned demands, were similarly not strictly compliant.

- The Union/Government of India's (Beneficiary of principal guarantees) demands in respect of the principal guarantees were fraudulent and therefore the Indian Banks' demands in respect of the counter-guarantees were similarly fraudulent since they were made with full knowledge of the fraudulent demands in respect of the principal guarantees.

Denel's case was thus based on non-compliance and fraud. Denel argued that because the question whether the Union/Government of India made fraudulent demands on the principal guarantees had been referred to arbitration in India, it would be desirable and practical that the question of fraud be resolved before the counter-guarantees were called up.

The two Indian Banks (Second and Third Respondents) resisted the application on various grounds. First, as the counter-guarantee was independent from the principal guarantees, it was therefore independent from any dispute that might arise from the underlying contract (contract of sale) between Denel and the Union/Government of India (Beneficiary of principal guarantees). Second, although established fraud on the part of the beneficiary was an exception to the principle that the demand guarantee was payable on the presentation of a demand regardless of whether the obligations in the underlying contract have been performed or not, Denel has failed to establish fraud on either ABSA Bank's (Guarantor of counter-guarantee) part or on the part of the two Indian Banks (Beneficiaries of the counter-guarantees). Thirdly, the demands made by the Union/Government of India (beneficiary of the principal guarantees) on the principal guarantees were compliant. Lastly, ABSA Bank (Guarantor of counter-guarantees) and Denel (principal of the counter-guarantees) have waived their rights to refuse to honour the counter-guarantees because of alleged non-conforming demands for payment by the Union/Government of India (Beneficiary of principal guarantees).

The court referred to various legal writings where the independence of counter-guarantees were described (see, eg, M Kelly-Louw Selective Legal Aspects of Bank Demand Guarantees: The Main Exceptions to the Autonomy Principle (Published LLD-thesis, University of South Africa, 2009 (VDM Verlag: Germany) in para 2.5.2.8 and Anthony Pierce Demand Guarantees in International Trade (1993) at 28, 36 and 83-84) and acknowledged that the principal guarantees and the counter-guarantees involved in the case before it constituted independent guarantees that were not only independent from each other, but also from the underlying contract (contract of sale) in terms of which the principal guarantees were issued. The court agreed that as long as the beneficiary of the counter-guarantee's demand under the counter-guarantee complied with the requirements of the counter-guarantee, the beneficiary would be entitled to payment (in the absence of established fraud or another ground for non-payment), whether or not the beneficiary of the counter-guarantee has, in fact, paid the beneficiary of the primary guarantees or has received a demand for payment on the primary guarantee or was legally liable to pay a demand received on the primary guarantee.

The court also acknowledged the documentary nature of the principal guarantees and the counterguarantees. In deciding whether compliant demands were made on the counter-guarantees, the court referred to Roeland F Bertrams Bank Guarantees in International Trade: The Law and Practice of Independent (First Demand) Guarantees and Standby Letters of Credit in Civil Law and Common Law Jurisdictions 3 ed (2004) at 140-143 where Betrams expressed the view that the doctrine of strict compliance applied only to documentary credits (letters of credit) and substantial compliance applied to the demands made under demand guarantees (by implication also counter-guarantees). The court also inter alia referred to OK Bazaars (1929) Ltd v. Standard Bank of South Africa Ltd 2002 (3) SA 688 (SCA) where it has been implied by the South African Supreme Court of Appeal that the principle of strict compliance was applicable to letters of credit. It also pointed out that in Compass Insurance Co Ltd v. Hospitality Hotel Developments (Pty) Ltd 2012 (2) SA 537 (SCA) (abstracted at 2013 ANNUAL REVIEW 357) the South African Supreme Court of Appeal did not express its opinion as to whether 'strict compliance' was, in fact, necessary for demand (performance) guarantees. Reference was also made to Kelly-Louw's view that strict compliance should also apply to demand guarantees (see M Kelly-Louw Selective Legal Aspects of Bank Demand Guarantees: The Main Exceptions to the Autonomy Principle (Published LLD-thesis, University of South Africa, 2009 (VDM Verlag: Germany) at 89-91).

The court stated that the principal and counterguarantees in the matter before it were restricted to payment upon the occurrence of an event, which was "that the seller has not performed according to the warranty obligations" or that the Indian Banks (Second and Third Respondents) have been called upon "to make payment under and in terms of [their] guarantee", respectively. Neither the principal guarantors (i.e., two Indian Banks) nor the guarantor (ABSA Bank) of the counter-guarantees were obliged to pay for non-performance "according to their contractual obligations". Therefore, the guarantors' (Indian Banks') of the primary guarantee were obliged to make payment upon the condition that Denel (Applicant) has not performed according to the warranty obligations or has defaulted under and in terms of its warranty obligations. They were not obliged to pay the Union/Government of India (Beneficiary of principal guarantee) on the basis that Denel had not performed according to the contractual obligations nor was ABSA Bank (Guarantor of the counter-guarantees) obliged to pay the Indian Banks (Beneficiaries of the counter-guarantees) upon this premise. Therefore, the guarantors were only obliged to pay in terms of the promise made under the warranty obligations.

The court also referred to the English case of Frans Maas (UK) Ltd v. Habib Bank AG Zurich [2001] Lloyd's Rep Bank 14 in para 62 where it was stated that if the demand called for the term "failure to pay" it would not suffice if the demand made read "failure to meet contractual obligations":

"A failure to 'meet a contractual obligation' is far from being the same as 'failure to pay under a contractual obligation'. In effect, the former concept is wide enough to cover any claim for damages for unliquidated or unascertained sums arising from any breach . . . which would seem . . . to widen the scope of the guarantee far beyond that which the parties intended."

The court made the point that a failure to meet a contractual obligation was far from being the same as a failure to meet a warranty or guarantee obligation.

The court acknowledged that demand guarantees had to be paid according to its terms, without proof or condition, except if clear fraud was involved of which the guarantor had knowledge. A beneficiary had to meet the conditions set out in the guarantee if it wanted to be successful with its claim. Therefore, whether demand conformed strictly to the requirements of the guarantee or to the principle of strict compliance was a matter of a proper interpretation of the guarantee itself.

The court found that the demands made by the Indian Banks (Beneficiaries of the counter-guarantees) on ABSA Bank (Guarantor of the counter-guarantees) did not comply because they were made for a purpose that was too wide than the parties had agreed to - that the Indian Banks would pay the Union/Government of India (Beneficiary of the principal guarantee) in the event that Denel (Seller/Applicant) failed to meet its performance and warranty guarantees in terms of the contract of sale (underlying contract related to the principal guarantees) and that the Indian Banks' demands on ABSA Bank would similarly be restricted to those purposes. A further reason the court found why the demands were not compliant was (para 54):

"[I]n the proceedings in the High Court of Delhi, dated 23 March 2012, the Assistant Solicitor General explained to the Court that: 'The bank guarantees were invoked/encashed on the ground of the Appellant [Denel] having violated a clause, in the agreement of sale and supply of arms and ammunition, prohibiting offering of gift, bribe, inducement, etc.'"

The court also said the following (para 55):

"[T]he guarantees were only for the purposes pertaining to clauses 9 (warranty guarantee) and 12 (performance guarantee) of the agreement. This factor is also one of simply no compliance and therefore does not require any examination as to whether it meets the standard of 'strict compliance' or 'substantial compliance'. Both the principal and counter-guarantees were called for the reasons which were not promised by the Applicant."

The court was of the view that it did not have to determine whether Denel had established fraud against the Union/Government of India (Beneficiary of the principal guarantee) of which the Indian Banks had notice of, because that issue was before the courts and the arbitration proceedings in India.

The court granted the interdict requested.

Comment:

In South Africa, it is still a little uncertain what the required standard of compliance is regarding documents that are presented in terms of a commercial letter of credit. It has been implied indirectly (and by implication) in various cases that the principle of strict compliance is applicable to letters of credit. There is great uncertainty as the whether the principle of strict compliance applies to demand/independent guarantees. So although the court in Denel did not specifically state that "strict compliance" was applicable to demand guarantees, it does seem that this was, in fact, the standard that the court had applied when it had found that the various demands were not compliant.

[MKL/pt]

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