Article

Factual Summary: 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 (underlying contract). The sales contract contained warranty clauses concerning the goods sold and clauses concerning Denel's performance in terms of the contract.

The Union of India required Denel to provide one performance and seven 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, requested two banks in India, the State Bank of India and the Bank of Baroda, to provide the warranty and performance guarantees, respectively. The seven warranty 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. The performance guarantee called for a written demand stating that "the goods have not been supplied according to the contractual obligations" under the said contract. In each of the eight guarantees it was recorded that the Union of India's written demand would be conclusive evidence that such payment was due, which payment would be effected upon receipt of such written demand. These were the principal guarantees between the two parties to the underlying contract (ie, Denel and the Union of India) and they were governed by the laws of India. The two banks of India also required guarantees that Denel (Applicant of the principal guarantees) would pay them if and when they discharged their obligations under the principal guarantees (ie, warranty and performance guarantees) to the Union of India (Beneficiary of the principal guarantees). Therefore, Denel (applicant of the counter-guarantees) requested the South African bank, ABSA Bank Ltd to provide the Indian Banks with eight different counterguarantees (totaling around USD 5 582 714,00).

The counter-guarantees were first demand guarantees/independent guarantees. In terms of the counter-guarantees, 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- guarantees. The counter-guarantees provided that ABSA Bank 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 (ie, performance and warranty guarantees). It should be pointed out that initially (when the matter served before the court of first instance) it seemed that all the counter-guarantees were governed by the South African law (they were all silent as to any governing ICC rules). It was only later, when the matter was heard by the South African Supreme Court of Appeal (discussed below) that it transpired that one of the counter-guarantees was, in reality, subject to the laws of India.

During the course of the contractual relationship between the Union of India and Denel, the Union of India alleged that Denel had breached its contractual obligations and called upon the Indian Banks to pay in terms of the principal guarantees. The Indian Banks (Beneficiaries of the counter-guarantees) duly complied and in turn called upon ABSA Bank to pay the corresponding amounts due in terms of the counter-guarantees. The Union of India stated in their written demands made on the Indian Banks that "the seller has not performed according to the contractual obligations for the goods delivered". At first, ABSA Bank refused to pay contending that the demand made in terms of the counter-guarantees "were not worded under and in terms of the guarantees issued". Later on, ABSA Bank changed its mind and on 25 May 2011 it advised Denel of its intent to make payment at 12:00 on 26 May 2011 in respect of the counter-guarantees in the amount of USD 3 776 197. Denel disputed that Union of India was entitled to make a demand on the principal guarantees and maintained that ABSA Bank was accordingly not lawfully bound to honour the counter guarantees. On 26 May 2011, Denel obtained an urgent interim interdict (injunction) on an ex parte basis against ABSA Bank restraining the Bank from making payment to the two Indian Banks in respect of the counter-guarantees that ABSA Bank had issued pending the finalisation of this application before the court.

Denel had applied specifically for an order interdicting ABSA Bank from making payment to the Indian Banks in respect of the counter-guarantees pending the finalisation of arbitration proceedings, already instituted and pending in India, in respect of the principal guarantees. Denel also sought interdictory relief in India to restrain the Union 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 of India (ie, parties to the underlying contract (sales contract)) in arbitration proceedings in India. The two Indian Banks were also parties to the proceedings in India.

The application for confirming the interim interdict concerning the counter-guarantees was heard by the South Gauteng High Court, Johannesburg (ie, court of first instance). Denel based its application mainly on the two following grounds:

• The demands made by the Union 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 of India's 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 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 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 of India. 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 part or on the part of the two Indian Banks. Thirdly, the demands made by the Union of India on the principal guarantees were compliant. Lastly, ABSA Bank and Denel have waived their rights to refuse to honour the counter-guarantees because of alleged non-conforming demands for payment by the Union of India.

The court of first instance (per Malindi AJ) relying on various authority, 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 of first instance also acknowledged the documentary nature of the principal guarantees and the counter-guarantees. In deciding whether compliant demands were made on the counterguarantees, 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 opinion that the doctrine of strict compliance applied only to letters of credit and substantial compliance applied to the demands made under demand guarantees. The court then referred to OK Bazaars (1929) Ltd v Standard Bank of South Africa Ltd 2002 (3) SA 688 (SCA) where it was 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 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 of first instance stated that the principal and counter-guarantees 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 have been called upon "to make payment under and in terms of [their] guarantee", respectively. Neither the principal guarantors (ie, 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 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 of first instance 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 therefore 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 of first instance concluded that the demands made by the Indian Banks in terms of the counter guarantees on ABSA Bank 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 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. The court also added 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 [ie, Denel]."

The court of first instance was of the opinion that it did not have to determine whether Denel had established fraud against the Union of India of which the Indian Banks had notice of, because that issue was before the courts and the arbitration proceedings in India. Accordingly, the court of first instance confirmed the interdict requested. It effectively interdicted ABSA Bank from making payment in respect of the counter-guarantees, pending the final determination of arbitration and court proceedings in India concerning the principal guarantees.

Legal Analysis:

The parties agreed with the legal principles that applied to demand guarantees and counterguarantees, but differed on the application of these principles to the "peculiar" facts of the case (para 6).

1. Independence (autonomy) principle. The Supreme Court of Appeal (per Fourie AJA with Brand, Bosielo, Theron and Mbha JJA concurring) agreed with the court of first instance's view regarding the independent nature of the eight principal guarantees and the counter-guarantees. It specifically acknowledged the independence of the principal guarantees and the counter-guarantees from the underlying contract between Denel and the Union of India. It also confirmed the independence of the counter-guarantees from the principal guarantees.

2. Documentary nature. The Supreme Court of Appeal acknowledged that demand guarantees were documentary in character. It agreed with the court of first instance's view 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 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. All that was required for payment was, therefore, a demand by the beneficiary, stated to be on the basis of the event specified in the guarantee. Whether or not the demand was compliant would turn on an interpretation of the guarantee (para 9).

3. Fraud exception. The Supreme Court of Appeal confirmed that the only exception to the rule that the guarantor was "bound to pay without demur, is where fraud on the part of the beneficiary has been established" (para 10).

4. Complaint demands. Next the Supreme Court of Appeal considered whether the demands made by the Union of India for payment in terms of the respective principal guarantees, complied with the terms of the relevant guarantees. It pointed out that in each of the seven principal warranty guarantees the written demand made by the Union of India was basically similarly worded, namely, that, as the goods have not been supplied by Denel in accordance with the "contractual obligations" payment in terms of the principal guarantees was demanded. The Supreme Court of Appeal held that it was immediately clear that these demands differed from the wording of the seven principal guarantees which prescribed a demand that Denel had not performed according to the "warranty obligations" under the underlying contract (para 13).

Thereafter, the Supreme Court of Appeal said it was necessary to inquire whether the Indian Banks have addressed written demands to ABSA Bank regarding the counter-guarantees stating that they have been called upon to make payment under and in terms of their corresponding principal warranty guarantees. It said if that was so, then ABSA Bank would be obliged to honour the counter-guarantees without demur, but if not, it would not be liable to make any payment in respect of such guarantees (para 14).

The Court found that in six of the principal warranty guarantees and the corresponding warranty counter-guarantees, the demand was expressly premised on a failure by Denel to comply with its "contractual obligations" and not a failure to comply according to the "warranty obligations" under the contract. Therefore, in these six instances the Indian Bank had not complied with the terms of the counterguarantees. Accordingly ABSA Bank was not obliged to make payment to the Indian Banks under such circumstances (para 17).

The Court then proceeded to deal with the seventh warranty counter-guarantee. The Court pointed out that although the counter-guarantee had the same wording as the other six warranty counter-guarantees, it had an additional paragraph that provided "[t]his counter guarantee shall be governed by and construed in accordance with the Indian laws and is subject to the exclusive jurisdiction of courts in India". The Indian Banks argued that the effect of this clause was to oust the jurisdiction of the South African courts in regard to this specific counter-guarantee. Therefore, the court of first instance should not have interdicted payment on that counter-guarantee. The Supreme Court of Appeal stressed that this defence was not foreshadowed in the Indian Banks' papers in the court of first instance nor was it raised in their application for leave to appeal (para 19).

In dealing with the Indian Banks' submission, the Supreme Court of Appeal stated that it had to be borne in mind that there was a banker-client relationship between ABSA Bank and Denel. Denel had mandated ABSA Bank to make payment in terms of the warranty counter-guarantees and it had to be accepted that Denel was aware of the terms of the counter-guarantees, including this seventh guarantee. It thus follows that if a dispute were to arise regarding this seventh counter-guarantee, Denel would be aware that it would have to be interpreted in accordance with Indian law and be subject to the exclusive jurisdiction of the Indian courts (para 21). The Supreme Court of Appeal held that the court of first instance did not have the jurisdiction to issue the interdict (injunction) in this instance.

Lastly, the Court considered the demand made by the Union of India under the principal performance guarantee issued by one of the Indian Banks, namely State Bank of India and totaling USD 1 197 930,00. As, mentioned above, the demand called for a written demand stating that the goods supplied by Denel were not in accordance with the "contractual obligations". The corresponding counter-guarantee issued by ABSA Bank called for a written demand stating that State Bank of India had been called upon to make payment under and in terms of their principal performance guarantee. The actual demand made by State Bank of India simply stated that a demand had been made to pay the principal performance guarantee "for non-fulfilment of contractual obligations". Again the Supreme Court of Appeal reached the conclusion that this was not a complaint demand and ABSA Bank was not liable to make payment under the performance counter-guarantee (paras 23-25). The Supreme Court of Appeal held that, except for the matter involving the seventh warranty counterguarantee where the South African courts had no jurisdiction, the court of first instance was correct to have interdicted ABSA Bank from paying under the counter-guarantees (para 26). In relation to the costs of the appeal the Court pointed out that although the Indian Banks were successful on appeal in respect of one particular counter-guarantee, the jurisdictional defence upon which it succeeded was only raised on appeal. Therefore, parties had to bear their own costs on the appeal.

The Supreme Court of Appeal agreed with the court of first instance that it was not necessary, while the matter regarding the principal guarantees was still pending in India, to deal with the allegations that the Indian Banks had acted fraudulently.

Comments:

In the court of first instance, it was contended that the doctrine of strict compliance applied only to letters of credit and that a less strict standard was applicable to demand guarantees. In South Africa it is still uncertain what the required standard of compliance is regarding documents that are presented in terms of a letter of credit. It has been implied indirectly in various judgments, including those by the South African Supreme Court of Appeal, that the principle of strict compliance is applicable to letters of credit. However, regarding demand guarantees, it is still uncertain as to whether the principle of strict compliance also applies to demand guarantees. Although the court of first instance in Denel referred to Kelly-Louw's opinion that the principle of strict compliance should also apply to demand guarantees, it is unfortunate that the court not express any views on the topic. It is regretted that the Supreme Court of Appeal in Denel did not seize this opportunity to address this important issue. Although both courts in Denel did not specifically state that the principle of "strict compliance" was applicable to demand guarantees, it does seem based on the facts of this matter that this was, in fact, the standard that the courts had applied when they had found that the various demands were not compliant. The English case of Frans Maas (UK) Ltd v Habib Bank AG Zurich, of course, played a pivotal role in the decisions being reached by both courts in the Denel case.

The decision by the Supreme Court of Appeal cannot be faulted. It is, however, mind boggling how the issue of jurisdiction of the one counter-guarantee could only have been raised during the appeal.

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

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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.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.