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Beneficiary/Landlord told Applicant/Tenant that the premises had been approved by the city; however, the premises did not have the municipal authorization for occupation. Applicant/Tenant later received a letter from the City Council requesting that it discontinue its use of the premises. At that time, Applicant/Tenant owed Beneficiary/Landlord ZAR 1,193,024.54, and Beneficiary/Landlord had started proceedings in the Magistrates Court to recover this amount.

Applicant/Tenant sued Beneficiary/Landlord for an interim injunction preventing Beneficiary/Landlord from drawing on the Demand Guarantee pending the outcome of the case in the Magistrates Court. The High Court of South Africa, Siwendu, J., dismissed the application for an interim injunction and ordered Applicant/Tenant to pay the costs of the application.

Applicant/Tenant claimed that Beneficiary/Landlord had notice of the municipal planning violation and that its misrepresentation concerning the status of the premises constituted a fraud for which the Demand Guarantee should be voided. Applicant/Tenant also alleged it was not aware that the premises were not so authorized, and, had it known, it would not have provided the Demand Guarantee or entered the lease.

The Judge ruled that “[t]he legal nature of a Demand Guarantee as an independent contract…is an established long-standing principle of our law…It is considered akin to an irrevocable Letter of Credit; in that, the Demand Guarantee creates an obligation on the issuing bank to pay the beneficiary regardless of the underlying contract between the beneficiary and the principal.”

Applicant/Tenant contended that because Beneficiary/Landlord deliberately and intentionally withheld and misrepresented information about the premises, the Demand Guarantee should be voided. However, the Judge said that to void a Demand Guarantee there must be “exceptional circumstances recognised in law, proof of fraud relied upon in this case being such a circumstance.” “The fraud alleged must be in respect of the presentation thereof and does not extend to wider contractual inducements for which a bank in the place of [Issuer] cannot be aware.”

The Judge also had to determine whether the illegality of the lease rendered the Demand Guarantee void ab initio, or void from the very start. The Judge stated that, “to receive consideration, the illegality complained of can only be a valid defence where it extends to and directly affects the Guarantee. The Guarantee must have been entered into for a criminal purpose or in furtherance of an unlawful purpose.” However, in this case the “illegality” concerned the representation of the premises to the Applicant/Tenant, not the Demand Guarantee directly, and the Demand Guarantee was not entered into for a criminal purpose or in furtherance of an unlawful purpose. Were the court to allow the Demand Guarantee to be voided when the illegality did not directly concern it, the ruling “would subvert a longstanding payment instrument.”Moreover, the Judge ruled that Applicant/Tenant was not in a financial situation where it could not afford to wait for the outcome of the Magistrates Court’s proceedings and recover the amount Beneficiary/Landlord drew on should Applicant/Tenant succeed. Therefore, the Judge denied the application for an interim injunction.

Comment: The Demand Guarantee stated Beneficiary/Landlord could draw on it “regardless of whether a bona fide and genuine dispute exists with the Applicant on monies owed or issues arising between the First Respondent and the Applicant.” Can the clause be enforced if the Beneficiary/Landlord is shown to have committed forgery or fraud?

[VLG]

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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 the ICC or Coastline Solutions.