Guarantees and court intervention without fraud
It is a well-established
principle that demand guarantees are independent of the underlying contract –
and when a complying demand is made, then the guarantor must pay. Full stop. Or
rather “half stop” – because you have of course the “fraud exception” …. i.e.
the principle that the only excuse for not paying out under at demand guarantee
is fraud. In fact it must be more than an “excuse” – there must be proof … or
perhaps rather: there must be a court instructing the guarantor not to pay. And
in such case – the guarantor must not pay, because a court is “above” the
guarantee instrument. Full stop. Or perhaps rather “9/10 stop” …. Because just
the other day, a good friend of mine made sure that an old court case landed in
my mailbox.
This court
case shook me to my foundation. Here a judge stopped a payment under a demand
guarantee – even though there was no fraud. Okay this would not be the first
time in history that a judge has done that. However in the other cases that I
know of it has been due to ignorance of the judge. In this case however it is
clear that there is a judge that knows what he is talking about – and presents
some really convincing – and sound – arguments.
So
basically I wanted to share the case with you here …. So here goes:
The case is
know as “Kvaerner Singapore Pte Ltd v UDL Shipbuilding (Singapore) Pte Ltd [1993]
SGHC 146” – and the details are as follows:
The
plaintiff was the seller and the defendant the buyer in an agreement for the
sale of goods worth one million USD. The buyer was required to pay 30% of the
purchase price and the seller to furnish the buyer with a performance bond for
an equivalent amount.
The
performance bond was to be valid until the delivery of the equipment by the
seller to the buyer. After delivery of the equipment, the amount of the
performance guarantee was to be reduced to 10% of the total purchase price and
continue to be valid up to the commissioning of the system or until a specified
date, whichever was earlier.
In addition
the buyer was required to pay the balance of the purchase price amounting to
USD 700,000 by an LC.
The buyer
had deposited USD 300,000 but failed to establish the LC as they had
undertaken. Notwithstanding the buyer’s failure to establish the LC, the seller
said that they delivered on 5 June 1992 equipment to the buyer for USD 14,200
in value without receiving any payment. In June 1992 the buyer were informed
that the goods were ready for shipment. Yet there was still no LC established.
The seller informed the buyer that in the event the LC was not issued before 1
November 1992 they would treat the buyer as having repudiated the sale of goods
agreement. Notwithstanding this no LC was established by the buyer.
The buyer did
however get around to call on the performance bond, which made the seller apply
for an interlocutory injunction to restrain the guarantor from paying out under
the performance bond.
During the
court case the buyer invoked the principle that except in cases of established
fraud known to the guarantor of the performance guarantee he cannot be
restrained from making payment on the ground that the party to the underlying
contract disputes liability. The judge however noted that this it is not an
immutable principle of universal application, and has no application where the
injunction is sought against a party to the underlying contract who seeks to
take advantage of the performance guarantee where by his own volition he fails
to perform a condition precedent in the sense described in this case.
The judge
further stated that a demand under the performance guarantee can be made only
when “the seller has failed or refused to fulfil his obligations under the
contract”. The seller’s failure or refusal is a condition precedent to the
buyer making a demand. An assertion to that effect is implied in a demand made
by the buyer. In circumstances where it can be said that the buyer had no
honest belief that the seller has failed or refused to perform his obligation,
a demand by the defendants/buyers in his view is a dishonest act which would
justify a restraint order. On the facts of the case a demand made by the buyer
was utterly lacking in bona fides.
So all in
all a somewhat troubling case for the independence of the guarantee instrument
… but also a great win to the very sound logic that one party can not with one
hand 1) not do what he is supposed to, and with the other 2) claim under the
guarantee.
Just
thought I wanted to share with you …
Take care
of each other – and the LC!
Kim