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

 



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