Initiatives of the International Chamber of Commerce to Prevent Fraudulent Calls on Demand Guarantees and Standby Letters of Credit

• Jurisdiction: South Africa
• Author: Michelle Kelly-Louw
• Citation: (2009) 21 SA Merc LJ 710
• Date: 25 May 2019
• Pages: 710-733
• Published date: 25 May 2019

Initiatives of the International Chamber of

Commerce to Prevent Fraudulent Calls on

Demand Guarantees and Standby Letters of

Credit*

MICHELLE KELLY-LOUW**

University of South Africa

1 Introduction

A person (eg, a buyer or employer for construction work) planning to enter

into a contract for the purchase of goods or the construction of works by the

intended counterparty to the contract (eg, a seller, exporter, supplier or

contractor) may wish to have security for the counterparty’s performance of

his obligations, especially when no previous dealings have taken place

between them. In the past, it was common practice in international and local

transactions to require the furnishing of a cash deposit

1

to serve as a form of

security that the counterparty would indeed perform the undertaken

obligation. Later, when international trade expanded, this practice of

furnishing cash deposits became prohibitively expensive for the counterparty to

comply with. It was difficult for sellers, exporters, suppliers and contractors

to survive the strain on their cash f‌low if they had to rely on their own

resources to furnish the cash deposits, and therefore the assistance of

f‌inancial institutions became essential in this regard. In due course, this

practice was replaced with a safer and more convenient practice: the

provision of a written undertaking by a bank in favour of the buyer or

employer, payable on demand.

2

Nowadays such payment undertakings are known by various names, such

as ‘independent undertakings’, ‘performance bonds/guarantees’, ‘tender

* This paper is based on portions of chapters 1, and 3-4 of Michelle Kelly-Louw Selective Legal

Aspects of Bank Demand Guarantees (unpublished LLD, University of South Africa (2008)).

** BIuris LLB LLM LLD (Unisa) Dip Insolvency Law and Practice (UJ). Associate Professor in the

Department of Mercantile Law, School of Law,University of South Africa.

1

Post-dated bills of exchange were also sometimes used, but because of the risk of non-payment, this

practice was not popular and cash deposits that guaranteed payment were preferred. See also Roeland

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 3ed

(2004) at 2.

2

See Roy Goode Guide to the ICC Uniform Rules for Demand Guarantees 1992 ICC Publication No

510 (hence ‘Guide to the URDG’) at 8. The use of these undertakings seemed to have begun in

international trade transactions as a means of ensuring the performance of a party to the contract (see

Michael Brindle & Raymond Cox (eds) Law of Bank Payments 3 ed (2004) in par 8-026 at 673). For a

brief discussion of their history and origin, see R Perrignon ‘Performance Bonds and Standby Letters of

Credit: The Australian Experience’ (1991) Journal of Banking and Finance Law and Practice 157; and

Patrick O’Brien ‘Letters of Intent and Demand Guarantees’ ABLU 1993 (a paper delivered at the 1993

Annual Banking Law Update held at the Indaba Hotel, Johannesburg) 134 at 157–8.

710

(2009) 21 SA Merc LJ 710

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bonds/guarantees’, ‘independent (bank) guarantees’, ‘demand guarantees’,

‘f‌irst demand guarantees’, ‘bank guarantees’, and ‘default undertakings’.

3

In

addition to these common names, these payment undertakings are also

commonly known as ‘standby letters of credit’. However, although the standby

letter of credit is in essence the same type of instrument as the demand

guarantee,

4

the standby letter of credit has a historical development very

different from that of the demand guarantee. Standby letters of credit were

developed by banks in the United States of America as an extension of the idea

of the traditional (commercial) letter of credit used in international sales

contracts.

5

Banks in the United States developed the use of standby letters of

credit as a result of the accepted construction of the United States’ National

Bank Act of 3 June 1864 (as amended) which precluded the United States

banks from giving guarantees as part of their banking business. As those banks

were initially not permitted to issue guarantees, they adopted the term ‘standby

letter of credit’ to avoid the language of guarantees.

6

Other countries whose

banks were similarly precluded from giving guarantees, eg, Japan, also

3

See M Coleman ‘Performance Guarantees’ [1990] Lloyd’s Maritime and Commercial Law

Quarterly 223 at 223. The terminology surrounding these types of independent payment undertaking

referred to is rather confusing. It is important to note that these terms have no unique legal content (ibid;

and O’Brien op cit note 2 at 135). The fact that exporters, bankers and insurers rather than lawyers

developed them has contributed to the confusion in this area of the law. Another reason for the

confusion in terminology is the fact that different instruments are used internationally.Often the form of

the instrument is determined by a potential contracting party in another country who insists upon the use

of that form in order for the contract to be made. As a result, some of the terms used are often inaccurate

from a legal point of view, but well understood by the businessperson (see Anthony Pierce Demand

Guarantees in International Trade (1993) at 4). From a legal viewpoint, these various terms are all

legally synonymous in their essential character (see Guide to the URDG op cit note 2 at 8). The most

important point to remember here is the fact that the nature and contents of the obligations created by

such independent payment undertakings are not established by their label (title or heading), but by the

substance and construction of the undertaking (see also O’Brien op cit note 2 at 135). Therefore, as there

is no real consistency in terminology used in relation to these types of independent undertaking, it will

always be necessary to analyse the substance of the particular instrument in order to see which legal

category it falls into (see David Warne& Nicholas Elliott Banking Litigation 2 ed (2005) at 273–4). The

term ‘demand guarantee’ is the preferred term used in this article to refer to this type of payment

undertaking, because it is the term used in the International Chamber of Commerce’s Uniform Rules for

Demand Guarantees (see ICC Publication No 458 Paris (1992)) (hence ‘the URDG’). Article 2(a)ofthe

URDG def‌ines a demand guarantee as follows:

‘For the purpose of these Rules, a demand guarantee (hereinafter referred to as ‘‘Guarantee’’)

means any guarantee, bond or other payment undertaking, however named or described, by a bank,

insurance company or other body or person (hereinafter called the ‘‘Guarantor’’) given in writing

for the payment of money on presentation in conformity with the terms of the undertaking of a

written demand for payment and such other document(s) (for example, a certif‌icate by an architect

or engineer, a judgment or an arbitral award) as may be specif‌ied in the Guarantee, such

undertaking being given

(i) at the request or on the instructions and under the liability of a party (hereinafter called ‘‘the

Principal’’); or

(ii) at the request or on the instructions and under the liability of a bank, insurance company or any

other body or person (hereinafter ‘‘the Instructing Party’’) acting on the instructions of a

Principal to another party (hereinafter the ‘‘Benef‌iciary’’).’

Furthermore, the use of the word ‘bank’ in conjunction with the abovementioned terms is merely

indicative that the bank issued the undertaking and will act as the guarantor of it.

4

See AN Oelofse The Law of Documentary Letters of Credit in Comparative Perspective (1997) at

62.

5

See Bertrams op cit note 1 at 2.

6

Idem at 5–6. The power of the banks in the USA to issue letters of credit and other independent

undertakings (ie, demand guarantees) payable against documents without factual investigation into the

underlying relationship was f‌inally recognised in the 1996 Interpretive Ruling of the Comptroller of

INITIATIVES OF THE INTERNATIONAL CHAMBER OF COMMERCE 711

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