The Documentary Nature of Demand Guarantees and the Doctrine of Strict Compliance (Part 1)

• Jurisdiction: South Africa
• Citation: (2009) 21 SA Merc LJ 306
• Published date: 25 May 2019
• Pages: 306-321
• Date: 25 May 2019

The Documentary Nature of Demand Guarantees

and the Doctrine of Strict Compliance (Part 1)*

MICHELLE KELLY-LOUW**

University of South Africa

1 Introduction

A‘demand guarantee’ is usually a concise and simple instrument issued by

a bank (or other f‌inancial institution) under which the obligation to pay a

benef‌iciary a f‌ixed or maximum sum of money arises merely upon the making

of a demand for payment in the prescribed form and sometimes also the

presentation of documents as stipulated in the guarantee within the period of

validity of the guarantee.

1

Many demand guarantees are payable on f‌irst

demand without any additional documents, which ref‌lects their origin in

replacing cash deposits,

2

although increasingly guarantees require at least a

* This article is based on portions of chapter 2 of Michelle Kelly-Louw Selective Legal Aspects of

Bank Demand Guarantees (unpublished LLD thesis, University of South Africa (2008)).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

See David Warne& Nicholas Elliott Banking Litigation 2 ed (2005) at 277; Matti S Kurkela Letters

of Credit and Bank Guarantees Under International Trade Law 2 ed (2008); and James O’Donovan &

John C Phillips The Modern Contract of Guarantee English ed (2003) at 525.

2

A person (eg, 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, 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 to

serve as a form of security that the counterparty would indeed perform the undertaken obligation.

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 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 3ed

(2004) at 2). Later, when the international trade expanded this practice of furnishing cash deposits, it

became prohibitively expensive for the counterparty to do so. 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, namely the provision of a written undertaking by a bank in favour of the buyer or employer,

payable on demand (see Roy Goode Guide to the ICC Uniform Rules for Demand Guarantees 1992 ICC

Publication No 510 (hereinafter the ‘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; and 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 P O’Brien ‘Letters of Intent and Demand Guarantees’ (1993) ABLU (a paper

delivered at the 1993 Annual Banking Law Update held at the Indaba Hotel, Johannesburg) 134 at

157-8). Today such payment undertakings are known by various names, such as ‘independent

undertakings’, ‘performance bonds/guarantees’, ‘tender bonds/guarantees’, ‘independent (bank)

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

undertakings’ (see M Coleman ‘Performance Guarantees’ [1990] Lloyd’s Maritime and Commercial

Law Quarterly 223 at 223). In addition to these common names, these payment undertakings are also

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(2009) 21 SA Merc LJ 306

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statement indicating that the principal is in breach.

3

Therefore, a demand

guarantee is like a substitute for cash

4

and must be honoured on presentation

of a written demand that complies with the provisions of the guarantee.

5

Today demand guarantees are an established part of international trade,

particularly in overseas construction and engineering projects, and interna-

tional sale of goods contracts. They are also often used locally. For example,

when a supplier tenders for the supply of goods or services to the South

African Government he must comply with the government’s general

conditions of contract, which often require that potential suppliers must

provide tender guarantees (a type of demand guarantee).

In essence, the demand guarantee shares many of the characteristics of the

commercial and standby letter of credit.

6

Demand guarantees, standby letters

of credit and commercial letters of credit are all treated as autonomous

contracts the operation of which will not be interfered with by courts on

grounds immaterial to the guarantee or credit itself.

7

The idea in the

documentary credit transaction or demand guarantee transaction is that if

the documents (where applicable) presented are in line with the terms of the

credit or guarantee then the bank has to pay, and if the documents do not

correspond to the requirements then the bank must not pay. In this article

the documentary nature of the demand guarantee, as well as that of the

commercial and standby letter of credit, will be discussed.

A question that troubles bankers and lawyers is how strictly the documents

must conform to the terms of the demand guarantee and letter of credit. Is the

standard a strict one, so that even the most minor deviations entitle the bank to

refuse payment and, indeed, oblige it to do so unless otherwise authorised by

the applicant or principal of the credit or guarantee? Or is it a standard of

substantial compliance in terms of which deviations that the bank has no

reason to believe are of commercial signif‌icance are ignored? Or does the law

adopt another standard – a bifurcated standard (ie, strict compliance in suits

by the benef‌iciary against the issuing bank or guarantor, but only substantial

compliance in suits by the applicant or principal against the issuing bank or

guarantor) – in terms of which the bank is free to invoke a strict standard of

commonly known as ‘standby letters of credit’. The term ‘demand guarantee’ is the preferred term used

in this article to refer to this type of payment undertaking.

3

See also O’Brien op cit note 2 at 159.

4

See Intraco Ltd v Notis Shipping Corporation (The ‘Bhoja Trader’) [1981] 2 Lloyd’s Rep 256 (CA)

at 257.

5

See SITPRO’s Financial Guide: Demand Guarantees (2007) at 2 (available at http://

www.sitpro.org.uk,visited on 3 May 2009). (SITPRO was formerly the Simpler Trade Procedure Board;

a non-departmental public body for which the United Kingdom Department of Trade and Industry has

responsibility.)

6

At present, South Africa has limited literature on demand guarantees; therefore guidance is found

by looking at similar South African case law dealing with commercial and standby letters of credit and

applying these similar principles to demand guarantees. The South African courts also f‌ind guidance by

looking at how other jurisdictions, in particular the English courts, deal with these issues. Therefore, no

discussion (including this article) of demand guarantees will be complete without containing references

to commercial and standby letters of credit and the English law.

7

See Bertrams op cit note 2 at 2-3; and Friedrich Schwank ‘Electronic International Bank Guarantees

and Letters of Credit’ (1991) 13 Comparative Law Yearbookof International Business 317 at 317.

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