THE PURPOSE AND CLASSIC USES OF THE DEMAND GUARANTEE 

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CHAPTER 4: INTERNATIONAL INITIATIVES TO PREVENT UNFAIR OR FRAUDULENT CALLS ON DEMAND GUARANTEES AND STANDBY LETTERS OF CREDIT

INTRODUCTION

The International Chamber of Commerce (‘ICC’) ¹ and the United Nations Commission on International Trade Law (‘UNCITRAL’) ² have both been active in seeking a solution to the problems caused by unfair calls on demand guarantees and standby letters of credit. Four instruments that are particularly relevant are (1) the ICC Uniform Rules for Contract Guarantees (‘URCG’); ³ (2) the ICC Uniform Rules for Demand Guarantees (‘URDG’); ⁴ the International Standby Practices (‘ISP98’); ⁵ and (4) the United Nations Convention on Independent Guarantees and the Stand-by Letters of Credit (the ‘UNCITRAL Convention’). ⁶ The first three instruments are, in effect, standard-term contract rules available for incorporation into demand guarantees by the parties; and the adoption of the UNCITRAL Convention by a state has the effect of making it law in that state.⁷
In this chapter particular attention will be paid to the international attempts made by the ICC and UNCITRAL to prevent unfair or fraudulent calls on demand guarantees and standby letters of credit. The chapter also examines which of the ICC instruments and the UNICTRAL Convention departs the furthest from the principle of autonomy in the context of demand guarantees and standby letters of credit. Broadly speaking, the URCG and UNCITRAL Convention have both attempted to protect the principal against unfair calls in a manner that severely weakens the principle of autonomy, whereas the URDG have attempted to effect a compromise between the parties by effectively subjecting all calls on demand guarantees to documentary conditions.

EFFORTS MADE BY THE ICC TO TRY AND PREVENT UNFAIR AND FRAUDULENT CALLS

Uniform Customs and Practice for Documentary Credits

The Uniform Customs and Practice for Documentary Credits (2007 version) (‘UCP 600’) ⁹ contain no provisions that attempt to prevent unfair or fraudulent calls on commercial or standby letters of credit. Neither did their predecessor, Uniform Customs and Practice for Documentary Credits (1993 version) (‘UCP 500’). ¹⁰ The UCP do not deal with the problems that arise where documents presented under a credit are forged or otherwise fraudulent. Article 34 of the UCP 600 goes as far as stating that a ‘bank assumes no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any document’. ¹¹ In fact, the UCP is completely silent on the issue of fraud and the fraud rule. The reason for this, as already mentioned in the previous chapter, is that the UCP were primarily devised to provide a contractual framework for dealings between issuers and beneficiaries, and issuers and correspondent banks. The UCP do not deal with the rights and duties of parties to the underlying contract, nor is it the function of the UCP to regulate issues that are the proper province of national law and national courts. The content and the interpretation of the ICC uniform rules are equally influenced by the fact that their function is to serve as rules of best banking practice, not rules of law; and the fraud rule issue is commonly considered as the province of the applicable national law and of the courts of the forum.¹² Therefore, national laws should deal with any injunctive relief on the grounds of fraud by the beneficiary. The drafters of the UCP 500 and UCP 600 respectively deliberately decided to leave out the fraud issue. Accordingly, the lack of a provision for fraud in the UCP clearly indicates that the intention of the drafters was that the issue of fraud should be determined by the applicable national law.¹³ The difficulty with leaving these issues to national law is that, except in the United States, such cases come so rarely before the courts that there are very limited opportunities to develop a coherent body of rules.¹⁴
The view has been expressed that the decision of the drafters of the UCP 500 not to address the issue of fraud reflected either an unwillingness to tackle a difficult but necessary issue or an outdated view of the limited scope of the UCP as merely a ⁹ See ICC Publication No 600, Paris (2006) (hereinafter the ‘UCP 600’). See also the full discussion of UCP 600 in para 3.2.2 in Chapter 3. codification of bankers’ practices rather than a dispositive regime of rules.¹⁵ It has been said that one of the main weaknesses of the UCP 500 was that it did not address the rights of an applicant of a documentary credit against a bank that proposes to pay on documents that are forged or otherwise fraudulent.¹⁶
Then again, several commentators have welcomed this inactive approach of the UCP as a remarkable success. It is their view that any attempt by the ICC to formulate a uniform fraud rule is unnecessary and bound to fail, since the fraud rule is rather sensitive to national laws and these rules vary among jurisdictions.¹⁷ They contend that the current position of the UCP may generate an incentive for the different jurisdictions to fashion fraud rules that do not interfere with the marketability of credits issued by the jurisdiction’s banks.¹⁸
Xiang Gao disagrees. He is of the view that although it is correct that the UCP are technically not law, but a collection of accepted commercial practices, the truth is that the UCP are currently incorporated into substantially all cross-border documentary credits (and also to a lesser extent into standby letters of credit), studied and observed by letter of credit bankers and users globally, and accordingly, treated as quasi-law of credit. Therefore, the UCP have basically become de facto law.¹⁹ He also says that a good commercial law is one that serves commerce best. A law that serves commerce best maximises certainty and predictability for the commercial world. To have such an effect, a law should provide the best answer it can give to problems that can be predicted. Furthermore, it is debatable whether the UCP satisfy this standard without dealing with the fraud issue. Although the drafters of the UCP knew of this problem and that it caused problems in documentary credit transactions, they still chose not to address it, leaving users of commercial and standby letters of credit without any guidance on how to deal with the fraud they might encounter. Accordingly, this has left both the commercial and standby letter of credit community with a degree of uncertainty and unpredictability.²⁰
What makes matters worse is the fact that national fraud rules are diverse and lacking in clarity.²¹ In such a situation, when a fraud case goes to court and a decision is made, the decision will most likely not be criticised by the letter of credit experts for non-conformity with the practice of the letter of credit community and for being detrimental to the commercial utility of letters of credit. It is therefore ironic that in drafting the UCP, those same letter of credit specialists say that it is for the courts to make the relevant rules. According to Xiang Gao, this is neither logical nor fair to the courts.²²It is true that the letter of credit is a specialised commercial creature and that the law governing it is complex. Even letter of credit specialists are at times perplexed by its complicated structure and the relationships between the parties. Although judges should be legal experts, it is not practical to expect each judge to be an expert in the law of letter of credit or to make good law within the short period of time that a case is before a court. In reality, most trial judges have hardly had any experience with letter of credit matters.²³
I agree with Xiang Gao’s opinion that it is desirable for the drafters of the UCP, who are well-known letter of credit experts, to provide guidance for issues commonly raised during practice, such as the issue of fraud. I also concur with his view that even if a detailed rule is not practical, guidance is better than nothing.²⁴ Schmitthoff had already submitted in 1982 that it would have been desirable for the 1983 version of the UCP²⁵ to have dealt with the problem of fraud.²⁶ It is regretted that the 2007 version of the UCP has again remained silent on the issue of fraud.

Uniform Rules for Contract Guarantees

The URCG²⁷ are aimed at encouraging more equitable practices in the area of contract guarantees (i.e., tender, performance, or repayment guarantees (demand guarantees)), particularly by limiting the problem of unfair calling of these guarantees. Therefore, unlike the UCP, the URCG have attempted to deal with the unfair calling of demand guarantees.²⁸ Of the instruments examined in this chapter the URCG went furthest in protecting the principal against unfair calls.²⁹ It was considered desirable that the URCG should not provide for first demand guarantees payable without any evidence of default. To prevent abuse by unscrupulous beneficiaries, the URCG therefore provide that ‘evidence’ of default by the principal is required to justify the honouring of a claim under a contract guarantee. It can be expected that in most cases the parties to such a guarantee will specify in it what form of evidence is required. Guarantors have been advised to require documentation prepared independently of the beneficiary and in a form capable of verification by the guarantor. For example, a claim under a performance guarantee could be required to be supported by a certificate from specific engineers indicating the defect in the construction or performance of a particular structure.³⁰

^{CHAPTER 1:,GENERAL INTRODUCTION AND THEME OF THESIS .
1.1 GENERAL INTRODUCTION 
1.2 TERMINOLOGY USED IN THE THESIS 
1.3 THEME OF THE THESIS
CHAPTER 2: AN INTRODUCTION TO DEMAND GUARANTEES AND STANDBY LETTERS OF CREDIT
2.1 DEFINITION OF A DEMAND GUARANTEE
2.2 THE PURPOSE AND CLASSIC USES OF THE DEMAND GUARANTEE 
2.3 DEMAND GUARANTEE STRUCTURES: THEIR OPERATION, THE PARTIES INVOLVED AND THE RELATIONSHIPS CREATED
2.4 TYPES OF DEMAND GUARANTEE
2.5 THE LEGAL NATURE, CHARACTERISTICS AND FUNDAMENTAL PRINCIPLES OF DEMAND GUARANTEES
2.6 KEY ELEMENTS IN A DEMAND GUARANTEE
2.7 AMENDMENT TO A DEMAND GUARANTEE
2.8 DEMAND GUARANTEES AND COMMERCIAL LETTERS OF CREDIT COMPARED 
2.9 STANDBY LETTERS OF CREDIT 
2.10 CALLING OF A DEMAND GUARANTEE
2.11 DEMAND FOR PAYMENT IS DEFECTIVE OR LATE 
2.12 INSURANCE AS AN ALTERNATIVE TO DEMAND GUARANTEES 
CHAPTER 3: SOURCES OF THE LAW RELATING TO DEMAND GUARANTEES AND STANDBY LETTERS OF CREDIT
3.1 INTRODUCTION
3.2 RULES OF THE INTERNATIONAL CHAMBER OF COMMERCE
3.3 THE UNCITRAL CONVENTION ON INDEPENDENT GUARANTEES AND
STAND-BY LETTERS OF CREDIT 
3.4 NATIONAL LAWS AND PUBLIC POLICY 
3.5 CASE LAW AND LEGAL WRITINGS 
3.6 SUMMARY AND CONCLUSION 
CHAPTER 4: INTERNATIONAL INITIATIVES TO PREVENT UNFAIR OR FRAUDULENT CALLS ON DEMAND GUARANTEES AND STANDBY LETTERS OF CREDIT 
4.1 INTRODUCTION 
4.2 EFFORTS MADE BY THE ICC TO TRY AND PREVENT UNFAIR AND FRAUDULENT CALLS
4.3 EFFORT MADE BY THE INSTITUTE OF INTERNATIONAL BANKING LAW AND PRACTICE AND INTERNATIONAL FINANCIAL SERVICES ASSOCIATION TO TRY AND PREVENT UNFAIR AND FRAUDULENT CALLS
4.4 EFFORT BY THE UNCITRAL TO TRY AND PREVENT UNFAIR AND FRAUDULENT CALLS
4.5 SUMMARY AND CONCLUSION
CHAPTER 5: THE FRAUD EXCEPTION TO THE AUTONOMY PRINCIPLE .
5.1 INTRODUCTION 
5.2 MEANING OF AND RATIONALE FOR THE FRAUD EXCEPTION 
5.3 BRIEF HISTORICAL DEVELOPMENT OF THE FRAUD EXCEPTION 
5.4 ENGLISH LAW
5.5 AMERICAN LAW 
5.6 SOUTH AFRICAN LAW
CHAPTER 6: ILLEGALITY AS AN EXCEPTION TO THE AUTONOMY PRINCIPLE .
6.1 INTRODUCTION 
6.2 ENGLISH LAW 
6.3 AMERICAN LAW 
6.4 SOUTH AFRICAN LAW 
6.5 ILLEGALITY AND THE UNCITRAL CONVENTION .
6.6 CONCLUSION
CHAPTER 7: INTERIM COURT RELIEF
7.1 GENERAL INTRODUCTION 
7.2 ENGLISH LAW
7.3 AMERICAN LAW
7.4 SOUTH AFRICAN LAW
7.5 UNCITRAL CONVENTION
CHAPTER 8: SUMMARIES, CONCLUSIONS AND RECOMMENDATIONS 
8.1 BRIEF OVERVIEW
8.2 DEFENCES THAT ARE NOT CONCERNED WITH THE AUTONOMY PRINCIPLE
8.3 EXCEPTIONS TO THE AUTONOMY PRINCIPLE 
8.4 INTERIM INJUNCTIONS AND INTERDICTS 
8.5 INTERNATIONAL RULES AND INITIATIVES TO PREVENT FRAUDULENT OR UNFAIR CALLS .
8.6 USE OF INTERNATIONAL RULES LOCALLY
8.7 CODIFICATION OF THE LAW VERSUS THE ADOPTION OF THE UNCITRAL CONVENTION *
8.8 RECOMMENDATIONS 
BIBLIOGRAPHY
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