Autonomous Demand Guarantees: beneficiary’s belief in validity of its demands and the fraud exception revisited

Recent Court of Appeal decisions provides guidance on validity of demands made under standby letters of credit or other Autonomous Demand Guarantees

Two recent decisions of the Court of Appeal provide useful guidance on the validity of demands made under standby letters of credit or other Autonomous Demand Guarantees provided by way of security in circumstances where a final determination in law on amounts owing under the underlying contract is not available.

Impact

The decisions underline the function of Standby Letters of Credit (SBLCs) to pay against conforming documents notwithstanding disputes between the parties to the underlying contracts, and provide useful analysis of whether the demand made under the SBLCs was correct and whether that is a matter of law or a matter of fact.

Trade risk insurers seeking to assess whether calls may be unfair calls will find the decisions of interest.

Decisions

Novo Banco

In this case, invoices in respect of drilling services rendered by an offshore drilling contractor had not been paid and disputes with the contracting party, a Venezuelan state entity, had been referred to arbitration.

Among the numerous and complex issues arising was the interplay between:

  • A term in the drilling contract which stipulated that disputed amounts be paid and argued over later.
  • The provisions of Venezuelan law (which law governed the drilling contract) which set out a mechanism for State entities to ascertain in the public interest whether an invoiced sum was in fact properly due and payable.

The offshore drilling contractor, as beneficiary of the SBLC, sought to enforce its security. It certified the representation required by the SBLC that there was an underlying payment obligation in respect of the invoices duly submitted under the drilling contract which Article 141 of the Venezuelan Public Contracting Law prevented the Venezuelan State entity from discharging at that time. The signatory asserted that the representation in the certificate was true as a matter of law and of his honest belief and sought to claim against the bank by way of security.

At first instance the English Commercial Court judge held that the Venezuelan State entity was not bound to pay because any underlying liability arising from the invoices could not yet be enforced and there was, in the judge’s view, no present obligation to pay, and the representation was as a result false and the contractor had not been entitled to call for payment under the SBLC.

Following an expedited appeal the Court of Appeal found that the signatory’s understanding of the meaning of the certificate was entirely correct as a matter of law. In the particular circumstances of the case, a statement that the obligor was obligated to pay must be taken to mean that the obligation to pay had accrued due so that the obligor had become liable to make payment even though it was precluded from discharging that liability until the relevant procedure under Venezuelan law had been complied with. The appeal judges considered that the signatory’s understanding not only was not fraudulent but was “consistent with commercial good sense”.

Banco Santander

In this case the Commercial Court judge at first instance had found that the documents presented were on their face in the form prescribed and that the trigger for payment was the claimant’s belief in its entitlement even though that entitlement had not been finally determined.

In its appeal the paying bank argued, amongst a number of points, that there was a real prospect of establishing that no sums were due and owing under the SBLCs because the claim presented had been for unliquidated damages and was in law not a claim for money that was “due and owing”; and further that the only realistic inference on the facts was that the beneficiary claimant could not honestly have believed in the validity of its demand.

In response to the argument that no sum was “due and owing” in law, the Court of Appeal found that this ground of appeal was misconceived because it was the beneficiary’s belief in the validity of its demands which was relevant, not whether the demand was correct as a matter of law. In light of the context in which the SBLCs were issued it must be arguable that the SBLCs constituting performance security covered the sums claimed and could include a claim in respect of unliquidated damages for wrongful termination.

In response to the argument that the beneficiary had no genuine belief that money was due and owing as a result of an alleged wrongful repudiation of the construction contract, the Court of Appeal considered that it would be extremely difficult to establish that the beneficiary was fraudulent in asserting that money was due and owing. It could not be fraudulent to make a demand one is entitled to make. Even if there was in fact no entitlement in law to make the demands, there was nevertheless a strongly arguable case as to such entitlement and the question whether as to the facts there was a real prospect of establishing that the beneficiary could not honestly have believed in the validity of its demands virtually answered itself.