In this alert we ask: What is the status of on-demand guarantees? Should commercial local banks concern themselves with force majeure events affecting the underlying contract between for instance a tenant and a landlord to the bank guarantee? Does it matter that the occurrence of the event triggering the guarantee came about due to COVID-19?
Status of the on-demand guarantee
An “on demand” bank guarantee establishes a contractual obligation on the part of the guarantor to pay the beneficiary on the occurrence of a specified event and is independent of the underlying contract which gave rise to the guarantee. Regardless of a dispute between the parties to the underlying contract, the guarantee must be paid on demand. The South African common law position was defined in the Supreme Court of Appeal when it stated in the matter between State Bank of India and another v Denel Soc Limited  2 All SA 152 that “a bank issuing an on demand guarantee is only obliged to pay where a demand meets the terms of the guarantee. Such a demand, which complies with the terms of the guarantee, provides conclusive evidence that payment is due.”
What obligations, if any, does the bank have towards third parties?
A guarantee constitutes an autonomous agreement between the guarantor and beneficiary party and must be paid according to its terms. The Supreme Court of Appeal made it clear in First Rand Bank Ltd v Brera Investments CC 2013 (5) SA 556 (SCA), stating that: “A guarantee of this nature must be paid according to its terms, and liability under it is not affected by the relationship between other parties to the transaction that gave rise to its issue”. Put differently, the guarantee agreement is not tied to the underlying agreement which gives rise to the obligation between, for example, a retail tenant and retail landlord. It is a separate agreement, with distinguishable obligations and to which the third party, in this example the retail tenant, is not party to.
A third party thus cannot prevent payment of the on-demand guarantee when all the requirements as set out in the specific guarantee have been met – it is for the guarantor (the bank) to determine whether the conditions are met. Notably, our common law also recognises that where the payment mechanism in the guarantee is “payment on first demand”, that such form of payment does not require any proof of default from, for instance, the retail tenant.
When a demand is received, a bank has to determine whether the terms and conditions set out in the guarantee itself have been met, and once that is the case, then it has an obligation to perform in terms of the guarantee. It is generally sufficient for the guarantor to rely on the statement of events presented by the person (who would have to be entitled to do so and have the requisite representative authority) demanding payment. The guarantor (the bank) must determine, based on the documents alone, whether they appear on the face of it to comply with the terms and conditions of the guarantee. This must be done without consideration whatsoever to the underlying contract or a dispute between the third party and beneficiary of the guarantee. There is thus no duty on the bank to look behind the demand or matters between the beneficiary and third party at the time of assessing whether it should pay or not. All it has to do is to satisfy itself that the beneficiary complied with the formal requirements set out in of the on-demand guarantee.
Presence of fraud
“The only exception to the rule that the guarantor is bound to pay without demur, is where fraud on the part of the beneficiary has been established. The party alleging fraud has to establish it clearly on a balance of probabilities”: The Supreme Court of Appeal stated in State Bank of India and another v Denel Soc Limited  2 All SA 152 (SCA).
Fraud is defined as the unlawful and intentional making of a misrepresentation which causes actual prejudice or which is potentially prejudicial to another. It is likely that banks may be faced with a situation where a party to the underlying agreement claims that, due to the presence of force majeure causing their inability to perform (and thus triggering the guarantee), a claim for payment by the beneficiary amounts to fraud. Our courts have yet to deal with the merits of such a contestation and until such time, a mere claim of potential fraud by a third party is not enough to prevent a bank from paying in terms of the guarantee.
As stated above, all that is required in law of the guarantor in this situation is to evaluate the claim for payment against, and based on, the conditions set out in the guarantee itself. If the conditions have been met, the guarantor is required to pay in terms of the guarantee and cannot be held liable for such action.
To mitigate the risk, especially in circumstances where, for instance, a tenant notifies a bank that it disputes the obligation to pay rental during the national lockdown, banks must consider giving a tenant notice when a demand is received from a landlord for payment in terms of the guarantee. This will afford the tenant the opportunity to approach a court for an interdict to be granted against payment in terms of the guarantee, pending the outcome of the dispute between the tenant and the landlord.
Impact of COVID-19
In the midst of uncertainty surrounding COVID-19 and a variety of force majeure events rippling through various industries, on-demand bank guarantees appear to be relatively unaffected. In the regulations issued by Government under the national lockdown imposed as a result of COVID-19, it specifically makes provision for the continued operations of banks as “essential services”. Banks, and the payment of bank guarantees, can continue to function as normally as possible under the circumstances.
As already mentioned, a guarantee constitutes a separate agreement, with distinguishable obligations to the agreement underlying the guarantee. Therefore, if the underlying agreement is affected by COVID-19 (in that the “trigger event” for payment of the guarantee came about as a result of a force majeure), this does not necessarily mean that the force majeure is of any relevance to the bank, unless:
1) The guarantee agreement itself makes provision for a force majeure event or the guarantee is subject to the international Uniform Rules on Guarantees (URDG 758), which makes provision for force majeure; or
2) Government issues directions that directly impact on the banks’ ability to perform due to economic measures it elects to enforce to assist business during the COVID-19 lockdown.
In these uncertain times, beneficiaries of on-demand guarantees have, at the very least, some certainty regarding the payment of such a guarantee if the beneficiary is able to show that it has met all the conditions set out in the guarantee and that they have lawfully made a demand. Despite the presence of COVID-19, the subsequent impact of the nation-wide lockdown and the economic uncertainty that has come with it, an on-demand guarantee should be able to live up to its name: payment is guaranteed, on-demand.