Under a bank guarantee, the bank undertakes to pay a specified sum to a named beneficiary upon the occurence of certain prescribed events. The real issue arising when considering the question To Pay Or Not To Pay is the contractual interpretation of the guarantee itself, and not any of the surrounding circumstances (ie. disputes between the customer and beneficiary).
An unconditional guarantee is one that requires a simple demand by the beneficiary to the bank to trigger it. Once the demand is made, the bank should honour it, and the Courts tend not to interfere with a bank’s obligation to honour an unconditional guarantee. In RD Harbottle v National Westminister Bank Kerr J succinctly stated that “It is only in exceptional cases that the court will interfere with the machinery of irrevocable obligations assumed by banks. They are the lifeblood of international commerce.”
The second type of bank guarantee is one where some specified event or circumstance must exist or have taken place to trigger the obligation to pay, and the demand must specify it. In Teknik Cekap Sdn Bhd v Public Bank Berhad, the performance bond provided that the bank would pay the contractor if the subcontractor “shall in any respect fail to execute the contract or commit any breach of his obligations thereunder.”
The Court of Appeal held that a simple demand on the performance bond was insufficient to trigger it and that the demand needed to specify the event or circumstance that led to the call on the guarantee.
However, to trigger the guarantee, the beneficiary need only inform the bank in the demand that he does so on the basis provided for in the guarantee and nothing more. The guarantor bank does not have to be satisfied that the event or circumstance exists, nor is the beneficiary required to substantiate its existence.
“Clear Fraud of Which the Bank has Notice”
A guarantor bank is entitled to refuse to pay where there is clear fraud of which the bank has notice. However, fraud must be established, it must be on the guarantee itself and not on any other document, it must be specifically pleaded and proved, and the evidence of fraud must be clear, both as to the fact of fraud and as to the bank’s knowledge.
A bank may refuse to honour a demand on a guarantee where the demand has not been made within the validity period of the guarantee or, in the case of a conditional guarantee, where the beneficiary does not inform the bank in the demand that he does so on the basis provided for in guarantee.
A further ground to refuse payment is where there is clear evidence that the demand on the guarantee is clearly tainted by fraud. Other than these reasons, banks should honour the demand.
Whilst there may even exist commercial reasons to avoid or delay honouring a valid demand on a guarantee (particularly where the value of the security taken from the customer is a mere fraction of guaranteed amount), banks should refrain from doing to avoid needless litigation and, consequently, costs and damages against the bank. Far more importantly, banks should avoid damage to its reputation.
Azlan Sulaiman (email@example.com)