Demand guarantees – some thoughts for banks

A recent judgment will be of interest to banks taking “demand guarantees”. It provides a reminder of the difficulties in ensuring they will work – previous case law established a presumption that where they are not taken from banks, they will not provide the required independent primary obligation – and some assistance in considering what wording in the document can be used to overcome them.

The legal weaknesses of guarantees and the practical difficulties of enforcing them - in particular the risk of challenges based on changes or deficiencies in the guaranteed obligations, or arguments over what amount is actually owed - often lead beneficiaries to require that guarantors accept liability as “principal obligor”. Ideally (from the beneficiary’s perspective), there will be a “demand guarantee” under which they can demand payment of a certain amount, which the guarantor will be obliged to pay without further challenge or investigation. Except when they are given by banks, there is a strong presumption against guarantees being interpreted this way.

In Van Der Merwe and another v IIG Capital LLC, this presumption was overridden by the wording of the guarantee, in particular:

• i) the definition of “Guarantee Monies” – this covered not just all monies owed but all monies “expressed to be due, owing or payable” by the debtor (suggesting the guarantor’s obligations were distinct from the debtor’s obligations);
• ii) that the guarantor undertook its obligations “as principal obligor and not merely as surety”, and would make payment “immediately upon demand” (although these were not, by themselves, conclusive); and
• iii) a clause providing that a certificate by the lender (in prescribed form) stating the amount at any particular time due and payable under the guarantee would, save for manifest error, be conclusive and binding on the guarantor.

It was the last point which, according to the judgment, clinched the argument in this case. The judge held that these three factors, together, were sufficient to override the presumption against this being an “on demand” performance guarantee, and declined to consider whether any of them by itself would have been enough.

This case emphasises the need for clear wording, if a guarantee from a person other than a bank (and, especially, from an individual) is to operate as a “demand guarantee”. It is advisable to ensure there are a range of provisions giving weight to this interpretation, since simply stating that the guarantee is “on demand” and involves liabilities as “principal obligor” may not be enough.

Although the document will always be looked at as a whole, in view of the facts of the individual case, the judgment gives some assistance in predicting what weight the court will attach to certain provisions and forms of wording. It may provide a useful opportunity for banks to review the terms of standard form guarantees in light of this.