A Commercial Court decision earlier this month has considered the extent to which the principle of strict compliance applicable to letters of credit also applies to on-demand guarantees. The decision suggests a broader approach is to be adopted to on-demand guarantees and performance bonds. The decision also contains an interesting finding that the prescribed means of communicating a demand under the guarantee in question was not mandatory and that a valid demand could be made by other means.
MUR Joint Ventures BV v Compagnie Monegasque de Banque
MUR entered into a joint operations agreement with Seatrade for the chartering and operation of a bulk carrier. Seatrade’s obligations under the agreement were secured by an on-demand guarantee issued by a Montenegrin bank (the “Bank”). MUR alleged that Seatrade had failed to make payments due under the agreement and made a demand under the guarantee.
The guarantee required the Bank to make payment to MUR “forthwith upon written demand sent to the bank by way of registered mail to the above mentioned bank’s address”. The guarantee also required certain authorisation and authentication requirements to be complied with.
Seatrade objected to the demand on the grounds that the authorisation and authentication requirements had not been complied with and that the demand had not been sent by registered mail. The Bank refused to pay and MUR commenced proceedings against the Bank.
Strict compliance required?
The court upheld MUR’s demand, finding that the authorisation and authentication requirements had been complied with and that the failure to send by registered mail did not invalidate the demand. There was no question that the demand had been received by the Bank. The requirement for registered mail was “directory, not mandatory … because the guiding principle is one of effective presentation of a demand”.
In reaching its conclusion, the court considered the correct approach to the interpretation of on-demand guarantees and noted that a rule of strict compliance applied to letters of credit: “It is hallowed law that payment can be refused under a letter of credit for what may seem to the presenter to be trivial or insignificant.” However, the court noted that “[t]he principle of strict compliance does not necessarily apply to demand guarantees”. The court relied in this regard on an earlier decision of the English Court of Appeal in IE Contractors Ltd v Lloyds Bank Plc which emphasised that the question is one of contractual interpretation and that “[t]he degree of compliance required by a performance bond may be strict, or not so strict.”
Conclusions and implications
This case is likely to have a number of implications for transactions involving on-demand guarantees or performance bonds, which are frequently used on international construction projects and in international commerce generally. The court’s finding that the prescribed means of making a demand need not be strictly complied with, so long as the demand has been effectively presented to the bank, may come as a surprise to some. The fact that such a demand must be complied with immediately by the bank and involves the payment of large amounts of money may have been thought to require strict compliance with any stipulated means of communication.
The court’s conclusion that the principle of strict compliance does not necessarily apply to on-demand guarantees, as opposed to letters of credit, is likely to be of more general application. Earlier this year, we reported on the Scottish Case of South Lanarkshire Council v Coface (see our Law-Now here) where a similar conclusion was reached in reliance on the IE Contractors decision.
Although the proposition that a performance bond must be interpreted in accordance with its terms is uncontroversial, the IE Contractors decision suggests that an inherent distinction is to be made between on-demand guarantees or performance bonds on the one hand and letters of credit on the other. Lord Justice Staughton in IE Contractors commented that:
“… there is less need for a doctrine of strict compliance in the case of performance bonds, since I imagine that they are used less frequently than letters of credit, and attract attention at a higher level in banks. They are not so much part of the day-to-day mechanism of ordinary trade. And….the kind of documents which they require is usually different from the kind required under a letter of credit.”
IE Contractors was decided in 1990 and more recently the existence of such a distinction has been challenged. In Sea-Cargo Skips AS v State Bank of India (2013), Teare J noted that:
“The distinction suggested by Staughton LJ between letters of credit and performance bonds has not met with universal approval … For my part I would respectfully doubt that there is less need for a doctrine of strict compliance in the field of performance bonds than in letters of credit.”
More recently still, the Privy Council has noted that: “The principles governing letters of credit are as much applicable to letters of indemnity of the present nature, as well as other forms of on demand guarantee.” (Mauri Garments Trading and Marketing Ltd v The Mauritius Commercial Bank).
Whilst the present case appears to affirm the broader position taken in IE Contractors, it is likely that further clarification will be needed from the Court of Appeal before a settled position on this issue begins to emerge.
IE Contractors Ltd v Lloyds Bank Plc  2 Lloyd’s L R 496