The Future of Consumer Credit Regulation

Emergence of Illegality in the Underlying Contract as an Exception to the Independence Principle of Demand Guarantees

“…This will be the situation where it is against specific legislation to issue a demand guarantee in favour of beneficiaries from specific countries (eg, where the beneficiary is a citizen of a country considered to be a foreign enemy of the state or where the outbreak of war makes the beneficiary such a foreign enemy). 58 Where the demand guarantee is itself illegal but the underlying contract is legal, the principle of independence does not come into play and no problem arises as a result of that principle. 59 Furthermore, if both the demand guarantee and the underlying contract are illegal for the same reason (eg, under the same prohibition), the illegality of the demand guarantee is not influenced by the independence principle, because the guarantee is illegal itself instead of through illegality in the underlying contract.…”

“…60 It has also been argued correctly that South African courts are unlikely to arrive at a different conclusion regarding instances where the guarantees themselves are illegal. 61 Although no South African court has dealt with such matters or expressed opinions on them, support for some of the aforementioned views regarding guarantees that are themselves illegal may be found in the Mattress House judgment 62 (discussed below).…”

“…However, what is less certain is whether South African courts will have a similar view in the case where the demand guarantee itself is contrary to the law, public policy or good morals of a foreign jurisdiction (country). 63 It is true that it should not make any difference whether the demand guarantee is illegal in terms of South African law or the law of another jurisdiction. 64 However, on condition that it can be confirmed to be contrary to the law that is applicable to the demand guarantee or the law of the place of execution (performance) of the guarantee, the South African courts should not enforce such guarantees.…”

“…To our knowledge, the English Court of Appeal and the House of Lords have not yet specifically accepted the illegality of the underlying contract as constituting an exception to the independence principle of demand guarantees or letters of credit. 101 As many of the statements made by the courts in the Mahonia cases, particularly by Cooke J, regarding the acceptance of the illegality exception to the independence principle were merely made obiter, the illegality exception remains fairly controversial under English law and its ambit remains unsettled. 102 For instance, the following issues remain speculative: the precise application of the illegality exception; the specific types (degree) of illegality that would be considered sufficient to constitute an exception (ie, 'illegality' and 'taint' as concepts); 103 the difficulty in determining whether a specific illegality is serious or trivial; 104 what state of mind the beneficiary and the issuer must be in at the time of presentation for payment (ie, does it have knowledge of the illegality or not and when the knowledge must be known); 105 and the precise standard of proof 106 that is required.…”

“…Before the Mattress House case, 117 there were no other reported cases in South Africa where the courts had indicated their willingness to accept or even consider the possibility that illegality in the underlying contract could, in exceptional cases, constitute an exception to the independence principle of demand guarantees or letters of credit. 118 The only support for accepting such illegality as an exception was found in the writings of a few South African academic writers. 119…”