South Africa: Guarantees - The Risk Lies In The Wording

Last Updated: 26 September 2011
Article by Jay Da Conceição

Introduction

Contractors and Employers alike both tend to assume that banks and insurers who issue guarantees are experts who understand the consequences of the terminology that they employ in drafting guarantees. Very often these consequences can have unintended results for one of the parties. In the recent unreported decision of Minister of Transport & Public Works, Provincial Government of the Western Cape & Another v Zanbuild Construction (Pty) Ltd & Another 2011 JOL 26880 (SCA), the Supreme Court of Appeal was called upon to interpret the nature of a performance guarantee and to determine the liability in terms thereof.

The Facts

Zanbuild Construction (Pty) Ltd ("Zanbuild") was awarded two projects to build pathology laboratories in Worcester and Paarl for the Provincial Government of the Western Cape ("Provincial Government"). The parties agreed to be bound by the standard terms of the Joint Building Contracts Committee ('JBCC") which required Zanbuild, as the contractor, to provide a performance guarantee. The Provincial Government had its own format of performance guarantee but this was not utilised. Zanbuild instead obtained two guarantees from Absa Bank which were duly submitted and accepted by the Provincial Government ("Guarantees"). The material terms of the two Absa Guarantees were identical in nature.

The Guarantees contained a clause which allowed Absa to withdraw the Guarantees upon providing the Provincial Government with 30 days written notice. On 28 August 2008, Absa notified the Provincial Government that it wished to withdraw the Guarantees. On 26 September 2008, the Provincial Government responded to Absa by demanding payment of the full amount of each Guarantee and advising ABSA that Zanbuild had defaulted on both contracts. A letter from the Principal Agent was attached. The letter from the Principal Agent recorded that Zanbuild was in breach of contract in that it had failed to execute the works with "due skill, diligence, regularity and expedition" and called on Zanbuild to remedy its breach within 10 days, failing which the Provincial Government may cancel the contract.

It came to the knowledge of Zanbuild that the Guarantees had been called. Zanbuild approached the Western Cape High Court for an interdict preventing the Provincial Government from calling the Guarantees and Absa from making payment under the Guarantees. The interdict was granted and the Provincial Government was granted leave to appeal.

Arguments presented at the SCA

The Provincial Government proffered the argument that the Guarantees were independent from the construction contracts in a manner comparable to irrevocable letters of credit issued by banks, in which the banks obligation was wholly independent of the underlying contract of sale. Furthermore, the Guarantees could be invoked without any allegation or evidence. Zanbuild argued that the Guarantees were inextricably linked to the construction contracts in a manner akin to a suretyship agreement and that the bank's liability was limited to the extent that the department could demonstrate a monetary claim against Zanbuild. (It is interesting to note that no penalties had been imposed against Zanbuild and therefore there was no monetary claim made by the Provincial Government).

The dominant question before the SCA was whether the Guarantees were "on demand" guarantees (Provincial Government's argument) or "conditional" guarantees (Zanbuild's argument)? The SCA found support in our law for the distinction between the two types of guarantees. The crux of the matter turned on the interpretation of the terms of the Guarantees.

The SCA analysed the terms of the Guarantees which in themselves contained certain preconditions before payment could be demanded, namely the following:

  • With each payment under the Guarantee the bank's obligation would be reduced;
  • Each claim by the Provincial Government would need to be in writing accompanied by a signed statement that the contractor has failed to fulfil its obligations in terms of the contract; and

After interpreting the Guarantees as a whole, the SCA found that the Guarantees were not "on demand" guarantees but "conditional" guarantees and therefore were akin to surety undertakings.

The SCA rejected the Provincial Government's argument that in order to obtain payment, the Provincial Government had merely to send a claim in writing and a signed statement that the Contractor was in default under the construction contract. Thereafter, the full amount in terms of each Guarantee would be due and payable, on demand.

It should be noted that in the event of a breach of contract by Zanbuild, the Provincial Government could, in terms of the construction contract and via the Principal Agent, deduct penalties from Zanbuild or obtain the services of another contractor at the cost of Zanbuild to complete the works. In both instances, the Provincial Government would have a claim sounding in money and could therefore call against the Guarantees to satisfy the damages it had suffered.

The Provincial Government had, at no time, established that any monies were due to it by Zanbuild in terms of the construction contract and therefore, Absa was not liable to pay any monies to the Provincial Government. The SCA dismissed the appeal with costs.

Our law recognises both forms of guarantee, that is "on demand" and "conditional" guarantees. In the instance of a conditional guarantee, an Employer will need to not only demonstrate a breach of contract by the Contractor but also that an amount of money is due to it before the Guarantor becomes liable for payment.

There is an obvious conflict between the interests of the Employer on the one hand and those of the Contractor on the other hand. The Employer will be seeking a guarantee payment on demand, while the interests of the Contractor dictate that a guarantee equivalent to no more than a suretyship should be offered to the Employer. Thus the right to call under the guarantee must depend upon a careful analysis in each case of the contract as a whole. Consequently, the Employer may not assume that his right to call under the guarantee at any time is adequately entrenched by virtue of the provisions of the guarantee alone simply because the security itself is unconditional. The Employer must also ensure that the terminology used in the principal construction contract enshrines this right, failing which the Contractor may well succeed in relying upon the provisions of that contract to prevent a call under the guarantee in conflict with the provisions of the principal construction contract. The choice of words then becomes of critical importance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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