Article

Factual Summary: A building contractor entered into a written agreement with a property developer for the construction of a residential development. Pursuant to the agreement, the building contractor (Principal) furnished the property developer (Beneficiary) with a construction guarantee. The guarantee was issued by an insurance company (Guarantor) and underwritten by a third party (Surety).

Clause 5 of the construction guarantee provided:

"Subject to the guarantor's maximum liability referred to in 1.0 or 2.0, the Guarantor undertakes to pay the Employer the Guaranteed Sum or the full outstanding balance upon receipt of a first written demand from the Employer to the Guarantor . . . stating that:

5.1 The Agreement has been cancelled due to Contractor's default and that the Construction Guarantee is called up in terms of 5.0. The demand shall enclose a copy of the notice of cancellation" (Emphasis added.)

During the course of the construction, disputes arose between Principal and Beneficiary. Eventually Beneficiary cancelled the construction contract and demanded payment of the construction guarantee from Guarantor. Beneficiary presented a demand, attaching notice of cancellation which stated that the cancellation of the construction contract was due to the default on the part of Principal.

Principal disputed Beneficiary's right to terminate the construction contract and to draw on the construction guarantee. Principal also informed Guarantor that Beneficiary had committed a material breach of the construction contract and that because of this breach Beneficiary was not entitled to cancel the agreement and to receive payment in terms of the construction guarantee. Guarantor advised Principal that, unless an interdict prohibiting the payment was obtained, it would be obliged to make payment to Beneficiary.

Subsequently, the disputes between the parties were referred to arbitration. However, pending resolution of this dispute, Principal approached the High Court, moving for an order (interim interdict) restraining Guarantor (second respondent) and the Surety (the underwriter) from paying Beneficiary any amount claimed in terms of the construction guarantee. Guarantor did not oppose the relief sought. The application was granted in the form of a rule nisi (i.e., on the return date the beneficiary had to show cause why an interim interdict should not be granted). On the return day, Beneficiary (first respondent) raised the point in limine that it was entitled to payment of the construction guarantee because it had complied with the conditions set out in the guarantee (in clause 5, quoted above) for receiving payment and that the dispute raised by Principal did not constitute a ground for non-payment or for delaying payment. The Court agreed and discharged the rule and no interdict was issued.

Legal Analysis:

1. Independence Principle; Interdict (Injunction): Counsel on behalf of Beneficiary argued, using Loomcraft Fabrics CC v Nedbank Ltd and another 1996 (1) SA 812 (A) as authority, that the construction guarantee was analogous to an irrevocable documentary credit where the payment obligation was wholly independent of the underlying contract. Furthermore, an interdict restraining payment could only be granted in exceptional cases, for instance, where there was proof of fraud on the part of Beneficiary.

The autonomy principle of the construction guarantee was also acknowledged in clause 3 of the construction guarantee that provided (see in para 23):

"Any reference in this Guarantee to the agreement is made for the purpose of convenience and shall not be construed as any intention whatsoever to create an accessory obligation or any intention whatsoever to create a suretyship." (Emphasis added.)

Therefore, the Court held that the alleged disputes between Principal and Beneficiary in terms of the underlying contract were irrelevant to the construction guarantee. Guarantor did not take part in the court proceedings and had not contended any reason why it should not pay the guarantee to Beneficiary. It was Principal that requested the court to go behind the terms of the guarantee. The Court stated that it could not do so. It confirmed that the parties to the construction guarantee were Guarantor and Beneficiary. Therefore, Principal played no part in it.

2. Fraud: As the beneficiary had complied with the provisions (see clause 5 quoted above) of the construction guarantee, and there was no evidence that the beneficiary had committed fraud, the guarantor was obliged to comply with the terms of the guarantee (see para 28). Therefore the rule nisi was discharged and no interim interdict was granted.

Comments:

The Court correctly upheld the autonomy principle of the construction guarantee.

Over the years the South African courts have shown that they are prepared, in cases where the fraud exception applies and, of course, where fraud has been established not only to interdict the beneficiary from receiving payment or making a demand, but also to interdict the bank from paying. With the Petric case the South African courts have again shown that they are also willing to go to great lengths to protect the integrity and autonomy principle of letters of credit and demand guarantees.1

Text:

Excerpts from the Construction Guarantee:

"5.1 Subject to the guarantor's maximum liability referred to in 1.0 or 2.0, the Guarantor undertakes to pay the Employer the Guaranteed Sum or the full outstanding balance upon receipt of a first written demand from the Employer to the Guarantor at the Guarantor's physical address calling up this construction Guarantee, stating that:

5.1 The Agreement has been cancelled due to Contractor's default and that the Construction Guarantee is called up in terms of 5.0. The demand shall enclose a copy of the notice of cancellation; or

5.2 A provisional sequestration or liquidation court order has been granted against the Contractor and the Construction Guarantee is called up in terms of 5.0. The demand shall enclose a copy of the court order.

6.0 It is recorded that the aggregate amount of payments required to be made by the Guarantor in terms of 4.0 and 5.0 shall not exceed the Guarantor's maximum liability in terms of 1.0 or 2.0.

7.0 Where the Guarantor is a registered insurer and has made payment in terms of 5.0, the Employer shall upon the date of issue of the final payment certificate submit an expense account to the Guarantor showing how all monies received in terms of the Construction Guarantee have been expanded and shall refund the guarantor any resulting surplus. All monies refunded to the Guarantor in terms of this Construction Guarantee shall bear interest at prime overdraft rate of the Employer's bank compounded monthly and calculated from the date payment was made by the guarantor to the Employer until the date of refund.

...

The Construction Guarantee is neither negotiable nor transferable and shall expire in terms of either 1.1.4 or 2.1, or payment in full of the Guaranteed Sum or on the Guaranteed expiry date, whichever is the earlier, whereafter no claims will be considered by the Guarantor. The original of this Construction Guarantee shall be returned to the Guarantor after it has expired.

12.0 This Construction Guarantee, with the required demand notices in terms of 4.0 or 5.0, shall be regarded as a liquid document for the purpose of obtaining a court order."

1. See, e.g., also Ex parte Sapan Trading (Pty) Ltd 1995 (1) SA 218 (W). * Professor in Banking and Insolvency Law, Department of Mercantile Law, University of South Africa.

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