Article

Factual Summary: Mining Company contracted with Contractor to supply and install an accommodation village for its workers in Senegal. The contract included the Australian Standard General Conditions of Contract (AS 2124-1992) and was governed by the law of the State of Western Australia.

General Condition 5 (GC 5) dealt with security, retention moneys, and performance undertakings and provided inter alia:

"5.1 Purpose

Security, retention moneys and performance undertakings are for the purpose of ensuring the due and proper performance of the Contract.

...

5.3 FORM OF SECURITY

The security shall be in the form of cash or an approved unconditional irrevocable undertaking given by an approved financial institution.

...

5.5 Recourse to Retention Moneys and Conversion of Security

A party may have recourse to retention moneys and/or cash security and/or may convert into money security that does not consist of money where -

(a) the party has become entitled to exercise a right under the Contract in respect of the retention moneys and/or security; and

(b) the party has given the other party notice in writing for the period stated in the Annexure [which was two days] of the party's intention to have recourse to the retention moneys and/or cash security and/or to convert the security; and

(c) the period stated in the Annexure [two days] has or have elapsed since the notice was given."

Pursuant to GC 5, Contractor caused Bank (Guarantor) to issue two virtually identical performance guarantees, each in the amount of ZAR2,651,254 in favor of Mining Co. (Beneficiary). They included the following terms:

"[A]nd for the payment of all damages or other amount including interest due by the [Applicant] to the [Beneficiary] whether in terms of the contract or consequent upon determination thereof, and also all charges and expenses of whatsoever nature, including, but without derogating from the generality of the aforesaid attorney and client legal costs incurred by the [Beneficiary] in endeavouring to secure fulfilment of the obligations."

...

2. The [Beneficiary] shall have the absolute right to arrange his affairs with the [Applicant] in any manner he deems fit and without advising the [Guarantor], and the [Guarantor] shall not have the right to claim release on account of conduct alleged to be prejudicial to the [Guarantor]. Without derogation from the generality of the foregoing, no compromise, extension of time, indulgence, release, waiver of security, release of cosureties or variation of the [Applicant's] obligation shall, in any manner, affect the [Guarantor's] liability under this guarantee.

3. The [Guarantor] undertakes to be bound to effect payment of the above-mentioned amount, or any lesser portion thereof, to the [Beneficiary] upon receipt by the [Guarantor] at the above stated address of the [Beneficiary's] first written demand that the [Applicant] has committed a breach of the contract and/or has defaulted there under and/or has been provisionally or finally sequestrated or liquidated or placed under judicial management.

4. The [Guarantor] shall be bound by any admission of liability by the [Applicant] and by an award or judgment in arbitration proceedings or litigation between the [Beneficiary] and the [Applicant].

...

7. Notwithstanding anything to the contrary contained herein, the [Guarantor's] obligations hereunder shall be construed as principal and not as accessory to the obligations of the [Applicant] and compliance with any demand for payment received by the [Guarantor] in terms hereof shall not be delayed, nor shall the [Guarantor's] obligations in terms hereof be discharged, by the fact that a dispute may exist between the [Applicant] and the [Beneficiary].

...

13. This guarantee shall be governed by South African Law and subject to the jurisdiction of South African Courts.

After numerous disputes, Beneficiary notified Contractor/Applicant of its intention to draw on the Guarantees and Contractor/Applicant obtained an interim interdict pending an application for a final interdict that prohibited Beneficiary "from presenting a first written demand" or claiming or receiving payment under the Guarantees and prohibited Guarantor from making payment. At a subsequent hearing, the judge refused to grant final relief but granted leave to appeal and another interim interdict was imposed pending the outcome of the appeal. On appeal, affirmed.

Legal Analysis:

Applicant argued the proposition that the underlying building contract could, as a matter of law, qualify the right of the Beneficiary to present the guarantees for payment to the Guarantor, despite the unconditional wording of the guarantees and that GC 5.5(a) was such a qualification.

The South African Court applied the law of Australia and specifically commented that it was not deciding South African law. The appeal court concluded that it seemed well-established in Australian law that the proposition advanced by Applicant was correct. The Appeal court cited a number of Australian cases. Reed Construction Services Pty Ltd v. Kheng Seng (Aust) Pty Ltd (1999) 15 BCL 158 at 164 per Austin J: "... if the party in whose favour the bond has been given has made a contract promising not to call upon the bond, breach of that contractual promise may be enjoined on normal principles relating to the enforcement by injunction of negative stipulations in contracts".

In Bachmann (Pty) Ltd v. BHP Power New Zealand Ltd [1998] VSCA 40, the Victorian Court of Appeal stated:

[I]t is competent to the holder of a security provided by the other contracting party to promise as part of the contract under which the security is provided - the underlying contract - not to do some act in relation to the security except in a certain event. Such a contractual promise is efficacious ... No principle or rule of law would deny that a promise forming part of the underlying contract is in this sense efficacious, and the cases recognise this.

However, the Victorian court is confusing the distinction between a conditional and unconditional guarantee.

The question for the Appeal Court became whether GC 5.5 qualified the Beneficiary's right to present the guarantees only where "the party has become entitled to exercise a right under the Contract". However, the court stated that such a contention would be wrong in fact and in Australian law. On the construction of subsequent clauses the court accepted that the right had on the facts arisen in any event. This was based on GC 42.11 and an examination of the facts that no amount under a required certificate had been paid.

The Court stated:

"Accordingly, unless the Contractor can advance some valid reason for not doing so, the Principal would (in the words of GC 5.5) have 'become entitled to exercise a right under the contract in respect of the ... security', the right being that envisaged in GC 42.11 to 'have recourse to ... security under the contract' (the guarantees) because the Contractor 'failed to pay ... an amount due and payable under the contract', in terms of GC 42.1; and the existence of a dispute is not a valid reason because of the provisions of GC 47.1."

This analysis completely ignores the independence principle and the role of the bank in issuing its guarantees.

On the facts, the court found that the Contractor had no defence to its failure to pay. However, it accepted the principle that in "Australian law a building contractor may restrain the person with whom he had covenanted for the performance of the work, from presenting to the issuer a performance guarantee unconditional in its terms and issued pursuant to the building contract, if the Contractor can show that the other party to the building contract would breach a term of the building contract by doing so." The court added that this "should not readily be interpreted as conferring such a right".

Comments:

The judges in this case examined the nature and terms of the underlying contract and failed to make any attempt to examine the terms of guarantee by the Guarantor or the nature of the Guarantor's undertaking. Second, the Court failed to consider the possible distinction between an independent undertaking and a dependent undertaking. Banks cannot be placed in a position of examining the underlying contract when the terms of their undertaking requires it to be independent. Nevertheless this court accepted the principle that orders could be made against the presenter of a call under guarantees based on contract.

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