Article

Factual Summary: The facts of the case may be briefly summarized as follows. Renasa Insurance Co Ltd ("Renasa") had issued a guarantee on application by the contractor, Synthesis Projects (Cape) (Pty) Ltd ("Synthesis"), in favour of the employer, Dormell Properties 282 CC ("Dormell"). Dormell cancelled the underlying building contract on the basis of an alleged breach by Synthesis on 28 February 2008. On the same day Dormell then also claimed under the construction guarantee from Renasa. Renasa, however, refused to pay in terms of the construction guarantee alleging that the guarantee had already expired on 27 February 2008. Dormell then instituted legal action in the South Gauteng High Court, Johannesburg (the "court a quo") for a declaratory order that the guarantee was valid for the full day of 28 February 2008, that payment was demanded timeously and that Renasa was obliged to honour the guarantee. Renasa raised two defences: (1) that the guarantee had expired at midnight on 27 February 2008; and (2) that Dormell was not entitled to payment as the guarantee was issued in favour of a company called "Dormell Properties 282 (Pty) Ltd" and not a close corporation called "Dormell Properties 282 CC". Dormell was initially a private company, but it was later converted into a close corporation. Renasa was not notified of the employer's (Dormell's) conversion into a close corporation. Synthesis was also joined in the matter because of its interest in the proceedings. Synthesis, however, denied that the close corporation was the beneficiary of the guarantee, and disputed any allegation that it had been in breach of the building contact. Dormell also countered with an application for the rectification of the guarantee on the basis that all three parties always intended to procure and issue a guarantee. The claim was dismissed by the court a quo and Dormell (appellant) then appealed to the Supreme Court of Appeal. After the court a quo judgment was delivered, but before the appeal was heard, the dispute regarding the building contract (underlying contract) was submitted to arbitration. Synthesis went into liquidation before the arbitration was concluded, but it was represented by its joint liquidators thereafter. The arbitrator found that Synthesis had not been in breach of any term of the building contract and Dormell was therefore not permitted to cancel the building contract. The arbitrator held that Dormell had repudiated the building contract by its purported cancellation, which repudiation was validly accepted by Synthesis, which thereafter cancelled the contract, as it was entitled to do and, accordingly, he made an award in favour of Synthesis. The arbitrator's award was not subject to appeal and was not reviewed. After the finalisation of the arbitration the matter was heard by the Supreme Court of Appeal.

The construction guarantee contained the following important clauses (see clauses 3.1, 4, 5 and 8):

"3. The Guarantor hereby acknowledges that: 3.1 Any reference in this guarantee to the Agreement [ie, underlying building contract] 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."

"4. Subject to the Guarantor's maximum liability referred to in . . . the Guarantor hereby undertakes to pay the Employer the sum certified upon receipt of the documents identified in 4.1 to 4.3 [ie, certain specified documents]."

"5. Subject to the Guarantor's maximum liability referred to in . . . 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 the Contractor's default and that the Construction Guarantee is called up in terms of 5. 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 that the Construction guarantee is called up in terms of 5. The demand shall enclose a copy of the court order."

"8. Payment by the Guarantor . . . shall be made within seven (7) calendar days upon receipt of the first written demand to the Guarantor."

Legal Analysis:

The Supreme Court of Appeal dealt with three specific grounds upon which Renasa had refused to pay in terms of the construction guarantee.

Firstly, Renasa refused to pay on the ground that the construction guarantee had expired by the time the demand was made. The guarantee was called up on 28 February 2008 and that was also the date specifically mentioned in the guarantee as the expiry date. Renasa, however, contended that the civil method of calculation had to be used which would exclude the final date (ie, 28 February 2008). The court a quo accepted this argument by Renasa, but it was both rejected by the majority judgment as well as minority judgment of the Supreme Court of Appeal. In this regard, Bertelsmann AJA (Cachalia JA and Mhlanta JA concurring) who delivered the majority judgment of the Supreme Court of Appeal, correctly states (in par 28):

"With respect to the learned judge a quo, it is difficult to discern why the expiry date of the guarantee, which appears clearly from the guarantee itself, should have to be determined by a method designed to calculate a period of days."

Cloete JA (Mphati P concurring) who delivered the minority judgment, held a similar view (in pars 53-59).

Secondly, Renasa refused to pay because it alleged that the beneficiary (Dormell) was incorrectly described on the guarantee as "Dormell Properties 282 (Pty) Ltd" as opposed to "Dormell Properties 282 CC". The court a quo had rejected Dormell's claim for rectification of the guarantee. Bertelsmann AJA, overruled the court a quo in this instance and held that there was "merit in Dormell's argument that all three parties, and in particular Renasa and Dormell, intended to secure the employer's position" and, therefore, the "guarantee should have been rectified to reflect that intention" (in par 37). Cloete JA (Mphati P concurring) who delivered the minority judgment, held a similar view (in pars 51 and 52).

Lastly, Renasa also refused to pay arguing that in view of the arbitration award the guarantee was no longer enforceable. Renasa and the joint liquidators of Synthesis (respondents) applied for an order allowing evidence of the arbitration and its outcome. Bertelsmann AJA allowed the evidence regarding the arbitration and its outcome. In this regard, the question the Supreme Court of Appeal thus had to answer was whether the appellant (Dormell) should be allowed to enforce payment under the construction guarantee in light of the award by the arbitrator that Dormell was not entitled to cancel the building contract (underlying contract), and that Dormell's attempt to enforce the guarantee constituted a repudiation and that the building contract was cancelled by Synthesis. To this effect it was, firstly, argued by Renasa and the joint liquidators of Synthesis (respondents) that an award on appeal would have no practical force and effect as contemplated in s 21A of the Supreme Court Act 59 of 1959; and secondly, that Dormell's (the appellant's) attempt to enforce the guarantee constituted fraud in the sense of bad faith. Regarding this aspect the minority judges of the Supreme Court of Appeal differed substantially from that of the majority.

Bertelsmann AJA, delivering the majority judgment, highlighted the independence principle of demand guarantees and letters of credit. He stated that this meant that in principle, a demand guarantee had to be honoured when the beneficiary made a proper demand (ie, provided the specified documents). He stressed that in the matter before him there was no indication that Dormell did not make a proper demand under the guarantee and in the ordinary course of events payment should have been made within seven days of the receipt of the demand (in para 39). But, then he added (in pars 40-42, 44 and 45):

"[40] However, the facts of this matter are unusual because the arbitration of the dispute between Dormell and Synthesis resulted in the finding that the appellant [ie, Dormell] was not entitled to cancel the building contract. The arbitration is final, not subject to appeal, and has not been taken on review. . . . The question must thus be answered whether Dormell is entitled to persist in claiming payment of the guarantee, notwithstanding the fact that it has been held to have repudiated the contract which was lawfully cancelled by the second respondent [ie, Synthesis].
[41] There is no longer any dispute about the cancellation of the underlying agreement that still has to be resolved. The arbitration has established that Dormell is in the wrong. Its repudiation of the building contract was held to have been unlawful. As a consequence, Dormell has lost the right to enforce the guarantee. There remains no legitimate purpose to which the guaranteed sum could be applied.
[42] If it were to be ordered to honour the guarantee, Renasa or Synthesis would be entitled to repayment of the full amount guaranteed. . . .
[44] . . . The guarantee is not intended to provide a source of funds for the payment of any outstanding amounts that might be due by the contractor [ie, Synthesis] to the employer [ie, Dormell]-of which there is no evidence in any event, apart from an oblique reference to potential future claims by the employer against the contractor in correspondence.
[45] It would amount to an academic exercise without practical effect if Dormell were to be granted the order it seeks. It would immediately have to repay the full amount to Renasa or Synthesis. Such an order would, at best, cause additional cost and inconvenience to the parties, without any practical effect. In terms of s 21A of the Supreme Court Act 59 of 1959 the court must exercise its discretion against Dormell . . ."

In conclusion, the Supreme Court of Appeal held that Dormell was entitled to succeed with its appeal inasmuch as the court a quo's judgment had to be set aside. It also held that Dormell was also entitled to all costs of those proceedings together with the appeal proceedings up to the date of the arbitration award. It was not, however, entitled to an order that the construction guarantee should be enforced. Cloete JA who delivered the minority judgment was strongly motivated by giving effect to the independence principle, subject only to the fraud exception (in pars 61-63). He said (in pars 64 and 65):

"[64] Once the appellant [ie, Dormell] had complied with clause 5 [ie, presented a proper demand], the first respondent [ie, Renasa] had no defence to a claim under the guarantee. It still has no defence. The fact that an arbitrator has determined that the appellant was not entitled to cancel the contract, binds the appellant-but only vis-à-vis the second respondent [ie, Synthesis]. It is res inter alios acta as far as the first respondent is concerned. . . . [T]he appellant did not have to prove that it was entitled to cancel the building contract with the second respondent, as a precondition to enforcement of the guarantee given to it by the first respondent. Nor does it have to do so now.
[65] For these reasons, it is not in my view bad faith for an employer, who has made a proper demand in terms of a construction guarantee, to continue to insist on payment of the proceeds of the guarantee, when the basis upon which the guarantee was called up has subsequently been found in arbitration proceedings between the building owner and the contractor to have been unjustified. I would add that the fact that the arbitrator's award is final as between the appellant and the second respondent does not mean that it is correct, or that the appellant would have to set it aside before calling up the guarantee, much less that the appellant is acting in bad faith in seeking to enforce payment under the guarantee against the first respondent."

Cloete JA was of the opinion that the evidence regarding the arbitration was in deed irrelevant and ought not to have been allowed. According to him, there was insufficient evidence before the court for a finding that the order sought by Dormell, if granted, would have had no practical effect or result as contemplated in s 21A of the Supreme Court Act 59 of 1959. He stated that he would have allowed the appeal and dismissed the application to place further evidence before the court, rectified the guarantee to reflect the appellant (Dormell) as employer and have ordered Renasa to pay the guarantee together with default interest.

Comments:

The South African courts accept that in certain circumstances, the independence principle of demand guarantees and letters of credit may be ignored by the bank (guarantor or issuer) and regard may be had to the terms and conditions of the underlying contract. The South African courts clearly accept established fraud (by the beneficiary) as an exception that exists to the independence principle. So far, the South African courts have been extremely hesitant to acknowledge any other exceptions to the independence principle. The majority judgment delivered by the Supreme Court of Appeal in the Dormell case now recognizes, besides fraud by the beneficiary, another exception to the independence principle namely that if a court of law or arbitration tribunal has pronounced finally on the dispute between the parties in the underlying contract, this can be relied upon as a defence by the guarantor (and by implication also the issuer of a letter of credit). The Court, however, did not expressly place the defence within its framework. The main difference between the judgments of the majority and minority in this case is that the former recognizes this additional exception to the independence principle, while the latter does not and still accepts fraud as the only valid exception.

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.