Article

Factual Summary:

The sole question the South African Supreme Court of Appeal was concerned with in this appeal was whether or not the beneficiary, Hospitality Hotel Developments (Pty) Ltd, had complied with the requirements of the construction (performance) guarantee given by the guarantor, Compass Insurance Co Ltd, when it made its demand for payment.

Hospitality Hotel Developments (Pty) Ltd (beneficiary and respondent) was a property developer that had been contracted to carry out the upgrade of a hotel. It appointed a construction company for this purpose which in turn contracted with a subcontractor to install a computer network, wireless and internet system in the hotel. The work of the subcontractor was backed by an independent construction guarantee issued by Compass Insurance Co Ltd (guarantor and appellant), a short-term insurer. The sum guaranteed by the guarantee was ZAR1 444 428 and the expiry date of the guarantee was 30 April 2008 (par 2).

Clause 4 of the construction guarantee, which formed the subject of the dispute, provided that, subject to the guarantor's maximum liability, the guarantor (Compass) undertook to pay the beneficiary (Hospitality) the full outstanding balance 'upon receipt of a first written demand from the Employer [Hospitality]'. It also provided that the aforementioned written demand had to state that (par 4):

'4.1 The agreement has been cancelled due to the recipient's [the subcontractor's] default and that the Advance Payment Guarantee is called up in terms of 4.0. The demand shall enclose a copy of the notice of cancellation;

OR

4.2 A provisional sequestration or liquidation court order has been granted against the recipient and that the Advance Payment Guarantee is called up in terms of 4.0. The demand shall enclose a copy of the court order.' (Emphasis supplied.)

The subcontractor breached the contract and was issued with a breach notice. It was subsequently provisionally liquidated on 23 April 2008. As a result, the beneficiary (Hospitality) sent a letter to the guarantor of the construction guarantee (Compass) on 25 April 2008 demanding payment under the guarantee. The guarantor refused to pay on the ground that the demand did not comply with the conditions of the guarantee in that it was not accompanied by a copy of the court order of provisional liquidation (par 3). The beneficiary applied to the South Gauteng High Court, Johannesburg ('the court of first instance') for an order compelling payment. The order was granted by the court of first instance on the basis that as the provisional sequestration order had been provided subsequently (many months later - ie, on 26 November 2008 and long after the expiry of the guarantee) there had been sufficient compliance with the terms of the guarantee (pars 3 and 5). The Guarantor then appealed to the Supreme Court of Appeal against this judgment.

Legal Analysis:

It was common cause that when the letter of demand was sent to the subcontractor there had in fact been no cancellation at the time the letter of demand was sent, although the letter stated that there was, and that the subcontractor was provisionally liquidated prior to the issue of the demand. It was also common cause that the court order was not attached to the letter of demand, as required by clause 4.2 of the guarantee. The beneficiary, however, contended that all the parties concerned knew that the subcontractor had been provisionally liquidated and that once there was knowledge of the existence of the order that was sufficient for a demand to be made. It also pointed out that there was some difficulty in obtaining the liquidation order. Accordingly, the demand was not defective, despite the failure to attach the order to it. Therefore, strict compliance with the terms of the guarantee was not required. The beneficiary also argued, relying on cited dicta to this effect from English case law (see, eg, Siporex Trade SA v Banque Indosuez [1986] 2 Lloyd's Rep 146 159; and IE Contractors Ltd v Lloyds Bank plc and Rafidain Bank [1990] 2 Lloyd's Rep 496 (CA) 501) that the doctrine of strict compliance was restricted to letters of credit and did not apply to demand guarantees (pars 7-9 and 11).

The court of first instance, referred to various cases dealing with contractual interpretation and found that on a reading of the guarantee it was 'perfectly obvious' that it was not the intention of the parties that a failure to furnish the copy of the court order with the demand would be 'fatal' to it. The sentence concerning the furnishing of the copy of the court order was 'divisible' from the aspects entitling the beneficiary to payment. The copy could therefore be provided after the expiry of the guarantee date. The guarantor was therefore liable to pay the sum claimed (par 6).

In dealing with the arguments by the beneficiary the Supreme Court of Appeal referred to Kelly-Louw's views put forward in her LLD thesis (see See M Kelly-Louw Selective Legal Aspects of Bank Demand Guarantees: The Main Exceptions to the Autonomy Principle (Published LLD-thesis, University of South Africa, 2009 (VDM Verlag: Germany) at 89-91) that the English courts have swung back towards applying the doctrine of strict compliance to demand guarantees as supported in the case Frans Maas (UK) Ltd v Habib Bank AG Zurich [2001] Lloyd's Rep Bank 14 in pars 57-60. The court also referred to Kelly-Louw's opinion that 'courts in South Africa will also apply to demand guarantees the same "standard of strict documentary compliance" as they do to letters of credit' (see in par 12). The Supreme Court of Appeal, however, found it unnecessary, to decide whether 'strict compliance' was necessary for performance guarantees and simply said (par 13):

'since in this case the requirements to be met by Hospitality Hotel [beneficiary] in making demand were absolutely clear, and there was in fact no compliance, let alone strict compliance. The guarantee expressly required that the order of liquidation be attached to the demand. It was not.'

The Court further stressed that the guarantor was not obliged to ascertain the truth of the allegation made by the beneficiary that the subcontractor had been placed under provisional liquidation. This was the reason for requiring a copy of the order, or, if the guarantee was called up on the basis of cancellation of the underlying contract (as opposed to provisional liquidation of the contractor), a copy of notice of cancellation. The very purpose of the performance (construction) guarantee is, after all, that the guarantor has an independent, autonomous contract with the beneficiary and that the contractual arrangements with the beneficiary and other parties are of no consequence to the guarantor (par 14). As the guarantee in this case was an independent contract, the Court stated that it had to be fulfilled on its terms and '[t]here is no justification for departure and indeed allowing the furnishing of the copy of the court order months after the guarantee had expired would have defeated its very purpose' (par 15).

The Supreme Court of Appeal accordingly upheld the appeal and overturned the judgment of the court of first instance (par 16).

Comments:

A question that often troubles guarantors and lawyers is how strictly the documents must conform to the terms of the demand guarantee and letter of credit. Is the standard a strict standard, so that even the most minor deviations entitle the guarantor to refuse payment and, indeed, oblige it to do so unless otherwise authorised by the applicant or principal of the credit or guarantee? Or is it a substantial compliance standard in terms of which deviations that the guarantor has no reason to believe are of commercial significance are ignored?

In South Africa it is still uncertain what the required standard of compliance is regarding documents that are presented in terms of a commercial letter of credit. It has been implied indirectly (and by implication) that the principle of strict compliance is applicable (see, eg, Delfs v Kuehne and Nagel (Pty) Ltd 1990 (1) SA 822 (A); and Nedcor Bank Ltd v Hartzer 1993 CLD 278 (W); Standard Bank of South Africa Ltd v OK Bazaars (1929) Ltd 2000 (4) SA 382 (W); OK Bazaars (1929) Ltd v Standard Bank of South Africa Ltd 2002 (3) SA 688 (SCA), particularly at 697G- 698A; and Paul Casey and Another v First National Bank (unreported, GSJ, case no 2011/07680, 18 April 2012), particularly at pars 24 and 26 (although in that case the standby letter of credit was issued subject to UCP 500). However, there is no direct authority in the South African case law that directly sheds light on the matter. In the past the courts were basically guided exclusively by English judgments in cases related to documentary credits, and it is therefore also likely that the English approach of a strict documentary compliance will be followed in South Africa regarding commercial letters of credit.

The standard required for demand or performance guarantees under the English law, however, remains uncertain. For instance, in Siporex Trade SA v Banque Indosuez [1986] 2 Lloyd's Rep 146 (QB (Com Ct)) the application of the doctrine of strict compliance was questioned. There is also some authority in this case that this doctrine does not apply with the same rigour in relation to demand guarantees. This was also considered in I E Contractors Ltd v Lloyds Bank plc and Rafidain Bank [1990] 2 Lloyd's Rep 496 (CA) at 501, where Staughton LJ indicated that the reasoning behind the doctrine of strict compliance regarding letters of credit did apply and that the degree of documentary compliance required by a demand or performance guarantee might be strict or less strict, depending on the construction of the guarantee (see David Warne & Nicholas Elliott Banking Litigation 2 ed (2005) at 281). However, English legal writers have said that such an approach was a risky approach for individuals whose duty it was to examine documents, because it added an additional process of having to make an initial judgement about the required degree of strictness of compliance (see, eg, Mark Hapgood (with contributions from Neil Levy, Mark Phillips and Richard Hooley) Paget's Law of Banking 12 ed (2003) at 733). The better approach, according to them, was to adopt the same standard of strict documentary compliance as is applied to letters of credit. There are also indications that courts in England have now started to apply the same degree of strict compliance to demand guarantees as they do to commercial letters of credit (see eg, Frans Maas (UK) Ltd v Habib Bank AG Zurich [2001] Lloyd's Rep Bank 14).

It is mainly due to a lack of case law dealing specifically with this issue that the doctrine of strict compliance has not been fully established in South Africa regarding commercial letters of credit and demand or performance guarantees. So although the judgment by the Supreme Court of Appeal in Compass Insurance v Hospitality Hotel Developments cannot be faulted it is regretted that it did not express, a much needed, opinion as to whether 'strict compliance' was, in fact, necessary for demand or performance guarantees.

However, based on the fact that South Africa presumably already follows a standard of strict documentary compliance in relation to commercial letters of credit and that its courts often follow the English judgments in this area of law, the assumption (at this stage) is made that the South African courts will also apply the same standard of strict documentary compliance to demand guarantees.

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