Article

Factual Summary: The contractor (Construct Construction (Pty) Ltd) instructed the guarantor (Coface South Africa Insurance Company Ltd) to issue a construction guarantee (demand guarantee) for ZAR 1,172,583.80, subject to the law of South Africa and silent as to any governing ICC rules, in favour of the employer (East London Own Haven trading under the name of Own Haven Housing Association ("ELOH")). The underlying contract between the contractor and the employer related to the completion of building works in East London, South Africa. Clause 5.1 of the construction guarantee provided that the guarantor (Coface) would make payment upon receipt of a first written demand from the beneficiary calling up the guarantee and stating that the underlying contract had been cancelled due to the contractor's (principal's) default. The clause also called for a copy of the notice of cancellation of the underlying contract to be attached to the demand. The contractor (Construct) defaulted on the underlying contract and the beneficiary called up the guarantee and sent a letter of demand to the contractor as was required. The beneficiary (ELOH) then called upon the guarantor to make payment in terms of the guarantee.

The guarantor refused to make payment and the beneficiary approached the court to enforce the demand guarantee. In the guarantor's plea denying liability it alleged that the beneficiary was not entitled to cancel the underlying contract as the contractor had not defaulted in terms of the underlying contract and the beneficiary was responsible for a faulty design. The beneficiary excepted to this defence which was based on disputes concerning the underlying contract. The exception was heard by Satchwell J in the South Gauteng High Court, Johannesburg (see East London Own Haven t/a Own Haven Housing Association v. Coface South Africa Insurance Co. (09/12141) [2011] ZAGPJHC 18 (22 March 2011) who relied on Dormell Properties 282 CC v. Renasa Insurance Co and Others NNO 2011 (1) SA 70 (SCA) (discussed in 2012 ANNUAL REVIEW OF INTERNATIONAL BANKING LAW AND PRACTICE 406-410) as authority to dismiss the beneficiary's exception. (For valid criticism of this decision and the view that Satchwell J in this case completely ignored the documentary nature and autonomy principle of demand guarantees, see Charl Hugo "Documentary credits and independent guarantees" ABLU 2011 (a paper delivered at the 2011 Annual Banking Law Update held at the Indaba Hotel, Johannesburg on 4 May 2011) 116 at 130-132.)

Just before the trail was to start before Lamont J in the same court (ie, South Gauteng High Court, Johannesburg) the guarantor (Coface) applied to amend its plea and introduce a different defence (see East London Own Haven t/a Own Haven Housing Association v. Coface South Africa Insurance Co. (2009/12141) [2012] ZAGPJHC 182 (13 September 2012)). In essence, the guarantor argued that as the final payment certificate that was issued and the recovery statement that was attached to it both reflected a NIL balance owed by the contractor to the beneficiary the guarantor was not liable to pay in terms of the guarantee. The guarantor also relied on Dormell as authority for not having to paying in terms of the guarantee. Although the guarantor later accepted that the certificate was actually an interim payment certificate that was just incorrectly labeled by the beneficiary as being a "final" one, it argued that the interim certificate was actually the final certificate because no further certificates were issued. In deciding the application to amend Lamont J held that the introduction of extraneous issues as a defence was precluded, save for very limited exceptions like fraud. He sought to distinguish Dormell on the basis that, in that instance, it was impossible for the beneficiary to establish an entitlement to its claim. Returning to the facts before him, Lamont J took the view that the interim certificate did not become a final certificate by reason of no further certification. He accordingly dismissed the application for amendment and ordered the payment of the construction guarantee. The guarantor appealed to the Supreme Court of Appeal against the ruling.

Legal Analysis:

1. Independence (autonomy) principle. In dealing with the matter the South African Supreme Court of Appeal (per Navsa ADP and Pillay JA (Maya JA, Malan JA and Swain AJA concurring)) referred to the English case of Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] 1 QB 159 (CA) and the South African cases of Loomcraft Fabrics CC v. Nedbank Ltd 1996 (1) SA 812 (A) and Lombard Insurance Co Ltd v. Landmark Holdings (Pty) Ltd 2010 (2) SA 86 (SCA) (discussed in 2010 ANNUAL REVIEW OF INTERNATIONAL BANKING LAW AND PRACTICE 566-570) where the autonomy principle of demand guarantees and letters of credit were clearly acknowledged and were it was held that only fraud could constitute a ground to refuse payment.

2. Exceptions to the independence (autonomy) principle and the consideration of the Dormell case. In the controversial South African Supreme Court of Appeal case, Dormell Properties 282 CC v. Renasa Insurance Co Ltd and Others NNO 2011 (1) SA 70 (SCA) (discussed in 2012 ANNUAL REVIEW OF INTERNATIONAL BANKING LAW AND PRACTICE 406-410), the majority held that because the dispute between the parties to the underlying contract in that case was finally resolved by arbitration an order to enforce the independent guarantee in such circumstances would be of no practical effect. The majority allowed details of the arbitration award concerning the underlying contract to be placed before the court. In contrast, the minority in Dormell was of the view that fraud was the only ground upon which payment could be validly refused. The minority was also of the opinion that the details of the arbitration award were completely irrelevant to the court as the independence principle prohibited such details to be made to the court and should therefore not have been allowed by the Supreme Court of Appeal. The minority found that there was not enough evidence before the court in Dormell to determine if ordering the payment of the demand guarantee would have any practical effect or not. In short, the majority recognized, besides fraud by the beneficiary, another exception to the independence principle namely that if an arbitration tribunal (or by implication court of law) has pronounced finally on the dispute between the parties in the underlying contract, it could be relied upon as a defence by the guarantor not to pay in terms of an independent guarantee. Following the Dormell case various cases came before the courts in which the guarantors relied on the Dormell case as justification for them not having to pay in terms of independent guarantees, despite there being valid demands made on such guarantees and there being no fraud involved. Firstrand Bank Ltd v. Brera Investments CC 2013 (5) SA 556 (SCA) (also discussed in the 2014 ANNUAL REVIEW at 451) and Guardrisk Insurance Company Ltd v. Kentz (Pty) Ltd (94/2013) [2013] ZASCA 182 (29 November 2013) (also discussed in the 2014 ANNUAL REVIEW at 465) were two such cases that came before the Supreme Court of Appeal. In both these cases the Supreme Court of Appeal expressed the view that its minority view in Dormell was preferable.

Navsa ADP and Pillay JA (Maya JA, Malan JA and Swain AJA concurring)) in Coface stated that it was necessary for them to look at the majority and minority judgments of Dormell and compare them to how the Supreme Court of Appeal has dealt with cases involving demand guarantees (e.g., Brera and Guardrisk) since Dormell. They indicated that the subsequent Supreme Court of Appeal cases clearly preferred the approach of the minority in Dormell. They concluded, like the minority in Dormell, that the reliance by the majority in Dormell on the English case of Cargill International SA Antigua Geneva Branch v Bangladesh Sugar and Food Industries Corporation [1996] 2 Lloyd's Rep 524 (QB (Com Ct); and affirmed in [1998] 2 All ER 406 (CA) was misplaced. They pointed out that in Cargill the contesting litigants involved were the parties to the underlying contract and the case did not involve a dispute between the guaranteeing bank and beneficiary as was the case in Dormell. Cargill also involved an application for injunctive (interdictory) relief. The principals (plaintiffs) in that case applied for an injunction (interdict) restraining the beneficiaries from drawing on the demand guarantee and certain issues were also referred to trial. In Cargill, the sanctity of demand guarantees was reaffirmed. Navsa ADP and Pillay JA also stressed that the court in Cargill stated that a performance guarantee is in effect 'as valuable as a promissory note' and that it has to be met, pending the resolution of the contractual disputes, because to do otherwise, would be to frustrate the commercial purpose of the demand guarantee. 'Put simply, the court in Cargill held that performance bonds [guarantee] had to be met according to their terms and that disputes concerning the principal agreement could be dealt with later' (para 23). Regarding the reliance on the passage from Hudson & Wallace Hudson's Building and Engineering Contracts 11 ed (see para 17.078, quoted in the Cargill case) by the majority in Dormell as a further justification for the guarantor no having to pay where the default of the principal was disputed Navsa ADP and Pillay JA simply said (para 25 and footnote omitted from quotation):

"That passage . . . states that there would additionally be a total failure of 'consideration' for the payment. First, it should be noted that the English doctrine of consideration is not part of our [South African] law of contract. Second, Cloete JA in Dormell, at para 66, demonstrated why the reliance on that passage in Hudson was fallacious. The decision of the majority in Dormell was clearly wrong."

Navsa ADP and Pillay JA also made the following important and true statement (para 24):

"Since the decision in Dormell and perhaps predictably, there has been an increasing number of cases in which guaranteeing banks have sought to introduce contractual disputes in order to avoid meeting the guarantee. In some cases the allegedly defaulting contractor sought to join the fray. It is the very consequence that the line of cases prior to Dormell sought to avoid."

In conclusion, Navsa ADP and Pillay JA dismissed the appeal with costs.

Comments: The Supreme Court of Appeal in Coface held that the majority judgment in Dormell was wrong and this latest judgment is welcomed. It seems that the main reasons for the Supreme Court of Appeal deciding in Coface that the majority in Dormell was wrong was because of the majority's view that the order in Dormell would have no practical effect and that the English authorities it had relied on for its view did not substantiate it.

The Supreme Court of Appeal in Coface, however, did not elaborate on whether the type of exception to the independence principle that was acknowledged in Dormell could ever constitute an exception to the principle. It also did not indicate whether or not with such a ground could perhaps be used by a principal of an independent guarantee to prevent the beneficiary from making a demand on the guarantee.

[MKL/pt]

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.