Topics: Independence Principle; Fraud Exception; Payment Guarantee; Demand Guarantee; Independent Guarantee

Note: In Dormell Properties 282 CC v. Renasa Insurance Co Ltd and Others NNO 2011 (1) SA 70 (SCA) (abstracted at 2012 ANNUAL REVIEW 406), the South African Supreme Court of Appeal in its majority decision recognized, besides fraud by the beneficiary, another exception to the independence principle - namely that if an arbitration tribunal (or by implication a 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.

The majority in Dormell was of the view that granting the order to force the guarantor to pay under the construction guarantee (despite there being a compliant demand made) would have no practical effect because the dispute regarding the underlying contract was settled by arbitration and it had been found that the beneficiary was not entitled to have cancelled the underlying contract.

Cloete JA who delivered the minority judgment in Dormell, however, was strongly motivated by giving effect to the autonomy principle, subject only to the fraud exception. He did not agree with the majority to allow a further exception to the autonomy principle or the majority's decision to allow evidence to be placed before the court concerning the arbitration award. Naturally, after the Dormell judgment, various cases came before the Supreme Court of Appeal where guarantors of demand guarantees relied on Dormell as authority for them not having to pay in terms of demand guarantees, despite the fact that compliant demands were made in each instance. One such case was Firstrand Bank Ltd v. Brera Investments CC.

First Rand Bank (Guarantor) refused to pay a payment guarantee (governed by the South African law and silent as to any ICC rules) in the amount of ZAR 12,997,972.36. Spirit of Africa Developments (Pty) Ltd (Contractor/Principal) instructed Guarantor to issue the guarantee in favour of Brera Investments CC (Sub-Contractor/Beneficiary). The underlying contract between Contractor and Sub-Contractor related to the development of residential units and called for Sub-Contractor to make interim payments. These payments were made only after a principal agent issued interim payment certificates and payment was to be made within a specified number of days after the certificates were issued.

The payment guarantee envisaged two situations where Guarantor would incur liability. First, where the sum certified in the payment certificate was not paid by Contractor/Principal in seven days; and secondly, where Contractor/Principal failed to issue a payment certificate within seven days of a demand for it. The matter before the court involved a situation triggering the latter event.

On 17 March 2011, Sub-Contractor/Beneficiary demanded that Contractor/Principal issue a payment certificate for ZAR 1,065,864.29 within seven days, failing which, it intended to make a demand under the payment guarantee. As the certificate was not forthcoming, Sub-Contractor/Beneficiary demanded payment under the payment guarantee from Guarantor on 15 April 2011. Guarantor refused to pay.

Sub-Contractor/Beneficiary applied to the South Gauteng High Court, Johannesburg (the court of first instance) on 14 July 2011 for an order compelling payment. However, on 25 August 2011, a payment certificate for only ZAR 60,909.90 was issued on behalf of Contractor/Principal. The certificate stated that the other amounts claimed by Sub-Contractor/ Beneficiary were disputed. The court of first instance found in favour of Beneficiary and granted the order requested. The court pointed out that when the demand was made, the triggering event (i.e., the payment certificate was not issued within seven days of it being requested) on which liability was based had occurred. Therefore, Guarantor was liable for payment as the payment certificate was not issued timeously. Guarantor appealed to the Supreme Court of Appeal against the order.

Guarantor argued that it was entitled to rely on events that had occurred after a proper demand for payment was made to avoid liability in terms of the payment guarantee. It contended that the majority decision in Dormell entitled a party's right to rely on events that occurred after a demand for payment was made.

Malan JA (Lewis JA, Ponnan JA, Theron JJA, and Plasket AJA concurring) correctly disagreed and pointed out that in Dormell the court was concerned with a case where the dispute between the parties to the underlying contract was finally resolved by arbitration. He also said that in Dormell the majority was of the view that an order to enforce the guarantee in those circumstances would be of no practical effect, whereas the matter before him concerned no final arbitration award and related only to disputes concerning interim payment certificates and interim payments that were due.

For these reasons, the matter was distinguishable from Dormell. Malan JA also added in passing that the minority approach in Dormell was preferable. Relying on various South African, English, and American cases (see Phillips v. Standard Bank of South Africa Ltd 1985 (3) SA 301 (W); Lombard Insurance Co Ltd v. Landmark Holdings (Pty) Ltd 2010 (2) SA 86 (SCA); Sztejn v. J Henry Schroder Banking Corporation 31 NYS 2d 631 (1941); and Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] 1 QB 159 (CA)) where the fraud exception to the autonomy principle was acknowledged, Malan JA, like the minority in Dormell, expressed the view that fraud was the only ground upon which a guarantor could validly refuse to pay. As there was no fraud involved in the case before him, Malan JA accordingly dismissed the appeal.

Malan JA did not expressly overrule the Supreme Court of Appeal's earlier majority judgment in Dormell, but his view persuaded the Supreme Court of Appeal in 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), to express a similar view, and to eventually retract its initial ruling on the issue in Coface South Africa Insurance Co Ltd v. East London Own Haven t/a Own Haven Housing Association (050/13) [2013] ZASCA 202 (02 December 2013) (also discussed in the 2014 ANNUAL REVIEW at 421).



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.