Article

Factual Summary:

The facts, somewhat simplified for the purpose of this discussion, was that Guarantor had issued a construction guarantee for a maximum amount of ZAR 20 731 119.36 (approximately USD 1 295 694) on 31 October 2012 in favour of Employer/Beneficiary, who was the employer of the construction contract. The underlying construction contract (a South African Joint Building Contracts Committee (“JBCC”) contract) was cancelled on 30 April 2014 by Employer/Beneficiary on the basis of an alleged breach by the contractor third party (the applicant for the construction guarantee). Employer/Beneficiary e-mailed a copy of the letter of the cancellation of the underlying contract it had sent to the contractor third party to Guarantor on 20 May 2014. Guarantor acknowledged receipt of the copy of the letter of cancellation.

On 4 June 2014, Employer/Beneficiary officially demanded payment of ZAR 12 438 671.61 (approximately USD 777 416) premised on the construction guarantee from Guarantor. The construction guarantee contained the following clause (see clause 5):

“Subject to the Guarantor’s maximum liability referred to in 1.0 or 2.0, 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 at the Guarantors physical address calling up this Construction Guarantee. . . .”

Clause 5 of the construction guarantee further required that the first written demand had to state 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 5.0. The demand shall enclose a copy of the notice of cancellation; or

5.2 A provisional sequestration or liquidation court order had been granted against the Contractor and that the Construction Guarantee is called up in terms of 5.0. The demand shall enclose a copy of the court order.” [Emphasis added.]

The letter of demand that Employer/Beneficiary had sent to Guarantor stated the following (para 21):

“(3) On 30 April 2014, and as a result of the contractor’s default and repudiation of its obligations arising in terms of the Agreement, we cancelled the Agreement.

(4) We enclose under cover of this letter, marked as annexure “A”, a copy of our letter of cancellation.

(5) Pursuant to clauses 5.0 and 5.1 of the guarantee, we demand payment from you of the amount of the guaranteed sum, R12 438 671.61.

(6) Pursuant to clause 8 of the guarantee, we accordingly await payment by you of this amount within 7 days of the date of this letter”. [Emphasis added.]

It was common cause that the letter of cancellation was not attached to the letter of demand dated 4 June 2014 (para 23). However, a copy of the letter of cancellation, dated 30 April 2014, was sent to Guarantor on 20 May 2014 (i.e., a couple of days before the official demand was made). Guarantor’s attorneys were also copied on e-mails on meetings subsequent thereto during May 2014. So Guarantor was aware of the letter of cancellation and had in its possession a copy of said letter of cancellation.

Employer/Beneficiary then launched motion court proceedings against Guarantor claiming payment of ZAR 12 438 671.61 in terms of the construction guarantee. However, before the matter was heard by the court various dealings (meetings and a series of e-mails) took place between the parties by way of their respective attorneys in what appeared to be an attempt to resolve the matter. There was a difference in opinion between the parties to the construction guarantee’s respective quantity surveyors regarding certain aspects of the underlying construction contract (certain measurements). The parties also requested reports by their respective quantity surveyors. It seems that there was also a dispute regarding the cancellation of the underlying contract. In many of the communications sent by the attorneys of Employer/Beneficiary it was stated that “all of the information forwarded to you by our client was obviously done so as part of the without prejudice engagement taking place between our clients”. Employer/Beneficiary in certain e-mails requested Guarantor to indicate what their “overall settlement proposal” was and what the exact amount was that it would pay. This eventually led to Guarantor paying ZAR 6 060 404.22 into the trust account of Employer/Beneficiary’s attorney on 4 November 2014. On 11 November 2014 Employer/Beneficiary’s attorney acknowledged receipt of the payment and clearly indicated that the payment was accepted “without prejudice of its rights regarding the claim for payment of the balance of the guaranteed amount”. Employer/Beneficiary also requested a breakdown from Guarantor indicating how this amount had been calculated and its reasons for not paying the outstanding amount which was accordingly still owed in terms of the construction guarantee.

One of the terms the parties had seemingly agreed to during their dealings with each other was that each party’s quantity surveyor would after the payment was made into the attorney’s trust account assess the further costs incurred since the construction guarantee was called, together with any additional costs to be incurred, where after the attorney would then pay Employer/Beneficiary out of the funds held in trust, on receipt of an instruction to that effect.

In a further e-mail Employer/Beneficiary indicated that it was no longer prepared to postpone the matter and that it would institute an application (e.g., issue summons) to claim the balance of the guaranteed amount (i.e., ZAR 6 378 266.39) and that it would withdraw the initial motion court proceedings. Guarantor’s attorney responded on 5 December 2014 by indicating that there were still certain unresolved issues and the payment that was made was not made in full and final settlement of any particular heads or claim/components and that clause 7 of the guarantee remained applicable to the amounts claimed. The attorneys later that day confirmed in a second e-mail that the earlier e-mail was sent in a “without prejudice context, and without admission of liability, as also entirely [without] prejudice to all our client’s rights including its right in terms of clause 7 of the guarantee”. Clause 7 of the construction guarantee provides for the deduction of any prior part payments from the guaranteed payment and for calculation of final amounts owing.

Employer/Beneficiary decided to continue with action against Guarantor for non-payment of the balance owned in terms of the construction guarantee. The trial court found in favour of Employer/Beneficiary.

Legal Analysis:

Guarantor opposed the application on two grounds. Firstly, it claimed that the subsequent agreement of settlement novated the earlier construction guarantee. Secondly, it claimed that there was non-compliance with the terms of the guarantee. Employer/Beneficiary denied that there was an agreement reached which novated the original construction guarantee. According to Employer/Beneficiary, there was, “at most, certain proposal to resolve the dispute and an on-going attempt to resolve the matter which foundered upon the mechanisms of resolution”.

1. Novation.

The judge held that she was not convinced that there was an agreement reached between the parties which novated the earlier construction guarantee (paras 5 and 48). From the correspondence between the parties there were various uncertainties regarding the exact resolution that was to be achieved (e.g., there was no agreement as to what the situation would be if the two quantity surveyors had different views regarding the measurements of the underlying contract and how the issues of hoarding costs, interest and finance costs had to be dealt with – see para 7). The judge found that the terms or basis upon which the parties had met and agreed to resolve the matter was “uncertain, incomplete and apparently incapable of being finalised” (para 6). Her view was strengthened by the attorneys of Guarantor which wrote in their correspondence dated 4 September 2014 that they still had to resolve outstanding issues and they (the attorneys) would only be in a position to draw a draft agreement once those issues were resolved. Employer/Beneficiary’s attorneys in response wrote that they were still waiting for feedback on the matter and demanded Guarantor’s “overall settlement proposal” (para 14). Accordingly, Guarantor could not argue that an agreement and settlement had been reached or that the matter had been finalised. The judge said the agreement between the parties amounted to nothing more than a provisional attempt to resolve the dispute, which was already the subject-matter of litigation – payment of approximately ZAR 12 million pursuant to the construction guarantee. Therefore, the original construction guarantee remained operative and was never novated (paras 50 and 51).

2. Compliance with the guarantee

Guarantor argued that there had not been “strict” compliance with the terms of the construction guarantee by reason of the failure to attach the letter of cancellation to the letter of demand and, with such failure to comply with a peremptory provision of the guarantee, the demand was fatally defective. Employer/Beneficiary, in contrast, argued that “strict” compliance was not a requirement, that the letter of cancellation had been delivered prior to the letter of demand which constituted compliance and that, in any case, Guarantor had waived any entitlement to require Employer/Beneficiary to attach the letter of cancellation to the letter of demand (para 24).

The judge said she first had to decide whether or not “prior” compliance rather than “contemporaneous” compliance in the context of this particular matter meant that there had not been the required compliance with the construction guarantee (para 25).

The judge considered some of the South African and English case law dealing with the issue of strict compliance (para 26–33). She states that under the English law there is a distinction made between the standard of compliance required with letters of credit and construction guarantees (demand guarantees) and adds (para 30):

“Accordingly, the English courts (followed by the South African courts) have, thus far, taken the approach that there is a difference or ‘contrast’ between a guarantee where the call is simply based on the say-so statement of the one party that an event has occurred and between letters of credit where the bank is in possession of documents (such as bills of lading) establishing the foundation of the call. The courts have indicated that the more ‘strict’ compliance is required of the banks and of the documents presented to activate letters of credit because the banks themselves are in a position to evaluate the call by perusing the various documents. No mention has been made of the degree of rigour of compliance in the case of performance guarantees.”

The judge confirmed that the South African courts have not yet found it necessary to determine whether or not “strict” compliance was required of the beneficiary under a performance (construction) guarantee. As authority she relied on the judgment delivered by the South African Supreme Court of Appeal in Compass Insurance Co Ltd v Hospitality Hotel Developments (Pty) Ltd

2012 (2) SA 537 (SCA) (for a discussion of this case, see 2013 Annual Review of International Banking Law & Practice at 357–360) where the issue of “strict” compliance in the case of construction guarantees was left open for decision on another occasion (para 31). She confirmed that in Compass the South African Supreme Court of Appeal found that there was no compliance let alone sufficient compliance with the guarantee when the demand was made. In that case a copy of the liquidation order had to be attached to the demand, but it was not, and it was only supplied months later after the guarantee had already expired. Accordingly, it was held in Compass that there was no compliance.

The judge was of the view that the case before her was distinguishable from the Compass case. This was so because in Compass there “was only a belief or ‘knowledge’ that the required condition for breach, i.e. liquidation, had taken place – no one was in possession of the requisite order which was expressly required to be attached to the demand” (para 32). Whereas, in the current case (para 34):

“the notice of cancellation did exist. It was sent to the guarantor and received by the guarantor. Guarantor’s attorneys were also copied on the correspondence arranging meetings to discuss this cancellation in May 2014. The existence of the cancellation and the reasons therefor were known to the guarantor at the time demand was made.”

The judge added (para 38):

“[t]o require that this notice of cancellation, already received and discussed and engaged upon, be attached to the notice of demand 15 days later is not requiring moonwalking and beneficiary/applicant could certainly have complied therewith. However, to find that failure to attach a written cancellation already received and under discussion, constitutes complete non-compliance with the terms of the guarantee and therefor disentitles the beneficiary/applicant from proceeding with its demand under that guarantee is, I believe, a step too far. The reasons requiring compliance with terms of the guarantee, especially as restated by the Supreme Court of Appeal in Compass supra, are carefully kept in mind in the present instance.”

She concluded that the prior presentation of a copy of the cancellation letter by Employer/Beneficiary to Guarantor (and their attorney’s) instead of simultaneous presentation with the demand, based on the facts of this case, did constitute compliance with the guarantee (para 39).

3. Waiver

Employer/Beneficiary relied upon the acceptance of the letter of demand, payment of about ZAR 6 million in respect of which repayment had not been demanded, and the late raising of the issue of non-compliance by Guarantor to argue that Guarantor had waived any right to void the letter of demand required in the construction guarantee. Guarantor responded to this argument by stating that it had made its payment in terms of the settlement agreement and not the construction guarantee (para 40).

The question therefore to be decided was whether or not Guarantor clearly demonstrated the intention to surrender its right to dispute the demand (by reason of non-attachment of a copy of the cancellation letter) and therefore knowingly renounced its right to dispute the demand (para 41). In dealing with this question, the judge said the following (para 42):

“In all the correspondence to which I have referred there is no mention of or complaint by respondent of the failure to attach the letter of cancellation. Throughout this matter, respondent behaved and expressed itself as though the demand was good and compliant. This is because, submits respondent, respondent was acting in terms of and making payment in terms of a subsequent agreement which novated the agreement contained in the credit guarantee. However, I have found that there was no such agreement.”

The judge added that when the payment was made, it was not made in terms of any proposals towards the agreement – it was simply the amount which Insurance Company’s quantity surveyor had deemed appropriate – it was not an amount to which the parties had agreed (para 44). Furthermore, the payment was made “not in full and final settlement” and without prejudice to Guarantor’s “right in terms of clause 7 of the guarantee”. Therefore, in the circumstances, clause 7 (referred to above) remained applicable to the amounts claimed and the payment Guarantor was clearly done with the construction guarantee in mind (paras 44–45). She summarized the situation (para 46):

“payment can only have been made by reason of the existence of the guarantee to which such payment was subject. Payment can only be made when there is a call or demand made in terms of clause 5 of that guarantee. Respondent did not, prior to making payment, claim that the demand was non-compliant with the terms of clause 5 of the guarantee and advert to the failure to attach the notice of cancellation thereto. Respondent made payment in terms of the guarantee and by referring to clause 7 of the guarantee explicitly acknowledged that payment was pursuant to clause 5 thereof.”

The judge held, based on the facts of this case, that Guarantor had indeed waived its right of insisting on compliance with the terms of clause 5 of the demand guarantee (para 47). She said Insurance Corporation could simply have said no to the payment, but instead it chose to pay, thereby waiving its right to challenge the compliance of the demand (para 52).

4. Order

The judge ordered Guarantor to pay to Employer/Beneficiary the sum of ZAR 6 378 266, 39 plus interest at the legal rate of interest as follows: (a) on the amount of ZAR 12 438 671.61 from 11 June 2014 to 5 November 2014; and (b) on the amount of R 6 378 266, 39 to date of final payment. She also ordered Guarantor to pay the costs of this application including those costs of the unopposed motion of 23 February 2015 when costs were reserved.

Comments:

The judge was correct in finding that the construction guarantee was not novated by a subsequent agreement between the parties.

The judge is spot-on when she states that the application of strict compliance to construction/performance (demand) guarantees has not been settled in South Africa and that the issue was left open in the Compass case by the South African Supreme Court of Appeal (for more on this issue see the discussion of State Bank of India v Denel SOC Limited (947/13) [2014] ZASCA 212 (3 December 2014) in 2015 Annual Review of International Banking Law & Practice at 480–486). She is, however, mistaken when she avers that the facts of Compass are distinguishable from the facts in Kristabel. Under various English authorities, as well as South African authorities, it has clearly been acknowledged or implied that it is not a matter of whether strict compliance applies or not, but rather whether there has been compliance and whether what was called for in the guarantee was actually submitted or not. Compass confirms this point as well. The fact that what was called for in Compass – i.e., copy of liquidation order – was only submitted long after the demand was made, and what was called for in Employer/Beneficiary – i.e, copy of cancellation letter – was already submitted to the guarantor before the demand was made, is neither here nor there. In both cases, the beneficiaries of the guarantees had failed to attach what was asked for in the guarantee simultaneously with the demand. Therefore, in both instances there were non-compliant demands made and in both it was a matter of there being no compliance let alone strict compliance. The guarantor’s duty is to pay against specified documents that are presented within the period and in accordance with the other conditions of the construction guarantee.

The court went too far when it found that Guarantor, the guarantor, had waived its right to insist on compliance with the terms of clause 5 of the demand guarantee. During the dealings between the parties the guarantor clearly stipulated that the payment was made “without prejudice and without admission of liability”. From a reading of the judgment and the facts before the court there was nothing to suggest that the guarantor had waived its rights to insist on compliance. It is, however, strange that the guarantor did not raise the issue of non-compliance earlier when the demand was made. The court lost sight of the independent/autonomous nature of the construction guarantee. A guarantor that gives a construction guarantee must honour that guarantee according to its terms. A guarantor issuing a demand guarantee undertakes an absolute obligation to pay the beneficiary in accordance with the directions in the guarantee. Therefore, when the court considered the guarantor’s claim that there had not been compliance with the guarantee, it should not have entertained the beneficiary’s claim that the guarantor had waived its right to raise the issue of non-compliance, as that necessarily meant that the court had to look beyond the terms of the construction guarantee itself.

Excerpts from TEXT of Guarantee:

The Credit Guarantee – clause 5

“Subject to the Guarantor’s maximum liability referred to in 1.0 or 2.0, 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 at the Guarantors physical address calling up this Construction Guarantee…”. The Guaranteed Sum is defined to mean “the maximum amount of R 20 731 119.36”

19. Clause 5 of the credit guarantee requires a first written demand 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 5.0. The demand shall enclose a copy of the notice of cancellation; or

5.2 A provisional sequestration or liquidation court order had been granted against the Contractor and that the Construction Guarantee is called up in terms of 5.0. The demand shall enclose a copy of the court order.”

Excerpt from Letter of Cancellation:

20. The letter of cancellation reads at par 5-6:

“(5) Your e-mail to the Employer of 9 April 2014 constitutes a clear and unequivocal rejection by you of your obligations imposed in terms of the JBCC agreement.

(6) You are hereby advised that the employer accepts your repudiation of your obligations under the agreement, without prejudice to its rights to claim from you such amounts as are due by you to the Employer, and that the JBCC agreement is accordingly terminated with immediate effect”.

Excerpts from Letter of Demand:

21. The letter of demand states at par 3-6:

“(3) On 30 April 2014, and as a result of the contractor’s default and repudiation of its obligations arising in terms of the Agreement, we cancelled the Agreement.

(4) We enclose under cover of this letter, marked as annexure “A”, a copy of our letter of cancellation. [my underlining].

(5) Pursuant to clauses 5.0 and 5.1 of the guarantee, we demand payment from you of the amount of the guaranteed sum, R12 438 671.61.

(6) Pursuant to clause 8 of the guarantee, we accordingly await payment by you of this amount within 7 days of the date of this letter”.

* Professor of Law, Department of Mercantile Law, School of Law, University of South Africa.

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