Article

Factual Summary:

The South African National Roads Agency Limited concluded a contract for the construction of road works in KwaZulu-Natal (“the main contract”) with KNS Construction (Pty) Limited. KNS Construction in turn appointed a sub-contractor, Aqua Transport & Plant Hire (Pty) Ltd, for the construction works. In terms of the sub-contract, the sub-contractor was required to provide a performance guarantee to the value of 15 per cent of the main contract. The guarantee was not to have an expiry date. Mutual and Federal Insurance Company Limited (Guarantor), issued the guarantee on 5 April 2011 on behalf of the sub-contractor (Applicant) for the due fulfilment of the sub-contractor’s obligation to Beneficiary pursuant to the sub-contract entered into between Applicant and Beneficiary (para 1).

Clauses 1 to 3 of the performance guarantee issued by Guarantor provided as follows (para 2):

“1... Mutual & Federal Insurance Company Limited ... [Guarantor] do hereby hold at your disposal the amount of [ZAR 3,423,850.49] ... for the due fulfilment by Aqua Transport & Plant Hire (Pty) Ltd ... [Applicant] of its obligations to KNS Construction (Pty) Ltd ... [Beneficiary] in terms of the above stated contract between [Applicant] and [Beneficiary].

2. The Guarantor hereby renounces the benefits of the exceptions non numeratae pecuniae, non-causa debiti, excussion and division, the meaning and effect whereof we declare ourselves to be fully conversant.

3. The Guarantor undertakes to pay [Beneficiary] the said amount of [ZAR 3,423,850.49] ... or such portion as may be demanded on receipt of a written demand from [Beneficiary] which demand may be made by [Beneficiary] if, (in your opinion and at your sole discretion), the said Contractor fails and/or neglects to commence the work as prescribed in the contract or if he fails and/or neglects to proceed therewith or if, for any reason, he fails and/or neglects to complete the services in accordance with the conditions of contract, or if he fails or neglects to refund to [Beneficiary] any amount found to be due and payable to [Beneficiary], or if his estate is sequestrated or if he surrenders his estate in terms of the Insolvency Law in force within the Republic of South Africa.”

Soon after the main and sub-contracts were concluded and the guarantee was issued, Beneficiary started to experience financial problems which caused it to not being able to perform in terms of the main contract. This in turn also caused Applicant not being able to perform its obligations in terms of the sub-contract. Beneficiary was also not able to pay Applicant for work it had already performed. Eventually Beneficiary placed itself under voluntary winding-up in terms of a special resolution registered by the South African Master of the High Court on 13 December 2011. The next day the site was closed resulting in no work being carried out. This resulted in the South African National Roads Agency Limited cancelling the main contract (para 3).

During January 2012, Beneficiary was also placed under provisional winding-up at the instance of one of its creditors. The provisional order was made final and provisional liquidators were appointed. The appointment was made final on 11 July 2012. Prior to these two winding-up applications, one of Beneficiary’s creditors had already instituted a winding-up application in 2010 in the South African North Gauteng High Court, Pretoria, which application was dismissed. The creditors in that application were unhappy with the dismissal and lodged an appeal to the full bench. On 19 September 2012, a full bench upheld the appeal and Beneficiary was accordingly placed in final winding-up retrospectively to 8 October 2010 (para 4).

Notwithstanding these insurmountable difficulties, and the fact that the site was abandoned with no work being carried on in terms of the main contract, Beneficiary, on 14 December 2011, a mere day after it had placed itself under voluntary winding up, notified the sub-contract, that it intended to cancel their contract. Beneficiary gave Applicant 14 days’ notice to rectify its performance and warned that failing to do so would result in Beneficiary making a demand for payment in terms of the performance guarantee issued in its favour. The threat to make a demand in terms of the guarantee was later followed up by the liquidators on two different occasions. The ground for the calling up the guarantee was the failure by Applicant to commence, proceed with, or complete the construction contract (para 5).

Applicant instituted an application in the South African South Gauteng High Court, Johannesburg on 28 May 2012 to interdict Guarantor from making the payment in terms of the guarantee. By agreement between the parties, Guarantor was interdicted from honouring the guarantee pending resolution of proceedings to be instituted within 30 days by Beneficiary. Eventually, Beneficiary instituted an application in the South African Gauteng Local Division of the High Court, Johannesburg (“court of first instance”) demanding payment from Guarantor based on the guarantee. Beneficiary claimed payment on the ground that the guarantee was an independent/primary guarantee and therefore was payable. Applicant disagreed and contended that the guarantee was in reality an accessory (traditional) guarantee akin to a suretyship. Applicant also argued that it was not in breach of the sub-contract and, therefore, the guarantee was not due and payable (para 6).

The court of first instance concluded that the guarantee was an independent (primary) guarantee and therefore Guarantor was obliged to pay if a demand made in terms thereof complied with the terms of guarantee. Guarantor and Applicant appealed and the matter was heard by the South African Supreme Court of Appeal (para 7).

Legal Analysis:

The prime question the South African Supreme Court of Appeal had to answer was whether the guarantee in the case constituted an accessory guarantee or a primary guarantee. In deciding what the actual nature of the guarantee was, the court followed the modern interpretation method of “matrix of facts” or “background/surrounding circumstances” it had set out in its earlier judgment in Novartis SA v. Maphil Trading 2016 1 SA 518 (SCA). During this process, the court also among others referred to its earlier judgment in the Zanbuild case (see discussion of this case in 2012 ANNUAL REVIEW of International Banking Law & Practice at 469–472 and for a detailed discussion see Kelly-Louw, “Construction of demand guarantees gone awry”, (2013) 25 South African Mercantile Law Journal 404) where it had held that the guarantee there gave rise to a liability similar to that of a surety (see Zanbuild case in para 19):

“The first indicator in that direction is the assertion at the outset that the guarantee provide ‘security for the compliance of the contractor’s performance of obligations in accordance with the contract’. And in the body of the document the bank guarantees “the due and faithful performance by the contractor”. This accords with language associated with suretyships.”

The Supreme Court of Appeal in Mutual and Federal held that “the language used in the guarantee and its purpose reveal the true intention of the parties” (para 13). It found that the language used, particularly in clause 1 and 3 of the guarantee (quoted above), was similar to that in the Zanbuild case (para 13). It emphasised that although the guarantee in the case before it provided that it was payable at the discretion of Beneficiary, and that payment in terms of it could be demanded “at any stage”, the true purpose was to guarantee the due performance by Applicant (para 14). Furthermore, the guarantee was clearly only payable if Applicant breached his contract with Beneficiary (ie, the sub-contract) as explicitly stated in the guarantee (para 14). As a result, it held that though the demand was at the discretion of Beneficiary, that aspect did not affect the nature of the guarantee. The discretion vested in Beneficiary was to be exercised “arbitrio bono viri”. The trigger event for payment was when Applicant failed to commence, proceed with, or complete the sub-contract (para 15).

The Supreme Court of Appeal also added that the fact that the guarantee was not accompanied by any document before payment was demanded, but depended on breach of the sub-contract by Applicant in either failing to commence, proceed with, or complete the project, gave credence to the fact that the guarantee was inseparably linked to the sub-contract and therefore similar to a suretyship. The inescapable conclusion was therefore that the guarantee was similar to a suretyship (like that in the Zanbuild case) and not a demand guarantee (para 15). For that reason, the court of first instance erred in finding that the guarantee constituted a primary obligation. The appeal by Guarantor and Applicant was thus upheld (paras 16–18).

Comments:

It is important to bear in mind that it is not the name, label, title, or heading that is given to a payment obligation or undertaking that determines whether or not it is accessory or independent, but rather its substance and construction (see Kelly-Louw “Construction of demand guarantees gone awry” (2013) 25 South African Mercantile Law Journal 404). This point is well illustrated by the judgments delivered by the South African Supreme Court of Appeal in the Mutual and Federal and Zanbuild cases.

The South African Supreme Court of Appeal’s judgment in Mutual and Federal cannot be criticised. It is obvious that the wording used in the guarantee constituted an accessory liability, despite the use of the term “performance guarantee”. If one were to look exclusively at the title of the instrument in this case, without also considering the actual wording used, one could easily have assumed wrongly that a primary liability was created. Although the court relied on the wording used in clauses 1 and 3 of the guarantee, it could also have relied on clause 2 of the guarantee (quoted above) which excluded or limited the defences available in Mutual and Federal, to further strengthen its view that the guarantee was accessory rather than primary (see Hapgood (with contributions from Levy, Phillips and Hooley) Paget’s Law of Banking (2003) at 731).

The English Courts take into consideration all the relevant surrounding circumstances (ie, the “matrix of facts” method) when construing commercial instruments. For instance, in Rainy Sky SA v Kookmin Bank 2011 UKSC 50 (2011 1 WLR 2900 (SC)) the English Supreme Court outlined a modern approach to interpreting contracts (including demand guarantees), namely that the surrounding circumstances or “matrix of facts” must be taken into consideration in order to construe the contract where appropriate (eg, where a guarantee is vague) or to correct a clear drafting mistake such that literal interpretation will bring about an “uncommercial result” (see also Constable (ed) Keating on Offshore Construction and Marine Engineering Contracts (2015) 260–261, and 271–273). In a nutshell, it means that if there are two possible interpretations when construing a commercial instrument, an English court is permitted to prefer the interpretation which is consistent with business common sense and to reject the other (see, eg, Furmston and Chuah (eds) Commercial law (2013) 382).

The South African courts follow a comparable modern method of interpreting contracts, including commercial instruments. The South African courts will generally construe the common intention of the parties to a contract by considering the “language” used in the contract. As a rule, words and phrases in a contract are given their ordinary grammatical meaning as it appears from the rules of grammar, dictionaries, and also previous judicial decisions (see, eg, Coopers and Lybrand v Bryant (1995) 3 SA 761 (A)). Although this ordinary meaning of words is the base for the interpretation of contracts, the law does not compel a strict literal approach, but allows a more liberal interpretation, for example where the ordinary meaning would be visibly contrary to the real intention of the parties to the contract or in order to “avoid absurdity” or clarify an inconsistency or to give a contract a “commercially sensible meaning” (see Van der Merwe, Van Huyssteen, Reinecke et al Contract General Principles (2012) at 264–265 and the authorities cited in footnotes 361–363). Normally, where possible, effect must be given to every word in a contract and the words must be interpreted within the context of the contract as a whole, while taking into consideration the fact that a contract may consist of more than one document and that the content of a document may be supplemented by incorporation of terms from another document (see Van der Merwe, Van Huyssteen, Reinecke et al Contract General Principles (2012) at 265). This apparently means that the words must be interpreted in their full context, including all “background/surrounding circumstances” or “factual matrix” (see Van der Merwe, Van Huyssteen, Reinecke et al Contract General Principles (2012) at 265; and KPMG Chartered Accountants (SA) v Securefin Ltd 2009 4 SA 399 (SCA)).

The South African Supreme Court of Appeal in Mutual and Federal in deciding whether the construction guarantee constituted a suretyship or a primary/independent guarantee, supported and followed this contemporary interpretation method of “matrix of facts” or “background/surrounding circumstances.” It used this modern-day interpretation method to resolve that it was the intention of the parties in this case to create an accessory obligation similar to a suretyship in their performance guarantee.

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

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