Article

Factual Summary:

Eskom, the South African electricity public utility, concluded a construction contract (“the main contract”) with Raubex Construction (Pty) Ltd (Respondent in case and Beneficiary of the retention (demand) guarantee). Raubex Construction in turn appointed a sub-contractor, Peakstar 133 (Pty) Ltd trading as Dolphin Construction, to perform certain construction works (“the sub-contract”). In terms of the sub-contract, the sub-contractor (Dolphin) was required to provide a retention guarantee (“the guarantee”). The guarantee was issued by Bryte Insurance Company Ltd (Appellant in case and Guarantor of the guarantee) in favour of the main contractor, Raubex (Beneficiary).

The relevant parts of the guarantee issued by the guarantor (Bryte) provided as follow (para 4):

“The Guarantor renounces the benefits of excussion and division and undertakes to pay to the Main Contractor upon demand all such monies as the Main Contractor may require to be paid to it in lieu of any retention monies which have been repaid by the Main Contactor to the Subcontractor and which the Subcontractor would otherwise be liable to pay to the Main Contactor under and in terms of the Subcontract, and such monies shall be paid by the guarantor conditionally upon receipt of demand from the Main Contractor that any such retention monies are due and payable to the Main Contractor by the Subcontractor as provided for in terms of the Subcontract, provided however, that the liability of the guarantor hereunder shall not exceed the sum of [ZAR]1 686 721.89 . . . and is subject to the following further terms and conditions;

  1. Each demand by the main Contractor shall be in writing signed by the main Contractor and delivered to the Guarantor . . . and shall be accompanied by a certificate complying with clause 2, signed by the Main Contractor’s authorized representative.
  2. Each demand by the Main Contractor shall certify;
    1. That the signatory is the Main Contractor authorized representative;
    2. That the Subcontractor is in breach of his obligations under the Subcontract and that the Main Contractor is entitled to be paid amounts for which the Subcontractor is liable under the Subcontract; and
    3. That the amount demanded, which amount the certificate shall specify:
      1. Does not exceed the amount of Retention monies which, but for this Guarantee, would have been retained by the Main Contractor as Retention Monies in terms of the Subcontract at the date of the certificates, less the aggregate of the amounts, if any, of retention money and other securities actually retained or held by the Main Contractor in terms hereof and;
      2. Does not exceed a good faith estimate of the costs to the Main Contractor of having the breach referred to in paragraph (b) remedied less the aggregate of any amounts withheld by the Main Contractor from payment due to the Subcontractor in terms of the Subcontract by reason of the breach referred to, and any amount of Retention money actually held by the Main Contractor save to the extent that the same had been deducted from any previous demand in terms hereof. ...
  1. Subject to compliance with the provisions hereof, the Guarantor’s liability to make the payment herein referred to shall be unconditional and shall not be affected or diminished by any disputes, claims or counterclaims between the Main Contractor and the Subcontractor.’ [Emphasis added.]

Raubex, the Beneficiary, sought payment under the guarantee of an amount of ZAR1 409 726.11 plus interest. The issue in the case was whether Bryte, the Guarantor, was obliged to make payment to the Beneficiary under the guarantee. The High Court of South Africa, Gauteng Local Division, Johannesburg, the court of first instance, found that it was so obliged and ordered payment accordingly (para 5). The Guarantor (Appellant) appealed against this decision and the matter was heard by the full bench of the same court (para 1).

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

Legal Analysis:

The Guarantor’s main argument for refusing to pay in terms of the guarantee was that the Beneficiary had knowledge that it was not entitled to the payment demanded inter alia because the Beneficiary’s estimation of the costs of having the sub-contactor’s alleged breaches remedied was not bona fide. The Guarantor argued that the Beneficiary’s demand was not in accordance with requirements of the guarantee and, particularly, not in accordance with clause 2(c)(ii) of the guarantee, which required a certification that the amount demanded did not exceed a good faith estimate of the costs of having the breach rectified. Furthermore, this lack of bona fides by the Beneficiary constituted fraud and therefore the Guarantor had no obligation to comply with the demand (para 6).

The court referred to relevant authorities and confirmed the independent nature of the guarantee in this case (paras 7–9). It also confirmed the documentary nature of these type of guarantees (paras 13–16).

In dealing with the matter, the court pointed out that on the undisputed facts, insurmountable difficulties arose for the Beneficiary in relation to the accuracy of the estimate of the costs of remedying the alleged breach. It found that it was clear from the estimate which was attached to the papers in the application, that many alleged defects which formed the basis for the estimate, were discovered and dealt with before the practical completion envisaged in the sub-contract, and were therefore not costs covered by the guarantee. Therefore, a large proportion of the costs which were claimed were alleged to have been incurred by a third party electrician for remedying defects but, on closer inspection, were revealed to be in relation to costs already incurred in respect of the Beneficiary itself, in the form of past expenses, such as salaries, cell phone charges, diesel costs, accommodation and travel costs (para 10).

The Beneficiary conceded that the estimate in the circumstances could not be said to be a proper estimate of the costs to remedy the alleged breaches (para 10), but denied that there was anything fraudulent or mala fide about its inaccuracy (para 28). Although the Beneficiary admitted that the estimation of the costs was incorrect in a number or respects, it added that its admission was irrelevant to the case, because the guarantee required only that the demand be made in the terms specified. It argued that it had made a compliant demand and therefore, regardless of the accuracy or otherwise of the certifications in the demand, the payment obligation was triggered (para 11).The Guarantor disagreed and argued that the guarantee and, specifically clause 2(c)(ii) (quoted above) of the guarantee, had to be interpreted as meaning that the Beneficiary had to prove that the estimation in the demand was made in good faith (para 12).

The court said that the meaning of the requirement of bona fides in the context of the guarantee had to be determined before it could be decided whether the demand in this case had complied with the terms (para 17). In doing so, the court applied the rules of interpretation as it applies to contracts in general in South Africa (para 18).

The court confirmed that the guarantee required a certification that the specified amount demanded did not exceed a good faith estimate of the costs of having the breach remedied. Certification was defined “as the action or an instance of certifying the truth of something” (para 19).Therefore, the introduction of the requirement of good faith in this context, suggest that the parties intended that the certification contemplated not be of a mere routine estimate but one which allows for, and indeed, requires a substantive statement in the demand, to enable an objective assessment whether the estimate is made on a proper basis, in respect of future expenses and costs to be incurred to remedy the defects and that the claim is properly founded (para 20).The Beneficiary’s interpretation, accordingly, would result in negating the purpose of the document and, specifically, undermine the substantive concept of good faith. The court said the parties included the element of good faith in the guarantee in an attempt to eliminate and avoid a false or mala fide estimate (para 21). As a result, it was not enough for the Beneficiary to prove only that there had been a formal certification of good faith, but also that the certification was, in fact, made in the honest belief that it was a correct estimate of what it was entitled to be paid under the guarantee. The Beneficiary did not exceed to do so (para 22).

The court also dealt with the Guarantor’s allegation of fraud by the Beneficiary (paras 23–30). The court said because the Beneficiary conceded that the estimation of some of the costs to remedy the breach were incorrect and failed to provide reasons (explanations) for that it suggested mala fides by the Beneficiary in making this admittedly material inaccurate estimate. Accordingly, in the absence of a proper explanation for the false representation by the Beneficiary, the court concluded that the Beneficiary made the demand with knowledge of the lack or inaccuracy in the certification (para 26) and knowledge that it was not entitled to payment in terms of the guarantee (para 29).The appeal was upheld and the Beneficiary was ordered to pay for the costs of the appeal (para 31).

Comments

The case illustrates the importance of using standardised forms of demand guarantees, to avoid problematic and vague requirements, such as “good faith” being included in the guarantees.

The correctness of the decision is doubted. Although the court in Bryte acknowledged the fundamental principles underscoring demand guarantees, namely the independence principle and their documentary nature, it did not truly apply these principles to the case before it. In the matter before the court it was not in dispute that a compliant demand was made when looking at the demand from a purely documentary perspective. What seems to be in dispute was the truth of the certification required in clause 2(c)(ii). In terms of a demand guarantee a guarantor is not required to go on an expedition to establish the truth of the certification in the demand. A guarantor is not requested to go beyond its independent and autonomous contract with a beneficiary, for example, by making any enquiries to determine the truth of statements made in a demand or establishing whether a demand is valid. The demand in Bryte also required the Beneficiary to “certify” that the sub-contractor was in breach of his obligations under the sub-contract and that the main contractor was entitled to be paid amounts for which the sub-contractor was liable under the sub-contract. Therefore, if it is accepted that the court’s judgment is correct, the Guarantor would also have had to consider whether all the other certifications were correct (true). Such an interpretation undermines the autonomy principle and documentary nature of demand guarantees. The majority of demand guarantees in practice require that a demand contains a written declaration that the principal/applicant of the guarantee has breached its obligations under the underlying contract and if it had to be proven that these type of declaration is actually true it would diminish the effectiveness and use of demand guarantees and equate them to accessory payment obligations, such as suretyships.

It is trite law that where a compliant demand is made the guarantor has to pay, except in cases of clearly established fraud. The court in Bryte implies that fraud was proven. The reasons why the court held that the Beneficiary had made a fraudulent demand was because the Beneficiary conceded that a number of its estimated costs to remedy the breach were incorrect and also failed to advance reasons for the incorrect estimation of these costs. It also follows, however, by implication, that some of the estimated costs to remedy the breach claimed were correct. Therefore, in my view, it appears that what was truly in dispute in this case is the exact amount of costs to remedy the breach (in other words the amount for which a demand should be made). This relates to a dispute concerning the underlying contract (sub-contact) and the parties to that contract (ie, the Beneficiary and sub-contractor) rather than a dispute whether a compliant demand was made. It is questioned whether a “clear case of fraud” was proven by the Guarantor in this case. The Guarantor, for instance, did not allege that there was general fraud in the underlying contract. It did not even state that the sub-contractor did not breach the sub-contract. It solely limited the alleged fraud by the Beneficiary to the incorrect estimation of costs stipulated.

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 the ICC or Coastline Solutions.