Legal Case Summaries

Article

Factual Summary:

Group Five Power International (Pty) Limited (Applicant), a large African construction company, concluded a big contract for the construction of a power plant in Ghana (underlying contract) with Cenpower Generation Company Limited (Beneficiary) to the value of around USD 410 million. The construction contract called for a performance guarantee and a retention guarantee (hereinafter “guarantees”) to be issued in favour of Beneficiary. Two different banks (HSBC Bank, Johannesburg Branch, and Standard Chartered Bank (Guarantors) issued the guarantees. Both guarantees contained basically the same trigger provisions for drawing on the guarantees, providing the following:

“The bank hereby irrevocably and unconditionally undertakes to pay to owner within three business days following that on which it receives a written demand from owner in accordance with clause . . . stating [either] that the contractor is in breach of its obligations in terms of the contract or an event as stated in sub-clause . . . of the contractor has occurred in respect of the contractor, an amount equal to the lesser of:

(a) The amount specified in such demand; or

(b) The bond amount stated in the first schedule less the aggregate of all previous payments made under this bond.” [Emphasis added.]

It is clear from the facts presented in court that the Applicant did not complete the construction of the power plant on the agreed deadline. The Applicant requested an extension for the completion date, but the Beneficiary seemingly did not agree to the extension. There were also various disputes as to whether or not the Applicant breached the underlying contract. The parties also disagreed as to whether or not demands could be made on the two guarantees. The Beneficiary wanted to claim on the two guarantees mainly to cover alleged delay damages. Due to a failure to settle the contractual disputes, the Beneficiary ended up making demands on both the guarantees, totalling about USD 62.7 million. The Applicant approached the court and requested it to issue interim injunctions (or interim interdicts as it is known under South African law) to prevent the two banks from paying in terms of the respective guarantees.

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Legal Analysis:

Legal Analysis:

By the time the matter served before the court, the Applicant had requested an amendment to its Notice of Motion and requested an order for the interim injunction to be issued pending an arbitration between the parties. The Beneficiary opposed the amendment and the court requested the parties to deal with their arguments for and against the amendment in their main submissions (para 2). The two banks did not take part in court proceedings and agreed to abide by the ruling of the court.

The Applicant relied comprehensively on various terms of the underlying contract to justify the amendment and to convince the court to issue the injunctions in its favour. Some of the arguments included that demands on the guarantees were made contrary to what their true purpose was and the risks (costs) they were supposed to secure (cover). For instance, the Applicant argued in detail that there was a contractual prohibition against drawing on the retention guarantee for the purpose of covering any delay damages. It was understood that the Beneficiary made the calls on the two guarantees to recover delay damages it was entitled to claim in the event of a breach of the construction contract. The Applicant also alleged that completion of the power plant had to be tested using specific fuel as set out in the construction contract and the Applicant could not do this because the Beneficiary had not supplied the specific fuel (natural gas) that was required and agreed upon. In other words, the failure of the Beneficiary to supply the correct fuel prevented the testing of the power plant. Furthermore, there were allegations that the power plant was contaminated after the Beneficiary authorised use of non-specified fuels. The contamination also forced the Applicant to request an extension of time for the completion. The Applicant argued that it was entitled to an extension as provided for in the contract and an extension was justified for the aforementioned reasons. Therefore, the Beneficiary could not honestly state that the Applicant had committed a breach and, therefore, the demand on the guarantees were dishonest (and thus fraudulent; see paras 12 and 27). The fraudulent behaviour was further confirmed by the Beneficiary’s outright rejection of the Applicant’s request for an extension of time (para 28). The fraud of the Beneficiary was thus founded on two grounds: (1) the Beneficiary knew that the Applicant could not test the power plant in a timely manner; and (2) the Beneficiary was in bad faith when it rejected the Applicant’s numerous applications for extension of time.

The Beneficiary opposed the request for an amendment to the Notice of Motion. The Beneficiary disputed all the allegations made by the Applicant regarding the construction contract and the Beneficiary’s conduct in a lengthy manner. It insisted that the Applicant was, in fact, in breach of the construction contract.

The Beneficiary also focused on the general nature of demand guarantees and that of the two guarantees in the case. It also considered the exact requirements set out in the guarantees that would constitute compliant demands (eg, statement of breach requirement). It stressed that due to the nature of the demands involved, the banks were not “obliged to become involved in the underlying dispute between the owner and the contractor” (para 56). The Beneficiary pertinently denied that it was a requirement, particularly in the guarantees, that the Beneficiary first had to notify the contractor of a breach and to negotiate its resolution, before being able to make demands (para 57). The Beneficiary requested a dismissal of the application with the costs of two counsel (para 62).

In response, the Applicant requested a further amendment to the Notice of Motion, to provide for the interim relief to pend a referral to oral evidence of the question whether or not there was fraud on the part of the Beneficiary in making demands on the guarantees (par 63).

The court (per Van der Linde J) said that there were two main questions that needed to be answered. First, whether the Applicant had shown that there was a contractual prohibition (with or without having to show absence of honest belief in the asserted breach) against drawing on the retention guarantee for delay damages. Second, whether the Applicant had proven that there was no honest belief on the part of the Beneficiary in claiming breach by the Applicant (in other words, the Beneficiary’s demand was fraudulent).

Regarding the first question, the court held that such a contractual prohibition argument was not pleaded in the founding affidavit. The terms of the guarantees also did not expressly contain the limitation argued for by the Applicant. The Applicant, however, argued that the limitation would not be found in the guarantees itself anyway and the limitation, in reality, existed within the contractual scheme arranged between the parties (para 84). The Court stated that if it accepted that such a limitation existed, that is where it was to be found, the argument still required the “importation of an implied term (within its narrower meaning of a tacit term) into the parties’ contract” (para 85). Thus, by relying on case law, the court found that the Applicant should expressly have pleaded this as to have allowed both parties the benefit of presenting evidence and making submissions on this issue. Accordingly, the contractual prohibition argument could not be entertained.

In dealing with the second question, the court pointed out it was essentially a question of fraud. The court confirmed that cases of fraud are difficult and that injunctions could only be granted in “the most exceptional cases” (para 88). It also upheld the independence principle underpinning the two guarantees in this case. The very objective of these types of demand guarantees was to “serve as unclouded immediate cash despite the underlying real dispute” between the parties of the construction contract (para 91). The court said that the underlying contract provided for the manner in which contractual dispute between the contract parties should be resolved and by following that dispute resolution could bring about a situation where a completely different conclusion could be reached compared to that which the Applicant had suggested to the banks.

The arbitration process would bind only the parties involved, namely the parties to the underlying contract, while the issue of demanding payment in terms of the guarantees would be a different process. The court pointed out that inevitably there would have to be a final determination of the parties’ respective rights and obligations and pursuant thereto, a settling of accounts. It would be during that process that the Beneficiary would not be allowed to cling to a credit following payment by the banks under the guarantees, in case the final dispute resolution between the Applicant and the Beneficiary showed that the Beneficiary owed the Applicant money and not vice versa (para 93). Therefore, the contractual arbitration process would be the appropriate place to deal finally with the disputes between the parties by oral evidence (para 95). The court confirmed it was only where there was a clear case of fraud committed by the Beneficiary that payment could be prevented (para 94).

The court stated that its conclusion implied that an applicant who wanted to prevent the payment of a guarantee by way of an injunction also had to pass the muster of the approach to factual disputes in an application for final relief, namely that the applicant had to succeed on the respondent’s version, together with those allegations of the applicant which the respondent cannot (really) dispute (para 96). The court concluded that the Applicant had failed to do so for various reasons (paras 97-102). It did not deal in great detail with the merits of the contractual disputes raised in the case, but merely made some general observations. For instance, it said some of the disputes between the parties were very complex, real, of substance, and had merit which could not be decided merely on affidavit. Therefore, it could not be concluded on the papers before the court that the “clearest of cases has been made out that the [Beneficiary] dishonestly believes in its own position” (para 102).

Accordingly, the application had to fail. The application to amend the Notice of Motion was dismissed and the main application was dismissed with costs, including the costs consequent upon the employment of two counsel (para 103).

Comments:

The judgment has had a devastating effect on the business of Group Five. So much so that its share price immediately fell 49 percent immediately after the 16 November 2018 ruling and closed on that day 30 percent weaker.¹ The ruling placed further financial distress on the already struggling company. Despite the unintended consequences, the judgment of the court cannot be faulted as it is correct.

The parties in this case spent considerable time arguing on disputes relating to the underlying contract, which was irrelevant in any event, given the obvious independent nature of the two guarantees. The court was required only to determine whether or not compliant demands were made and, if so, whether there were any valid grounds (eg, fraud) that would prevent payment. The court was thus correct to base its judgment on the independence principle that underscored the two guarantees.

Fraud, being one of the exceptions to the independence principle of demand guarantees, remains difficult to prove. A clear dispute regarding a breach of the underlying contract cannot simply be equated to fraud unless it is the “only realistic inference” or it is clear that fraud was committed. Simply put, Group Five failed to prove fraud on the part of the Beneficiary and also failed to prove that any other exception existed (eg, arguing there was a tacit contractual prohibition against making a demand) that would prevent the banks from having to pay in terms of the demand guarantees.

From a reading of the judgment, it is at times unclear if the expiry dates of the guarantees were, in fact, extended and the guarantees were still valid at the time the demands were made. Mention is made by the Applicant that the expiry dates of the guarantees were 3 October 2017 and 30 December 2017 respectively, while it was common fact that demands were made only on 1 November 2018. The court does not deal with this aspect, nor are there any statements made by the Beneficiary whether or not the dates of expiry were extended. However, as the banks decided to abide by the ruling of the court, it is assumed that the issue of expiry of the guarantees prior to receiving the demands would surely have been raised when the demands were made.

It is understood that Group Five has, in the meantime, also proceeded to institute its own claims against the Beneficiary arising from the construction contract.

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

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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.