SOUTH AFRICA: POSSIBLE CHANGES IN HOW COURTS APPROACH INTERDICT PROCEEDINGS OVER CONSTRUCTION PERFORMANCE GUARANTEES

By Diana Burger,Lize-Meré Ludick Thursday, February 17, 2022
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A long-standing legal position in South Africa’s construction industry is that the terms of an underlying construction contract is irrelevant to a court when deciding interdict proceedings in relation to payment under an on-demand performance guarantee.

This position may well change in the near future, specifically in matters where the contractor is trying to interdict the employer (the beneficiary under the guarantee) from making a demand for payment against the performance guarantee.

In recent judgments, the courts have shown some willingness to consider the terms of the underlying contract to establish whether or not to interdict the employer – albeit in very restricted circumstances.

Current position on performance guarantees

A contractor in a construction contract is usually required by the employer to secure an on-demand performance guarantee as a form of security for the performance of its obligations under the construction contract. 

The performance guarantee is an agreement between the employer and a guarantor (usually a bank) and is autonomous from the underlying construction contract between the employer and the contractor. On the employer’s presentation of a demand for payment that complies with the requirements of the on-demand performance guarantee, the guarantor is obliged to make payment under the performance guarantee.

In South Africa, a call on an on-demand performance guarantee can only be interdicted where the contractor is able to show fraud, and any contractual disputes under the construction contract are irrelevant in interdict proceedings. Therefore, an on-demand guarantee must generally be honoured in accordance with its terms, without reference to the underlying contract.

Recent developments indicate that the courts may now also be willing to consider the wording of the underlying contract in circumstances other than fraud, to determine whether the employer must be interdicted from demanding payment under the performance bond.

This was evident in the November 2020 judgment of the Supreme Court of Appeal (SCA) in Joint Venture between Aveng (Africa) (Pty) Ltd and Strabag International GmbH v South African National Roads Agency Soc Ltd and Another (ASJV v SANRAL).

SCA emphasises autonomy principle while recognising an exception

While the judgment emphasised the autonomy of an on-demand guarantee from the underlying contract, the SCA also recognised there may be a basis other than fraud for a contractor to interdict an employer from demanding payment on an on-demand performance guarantee (i.e. before the call is made).

In principle, a party is entitled to interdict another party from breaching a contract.  It is in light of this principle that the court considered the underlying contract in the ASJV v SANRAL matter.  The SCA was called upon to consider whether, in terms of the underlying contract, the employer was prevented or restricted from demanding payment under an on-demand performance guarantee.

Although, at first blush, this consideration seems to fly in the face of the autonomy principle of on-demand guarantees, this argument has been successfully raised in other jurisdictions, whilst upholding the autonomy principle.

In this case, the contractor argued that South African law should be developed to recognise an exception, so that, if the underlying contract specifically restricts or qualifies a beneficiary’s right to call on the guarantee, a contractor is entitled to interdict an employer from doing so until the conditions in the underlying contract have been met (underlying contract exception).

The SCA considered Australian and English law where the underlying contract exception was successfully used by contractors in interdict proceedings and remarked that there is room in South African law to follow the same path as that taken in Australian and English law.

Relying on Australian law, Judge Makgoka illustrated that if a party wants to interdict an employer from making a demand on an on-demand guarantee, a party must demonstrate that the employer would clearly and unequivocally breach a term of the underlying contract by doing so.

Judge Makgoka further relied on English law to illustrate that there is no reason why the employer cannot be restrained from calling on the performance guarantee if the underlying contract terms clearly and expressly prevent the employer from making a demand under the guarantee.

The judge cautioned that the facts of each case must be considered and that, importantly, the underlying contract should not be readily interpreted as conferring a right to the contractor to restrain the employer from presenting a guarantee to the guarantor for payment.

Other matters, in addition to ASJV v SANRAL, where the South African courts have seemed willing to look at the wording of the underlying contract are:

  • Eskom Holdings v Hitachi Power Africa (139/2013) [2013] ZASCA 101 (12 September 2013) – paragraphs 9 and 15; and
  • Lombard Insurance Co Ltd v Landmark Holdings (Pty) Ltd 2010 (2) SA 86 (SCA), paragraph 20.

That said, the courts have found that the wording of the on-demand performance guarantee remains the first port of call to decide whether an employer can make a call or not.  If there is no specific prohibition in the guarantee, the court may then look at the terms of the underlying contract to establish whether there are any prohibitions.

The courts have made it clear that such prohibitions cannot be read into the contract, meaning that implied terms are not sufficient. The prohibition must be in clear and unambiguous language to show that calling on the guarantee would be a clear breach of the specific contract terms by the employer.

The courts will therefore not entertain a dispute about a contract term that does not expressly and clearly disentitle the employer from calling on the on-demand performance guarantee.

Implications for contractors and employers

Employers and contractors should be aware that the courts may soon take a position where they consider the wording of the underlying contract when deciding whether to grant an interdict against an employer from demanding payment under an on-demand performance guarantee.

Both parties should be careful in considering contract clauses dealing with entitlement to call on a performance guarantee, bearing in mind that the approach would be different for contractors and employers.

An employer will likely want as few restrictions as possible on these entitlements and some may want to take out these contractual clauses completely.

On the other hand, a contractor may want to propose that specific terms be included to clearly state that an employer may not call on the bond under certain circumstances.

The parties to the underlying contract must also take care to ensure that clauses restricting the employer’s entitlement to call on the guarantee are not construed as an intention to create a suretyship or other accessory obligation. There is a fine line between providing the restrictions in the underlying contract and ensuring that the guarantee remain autonomous and unconditional.

Above all, the language used must be clear and unambiguous, leaving no room for any doubt.