Are your guarantees performing?

In recent times, the Supreme Court of Appeal has reiterated that the interpretation of contracts is an objective exercise and the language used must be given effect to, taking into account the ordinary rules of grammar and syntax, the context in which they appear and the apparent purpose for which the contract was concluded (Natal Joint Municipal Pension Fund v Edumeni Municipality 2012 (4) SA 593 (SCA) at para 18; Bothma –Botha Transport (Edms) Bpk v S Bothma & Seun Transport (Edms) Bpk 2014 (2) SA 494 (SCA at paras 10 and 12 and Novartis v Maphil (20229/2014) [2015] ZASCA 111 at paras 27 and 28).

Despite the law now being clear that a text-in-context approach must be taken when interpreting contracts, contractual parties still run the risk that, if the contractual document is not entirely clear and unambiguous, effect may not be given to their true intentions. This is definitely true when it comes to performance guarantees (or performance bonds) and the consequences of not using words in such a document that do not accurately reflect the intentions of the parties, may completely change the nature of the performance guarantee.

In the construction industry performance guarantees are widely used to secure the employer against potential loss due to a breach of contract by the contractor. In the Minister of Transport and Public Works, Western Cape and Another v Zanbuild Construction (Pty) Ltd and Another 2011 (5) SA 528 (SCA), a distinction is made between so called "on-demand" guarantees and conditional guarantees. As far as conditional guarantees are concerned, such guarantees are ancillary contracts between the guarantor (usually a short-term insurance provider) and the employer. The employer, in seeking to enforce such guarantee, must allege and often submit proof, depending on the wording of the guarantee, that the contractor has in fact breached the contract and the employer is therefore entitled to call up the guarantee. In terms of an on-demand guarantee, the party seeking to call up the guarantee need not allege that the contractor has breached the underlying construction contract, but only that the condition, as stipulated in the guarantee, has been fulfilled, in which case, apart from when the party calling up the guarantee does so fraudulently, the guarantor is obliged to pay out the amount stipulated in the guarantee to the employer.

If parties intend to conclude an on-demand guarantee and the performance guarantee document does not unambiguously and unequivocally reflect that the employer is entitled to payment under the guarantee on demand thereof, the parties run the risk of having the guarantee rather interpreted as a conditional guarantee.

In the case of Group Five Construction (Pty) Ltd and Others v Member of the Executive Council for Public Transport, Roads and Works Gauteng and Others [2015] 2 All SA 716 (GJ) the court had to determine whether a proper demand was made for the guaranteed sum in terms of the provisions of the guarantee document.  The relevant clause read as follows:

"5. Subject to the guarantors maximum liability… the Guarantor undertakes to pay the Employer the Guaranteed sum of the full outstanding balance upon receipt of a first written demand from the Employer to the Guarantor at the Guarantor's domicilium citandi et executandi calling up this Construction Guarantee stating that:

5.1 The agreement has been cancelled due to the Contractors 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."

The applicants were signatories to an indemnity in favour of the second respondent, who signed a performance guarantee in favour of the first respondent. The argument put forward by the applicants and the second respondent was essentially that the demand letter issued by the first applicant did not conform to the guarantee document and was, therefore, invalid and payment could be enforced.

The relevant letter of demand sent by the first respondent to the second respondent to enforce the provisions of the guarantee, reads as follows:

"Kindly take note that the guarantee issued by you in terms of the construction guarantee number C05/21102 ('the guarantee') is hereby called up in terms of paragraph 5.0 of the guarantee. The Agreement (as defined in the guarantee) has been cancelled due to the Contractor's default. The notice of cancellation is contained in the summons in case number 31971/09, a copy of which is annexed hereto."

The above extract appeared in the second letter of demand sent by the first respondent. The first letter of demand sent by the first respondent was sent some nine months before the second letter of demand, but was withdrawn after being sent.  The applicants’ argument was to the effect that the relevant clause in the guarantee stipulates that "… upon receipt of a first letter of demand from the employer…" (own emphasis) complying with the guarantee document, the guarantor would be liable. Therefore, the applicants contended that because the first letter of demand was withdrawn, the second letter of demand need not be given effect to as only a "first letter of demand" would be valid in terms of the guarantee document. The court determined that it need not make a firm decision on this issue, but however stated obiter dictum that, even though it does not understand the need for the insertion of the word "first" in the guarantee, all words used in a contract must be given a purposive meaning. In other words a court is not entitled to ignore words in a contract when interpreting a contract, unless such words are proven to have been inserted as a bona fide mistake by the parties. This in itself again emphasises the importance placed on the wording used in contractual documents.

The court ultimately found that the demand (being the second demand letter) was not a valid demand in terms of the guarantee document, as the summons attached to the letter of demand did not constitute a "copy of the notice of cancellation" that was required for a valid demand to be made under the guarantee. The court held this view, for various reasons, including that the particulars of claim to the summons did not furnish a clear and unequivocal notice of cancellation, and the particulars of claim showed a tacit acceptance of the contractor's repudiation, which according to the court did not comply with the requirement for a written notice of cancellation.

The court therefore held that, in line with the Compass Insurance Company Ltd v Hospitality Hotel Development (Pty) Ltd (756/10) judgment, that it should not be incumbent on the guarantor to ascertain the truth of the assertion made by the beneficiary. The summons and the particulars of claim, therefore, did not meet the requirement for a clear and unequivocal notice of intention to cancel or notice of termination.

Parties to the conclusion of performance guarantee documents are therefore warned that the wording of such document may not only be interpreted in such a way that affects or changes the nature of the guarantee given, but also, the wording used may put stringent requirement for validity of a demand and a party seeking to rely on such a guarantee may find itself without the relief that it had hoped for.

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