Construction Law – The nature of on-demand guarantees

1.  In construction contracts, on-demand guarantees or unconditional performance bonds are a means of guaranteeing the performance of the contractor to its employer. 

2.  On-demand guarantees are similar to letters of credit or promissory notes payable on demand.

3.  In Lombard v Landmark & Others  the following was held:

“… The guarantee creates an obligation to pay upon the happening of an event. …The guarantee was to protect the Academy in the event of default by Landmark and it is to the guarantee that one should look to determine the rights and obligations of the Academy and Lombard.”

4.  Lord Denning in Edward Owen Engineering Ltd v Barclays Bank International Ltd stated the principle as follows:

“A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand if so stipulated, without proof or conditions.  The only exception is where there is a clear fraud of which the bank has notice.”

5.  Similarly, Donaldson LJ held in  Intraco Ltd v Notis Shipping Corporation (The Bhoja Trader) that:

Irrevocable letters of credit and bank guarantees given in circumstances such as that they are the equivalent to an irrevocable letter of credit have been said to be the lifeblood of commerce. Thrombosis will occur if, unless fraud is involved, the Courts intervene and thereby disturb the mercantile practice of treating rights thereunder as being the equivalent of ‘cash in hand”.

6.  In Compass Insurance Company Ltd v Hospitality Hotel Developments (Pty) Ltd  this ratio was taken further when it was held that:

the reason for requiring strict compliance with a letter of credit is that it is an instrument that compels a bank to pay on demand irrespective of the status of the underlying debt” .

7.  This allows for international commerce to take place.

ON-DEMAND BONDS AND CONDITIONAL BONDS (SURETYSHIPS)

8.  The distinction between an on-demand bond and a conditional bond was dealt with by Brand JA in Minister of Transport & Public Works, Western Cape & Another v Zanbuild Construction (Pty) Ltd & Another as follows:

“In the parlance of the English authorities the dispute can be usefully paraphrased as being whether the guarantees are ‘conditional bonds’ (as suggested by Zanbuild) or ‘on demand bonds’ (as suggested by the department). The essential difference between the two, as appears from these authorities, is that a claimant under a conditional bond is required at least to allege and – depending on the terms of the bond – sometimes also establish liability on the part of the contractor for the same amount.  An ‘on demand’ bond, also referred to as a ‘call bond’, on the other hand, requires no allegation of liability on the part of the contractor under the construction contracts. All that is required for payment is a demand by the claimant, stated to be on the basis of the event specified in the bond.”

9.  In the absence of fraud, or the demand somehow being deficient as measured against the terms of the bond, the Guarantor is obliged to pay the Applicant irrespective of any disputes between the Second Respondent and the Applicant. The Court does not look behind the demand.

THE FRAUD EXCEPTION

10.  What would constitute a fraud has been dealt with in a number of cases, the most recent of which is the Guardrisk Insurance Company Ltd v Kentz (Pty) Ltd where Theron JA held:

“It would be useful to briefly consider the legal position in relation to the fraud exception. It is trite that where a beneficiary who makes a call on a guarantee does so with knowledge that it is not entitled to payment, our courts will step in to protect the bank and decline enforcement of the guarantee in question. This fraud exception falls within a narrow compass and applies where:

‘… the seller, for the purpose of drawing on the credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representations of fact that to his (the seller’s) knowledge are untrue.’

Insofar as the fraud exception is concerned, the party alleging and relying on such exception bears the onus of proving it.  That onus is an ordinary civil one which has to be discharged on a balance of probabilities, but will not lightly be inferred.  In Loomcraft Fabrics CC v Nedbank Ltd and another, it was pointed out that in order to succeed in respect of the fraud exception, a party had to prove that the beneficiary presented the bills (documents) to the bank knowing that they contained material misrepresentations of fact upon which the bank would rely and which they knew were untrue. Mere error, misunderstanding or oversight, however unreasonable, would not amount to fraud.  Nor was it enough to show that the beneficiary’s contentions were incorrect. A party had to go further and show that the beneficiary knew it to be incorrect and that the contention was advanced in bad faith. …

Guardrisk contended that the demands under the guarantees were fraudulent as Kentz had not given Brokrew adequate notice within which to remedy the breaches alleged by it. It was argued that Kentz had elected not to rely on its right to summarily terminate the construction contract. Instead, and in terms of the letter dated 24 February 2010, it gave Brokrew seven days written notice to remedy its alleged breaches, when it was, in terms of clause 15.2(d) of the contract, obliged to provide 28 days written notice to Brokrew.  Furthermore, so the argument went, Kentz had failed to comply with the provisions of clause 2.5 of the construction contract in that it had not given notice to Brokrew of the clause it intended to rely upon and the amount that was to be paid to it in terms of clause 2.5. For these reasons, it was contended that the termination of the contract by Kentz was premature and unlawful.”

11.  These allegations proved to be insufficient and/or irrelevant with the result that payment under the guarantee was enforced by the Court.

12.  In Balfour Beatty Civil Engineering v Technical General Guarantee Co Ltd the Court held that:

“In this assessment one is entitled to remind oneself that the question is not whether Leadrail or its liquidator might be able to show that the sum claimed under the bond was in fact due. Nor is the question whether the beneficiary in the light of the evidence might not have some anxiety as to whether the sum was due and have some anxiety about whether Leadrail might not have a good claim to the return of the money if it is paid by the surety. The question is whether when the demand was made the persons acting on behalf of the plaintiffs knew that the sum claimed was not due from Leadrail, and dishonestly made a demand despite that knowledge.”

13.  The SCA’s finding in Coface South Africa Insurance Co Ltd v East London Own Haven t/a Own Haven Housing Association is also significant in this context:

“[15] … At paragraph 63 Cloete JA said the following:

‘The appellant complied with the provisions of clause 5. It was not necessary for the appellant to allege that it had validly cancelled the building contract due to the second respondent’s default. Whatever disputes there were or might have been between the appellant and the second respondent were irrelevant to the first respondent’s obligation to perform in terms of the construction guarantee.’

[16] Cloete JA recorded that there was no suggestion of fraud on the part of the employer at paragraphs 64 and 65 he said:

‘[64]   Once the appellant [the beneficiary] had comply with clause 5 of the guarantee, the first respondent [the guarantor] had no defence to a claim under the guarantee. It still has no defence. The fact that an arbitrator has determined that the appellant was not entitled to cancel the contract, binds the appellant – but only vis-à-vis the second respondent [the employer]. It is res inter alios acta so far as the first respondent is concerned. As the cases to which I have referred above make abundantly clear, the appellant did not have to prove that it was entitled to cancel the building contract with the second respondent as a precondition to enforcement of the guaranteed given to it by the first respondent. Nor does it have to do so now.

[65]    For these reasons, it is not in my view bad faith for an employer, who has made a proper demand in terms of a construction guarantee, to continue to insist on payment of the proceeds of the guarantee, when the basis upon which the guarantee was called up has subsequently been found in arbitration proceedings between the building owner and the contractor to have bene unjustified. I would add that the fact that the arbitrator’s award is final as between the appellant and the second respondent does not mean that it is correct, or that the appellant would have to set it aside before calling up the guarantee, much less that the appellant is acting in bad faith in seeking to enforce payment under the guarantee against the first respondent.’

[17] At this stage it is necessary to consider cases that have come before this Court after Dormell dealing with letters of credit and construction guarantees.

[18]  In Casey v First Rand Bank Ltd (608/2012) [2013] ZASCA 131 this court, in relation to a letter of credit, had to deal with an assertion that the principal debt had prescribed. The guaranteeing bank’s client sought a declarator to that effect, submitting that the claim that the client had made upon the bank knowing that the claim had prescribed was fraudulent. It was contended that the effect of a declarator that the debt had prescribed was to extend the ambit of legitimate challenges to a letter of credit beyond the narrow confines of the fraud exception. In Casey, Swain AJA noted that:

‘(12)   … An irrevocable letter of credit is not accessory to the underlying contract and is distinguishable in law from a suretyship which is accessory to the principal obligation. See ABSA Bank Bpk v De Villiers 2001 (1) SA 481 (HHA).’

Later, he confirmed:

‘(14)   The distinction sought to be drawn on behalf of Casey and Kimberley is without merit. The issue of the irrevocable letter of credit by the Bank of America in favour of Firstrand, established a contractual obligation on the Bank of America to pay Firstrand as beneficiary, provided that the conditions specified in the credit were met. Reciprocal obligations in these terms were created by the letter of credit between the Bank of America and Firstrand. An order declaring that Firstrand had no right to draw-down on the letter of credit, must inevitably have as a consequence that the Bank of America was not obliged to honour this draw-down claim. Such an order would infringe upon the autonomy of the irrevocable letter of credit. The argument was advanced simply to circumvent the autonomy of the letter of credit.’

[19] In First Rand Bank Limited v Brera investments CC (385/2012 [2013] ZASCA 25, this court was faced with a situation where the guaranteeing bank sought to rely on events that occurred after demand had been made in terms of the guarantee. In that regard the decision in Dormell was relied upon. Malan JA, preferred the minority view in Dormell. At paragraph 11 of Brera, the autonomy of letters of credit, demand guarantees, performance bonds and similar documents was restated. The dictum in Lombard referred to above was reaffirmed.”

14.  In Turkey IS Banhasi v Bank of China it was found that even the likelihood that it would be found that the creditor had no right to claim on the bond was insufficient to establish fraud.

15.  The aforementioned cases have now clarified the current legal position in our jurisdiction in relation the onus of proof of the available defences to on-demand guarantees.

Construction Law – The Binding Nature of Interim Adjudication Awards

In the matter of Stefannuti Stocks vs S8 Property the Court reconfirmed the enforceability of an adjudicator’s decision by court prior to final arbitration.  It also confirmed that an agreement between the parties that a decision is binding and shall be given effect to without delay, unless and until it is revised, requires immediate implementation.

Stefannuti Stocks sought an order compelling S8 Property to comply with its obligations in terms of a building agreement, more specifically for specific performance under the terms of the agreement by S8 Property by paying amounts determined by an adjudicator to be due and payable to Stefannuti Stocks.

The agreement between the parties was a standard written Joint Building Contracts Committee (‘JBCC’) Services 2000 Principal Building Agreement.

Clause 40 of the agreement provides that:

40.0 DISPUTE SETTLEMENT

40.1 Should any disagreement arise between the employer or his principal agent or agents and the contractor as to any matter arising out of or concerning this agreement either party may give notice to the other to resolve such disagreement.

40.2 Where such disagreement is not resolved within ten (10) working days of receipt of such notice it shall be deemed to be a dispute and shall be submitted to:

40.2.1 Adjudication in terms of the edition of the JBCC Rules for Adjudication current at the time when the dispute is declared. The adjudicator shall be appointed in terms of such Rules. …

40.3 The adjudicator’s decision shall be binding on the parties who shall give effect to it without delay unless and until it is subsequently revised by an arbitrator in terms of 40.5. Should notice of dissatisfaction not be given within the period in terms of 40.4, the adjudicator’s decision shall become final and binding on the parties.

40.4 Should either party be dissatisfied with the decision given by the adjudicator, or should no decision be given within the period set out in the Rules, such party may give notice of dissatisfaction to the other party and to the adjudicator within ten (10) working days of receipt of the decision or, should no decision be given, within ten (10) working days of expiry of the date by which the decision was required to be given.

40.5 A dispute which is the subject of a notice of dissatisfaction shall be finally resolved by the arbitrator as stated in the schedule. Where such person is unwilling or unable to act, or where no person has been stated, the arbitrator shall be chosen and appointed by mutual agreement within ten (10) working days of such notice, the arbitrator shall be the person appointed at the request of either party by the chairman, or his nominee, of the Association of Arbitrators (Southern Africa). The adjudicator appointed in terms of 40.2.1 shall not be eligible for appointment as the arbitrator.”

Stefannuti Stocks, being the building contractor, referred a dispute between the parties to an adjudicator. The adjudicator issued his decision in terms of which he determined, inter alia that “the Contractor is entitled to be paid the full original preliminaries value of R2,439,677.98.

S8 Property contended that it is not obliged to give effect to the adjudicator’s decision as it had given notice of its dissatisfaction therewith pursuant to clauses 40.3 to 40.5 of the agreement.

In a recent judgment of Tubular Holdings (Pty) Ltd v DBT Technologies (Pty) Ltd handed down on 03 May 2013, the Court interpreted the following contractual provision:

“The decision shall be binding on both parties who shall promptly give effect to it unless and until it shall be revised in an amicable settlement or an arbitrated award as described below.”

The Court stated that “the effect of these provisions is that the decision shall be binding unless and until it has been revised as provided. There can be no doubt that the binding effect of the decision endures, at least, until it has been so revised. …

The scheme of these provisions is as follows: the parties must give prompt effect to a decision. If a party is dissatisfied he must nonetheless live with it but must deliver his notice of dissatisfaction within 28 days failing which it will become final and binding. If he has given his notice of dissatisfaction he can have the decision reviewed in arbitration. If he is successful the decision will be set aside. But until that has happened the decision stands and he has to comply with it.”

In the unreported decision of Esor Africa (Pty) Ltd/Franki Africa (Pty) Ltd JV and Bombela Civils JV (Pty) Ltd, the parties had referred a dispute to the DAB in terms of clause 20.4 of the FIDIC Conditions of Contract. The DAB gave its decision in favour of the contractor.  The employer refused to make payment in terms of the decision relying, inter alia, on the fact that it had given a notice of dissatisfaction and the contractor approached the Court for an order compelling compliance with the decision.  The Court commented that it regarded the wording of the relevant contractual provisions to be clear and that the effect thereof is, that, whilst the DAB decision is not final, the parties are bound by it.  It held that the key to comprehending the intention and purpose of the DAB process is the fact that neither payment nor performance could be withheld when the parties are in dispute:

“the DAB process ensures that the quid pro quo for continued performance of the contractor’s obligations even if dissatisfied with the DAB decision which it is required to give effect to is the employer’s obligation to make payment in terms of a DAB decision and that there will be a final reconciliation should either party be dissatisfied with the DAB decision…”

The Court further held that the employer was not entitled to withhold payment of the amount determined by the adjudicator and that he “is precluded by the terms of the provisions of clause 20 (and in particular clauses 20.4 and 20.6) from doing so pending the outcome of the Arbitration.”

In the case of Stocks and Stocks (Cape) v Gordon the Court could find no objection to giving effect to an agreement in terms of which interim payments are to be made which may later be followed by an adjustment of account and a claim for repayment of what has been paid should the opinion of the mediator be set aside in arbitration.  The contract referred to mediation as opposed to adjudication. It provided that the parties could obtain the opinion of a mediator but if dissatisfied, it could refer it to arbitration. The wording of the agreement read:

“The opinion of the mediator shall be binding upon the parties and shall be given effect to by them until the said opinion is overruled in any subsequent arbitration or litigation.”

In Freeman NO and another v Eskom Holdings Limited the Court considered the NEC form of contract, which provides for adjudication and for notification by the dissatisfied party to a tribunal who has the power to settle the dispute referred to it. The contract also provides that the adjudicator’s decision is binding upon the parties “unless and until” revised by the tribunal as enforceable as a matter of contractual obligation between the parties and not as an arbitral award.

In Basil Read (Pty) Ltd v Regent Devco (Pty) Ltd, Clause 40 of the JBCC Principal Building Agreement deals with dispute resolution and allows a referral of a dispute to an adjudicator. Any party dissatisfied with the adjudicator’s decision was entitled to give notice of dissatisfaction within a stipulated time and may then refer the dispute to arbitration. It stipulates, however, that “the adjudicator’s decision shall be binding upon the parties who shall give effect to it without delay unless and until it is subsequently revised by an arbitrator”. The Court construed these provisions as imposing an obligation on the dissatisfied party to give effect to the decision without delay unless and until it is subsequently set aside by the arbitrator. The dissatisfied party’s remedy is to procure set-off or adjustment in the following payment certificates should he succeed in having the decision set aside after he had performed.

In the United Kingdom the matter is dealt with by statute which gives the same effect as the clauses referred to above. The Court of Appeal remarked in the Carillion matter that:

In short, in the overwhelming majority of cases, the proper course for the party who is unsuccessful in an adjudication under the scheme must be to pay the amount that he has been ordered to pay by the adjudicator. If he does not accept the adjudicator’s decision as correct (whether on the facts or in law), he can take legal or arbitration proceedings in order to establish the true position. To seek to challenge the adjudicator’s decision on the ground that he has exceeded his jurisdiction or breached the rules of natural justice (save in the plainest cases) is likely to lead to a substantial waste of time and expense – as, we suspect, the costs incurred in the present case will demonstrate only too clearly.”

The Court also referred to the United Kingdom case of Bouygues (UK) Limited v Dahl-Jensen (UK) Limited which concerned a dispute arising from a sub-contract, which provided for dispute resolution by adjudication pursuant to the Rules of the CIC Model Adjudication Procedure (2nd edition) which provided that:

“The object of adjudication is to reach a fair, rapid and inexpensive decision upon a dispute arising under the contract and this procedure shall be interpreted accordingly. … The Adjudicator’s decision shall be binding until the dispute is finally determined by legal proceedings, by arbitration (if the contract provides for arbitration or the parties otherwise agree to arbitration) or by agreement. The parties shall implement the Adjudicator’s decision without delay whether or not the dispute is to be referred to legal proceedings or arbitration. …”

Having regard to these Rules, Justice Dyson held as follows:

the purpose of the scheme is to provide a speedy mechanism for settling disputes in construction contracts on a provisional interim basis, and requiring the decisions of adjudicators to be enforced pending final determination of disputes by arbitration, litigation or agreement, whether those decisions are wrong in point of law and fact. It is inherent in the scheme that injustices will occur, because from time to time, adjudicators will make mistakes. Sometimes these mistakes will be glaringly obvious and disastrous in their consequences for the losing party. The victims of mistakes will usually be able to recoup their losses by subsequent arbitration or litigation, and possibly even by a subsequent arbitration.”

In the present case, the terms of the relevant contractual provisions are perfectly clear: the parties are obliged to promptly give effect to a decision by the DAB. The issue of a notice of dissatisfaction does not in any way detract from this obligation; whilst such a notice is necessary where the dissatisfied party wishes to have the decision revised it does not affect that decision; it simply sets in motion the procedure in which the decision may be revised. But until revised, the decision binds the parties and they must give prompt effect thereto.

Having regard to the purpose of the provisions of the agreement by introducing a speedy settling of disputes in construction agreements on a provisional, interim basis, the Court could find no reason not to follow the judgment in Tubular Holdings, which is in harmony with the decisions of Bombela and Basil Read referred to above. The purpose of the policy to implement the adjudicator’s decision is also to obviate the tactical creation of disputes with a view to the postponement of liability. For these reasons Stafannuti Stocks was successful and the order was granted in its favour.

 

Construction Law – Demand Guarantees and the Fraud Defence

Guardrisk Insurance Company Ltd v Kentz (Pty) Ltd

The law underlying the avoidance by a Guarantor of its obligations to make payment to a beneficiary under a demand guarantee is clarified and reaffirmed by the most recent ruling by the Supreme Court of Appeal in the case of Guardrisk Insurance Company Ltd vz Kentz (Pty) Ltd.

Two construction guarantees (on demand guarantees) were issued by Guardrisk in favour of Kentz, at the behest of Brokrew Industrial (Pty) Ltd (Brokrew) Kentz was one of the contractors involved in the construction of a new power generation plant, the Medupi Power Station, for Eskom.

During September 2008, Kentz entered into a construction contract with Brokrew relating to the supply of ducting at Medupi. Brokrew was obliged to secure “an irrevocable, on demand bank guarantee or a demand guarantee from a recognised financial institution” for proper performance. This guarantee was referred to as the performance guarantee.

Kentz had paid Brokrew an amount of R17 million after an advance payment guarantee had been issued by Guardrisk and submitted to Kentz to facilitate commencement of the works by Brokrew, under the contract.

Brokrew experienced severe financial difficulties which impacted on its ability to perform its obligations under the construction contract. By 31 January 2010, Brokrew’s liabilities exceeded its assets by more than R44 million. On 5 March 2010, Brokrew advised Kentz that unless the terms of the contract were renegotiated, it would not be in a position to perform its obligations in terms thereof.

On 24 February 2010 Kentz addressed a letter to Brokrew, confirming that Brokrew clearly had the intention not to continue with performance of its obligations under the Contract, had the intention to abandon the Contract and admitted to have become insolvent. In the alternative, that Brokrew had, by its conduct, repudiated the contract which entitled Kentz to accept same and cancel the Contract. Brokrew was placed on terms to perform its obligations under the Contract. Later, on 9 March 2010, Kentz addressed a further letter to Brokrew cancelling the Contract with immediate effect.

On 11 March 2010 Brokrew’s attorneys addressed a letter to Kentz, in which it disputed Kentz’s entitlement to cancel the contract, recorded its contention that Kentz thereby repudiated the contract and accepted Kentz’s repudiation of the contract whereupon it purported to cancel the contract. It also alleged that Kentz’s call on the guarantees was fraudulent given the latter’s knowledge that it was not entitled to cancel the contract.

Prior to the hearing of the matter in the High Court, Brokrew was finally liquidated. The High Court found that the evidence had failed to establish that Kentz, in making demand for payment under the guarantees, had acted fraudulently. It further found that Guardrisk was obliged to make payment in terms of the guarantees and accordingly granted judgment in favour of Kentz.

The essential difference between the two types of bonds namely “on demand” or “call” bonds on the one hand and “conditional” bonds on the other was described by Brand JA in Minister of Transport and Public Works, Western Cape & another v Zanbuild Construction (Pty) Ltd & another as follows:

“… [A] claimant under a conditional bond is required at least to allege and – depending on the terms of the bond – sometimes also to establish liability on the part of the contractor for the same amount. An “on demand” bond, also referred to as a “call bond”, on the other hand, requires no allegation of liability on the part of the contractor under the construction contracts. All that is required for payment is a demand by the claimant, stated to be on the basis of the event specified in the bond.”

The Court found that the terms of the guarantees are clear and unambiguous. They create an obligation on the part of Guardrisk to pay Kentz on the happening of a specified event. It was recorded in the guarantees that, notwithstanding the reference in its wording to the construction contract, the liability of Guardrisk as principal is absolute and unconditional, and should not be construed to create an accessory or collateral obligation. The guarantees go further and specifically state that Guardrisk may not delay payment in terms of the guarantees by reason of a dispute between the contractor and the employer. The purpose of the guarantees was to protect Kentz in the event that Brokrew could not perform its obligations in terms of the construction contract.

In Lombard Insurance Co Ltd v Landmark Holdings (Pty) Ltd & others, the Court described a guarantee very similar to the performance guarantee in this matter as:

“… not unlike irrevocable letters of credit issued by banks and used in international trade, the essential feature of which is the establishment of a contractual obligation on the part of a bank to pay the beneficiary (seller). This obligation is wholly independent of the underlying contract of sale and assures the seller of payment of the purchase price before he or she parts with the goods being sold. Whatever disputes may subsequently arise between buyer and seller is of no moment insofar as the bank’s obligation is concerned. The bank’s liability to the seller is to honour the credit. The bank undertakes to pay provided only that the conditions specified in the credit are met.”

The court found that the guarantees in this matter were unconditional and must be paid according to their terms. It confirmed our legal position that the only basis upon which Guardrisk can escape liability is to show proof of fraud on the part of Kentz.

Guardrisk also argued that each of the guarantees relied upon by Kentz requires that Kentz state that the amount claimed was payable to it in terms of the contract and that the Brokrew was in breach of its obligations under the contract. Guardrisk argued that the statements by Kentz in each of its demands to Guardrisk, to the effect that the amount claimed was payable to Kentz in terms of the construction contract with Brokrew, were material, knowingly false and constituted a fraud on both Kentz and Brokrew.

The legal position regarding the fraud exception is that where a beneficiary who makes a call on a guarantee does so with knowledge that it is not entitled to payment, our courts will step in to protect a guarantor and decline enforcement of the guarantee in question. This fraud exception only applies where:

“ … the seller, for the purpose of drawing on the credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representations of fact that to his (the seller’s) knowledge are untrue.”

Furthermore, the party alleging and relying on such exception bears the onus of proving it. That onus is to be discharged on a balance of probabilities, and will not lightly be inferred. In the matter of Loomcraft Fabrics CC v Nedbank Ltd & another it was pointed out that in order to succeed in respect of the fraud exception, a party had to prove that the beneficiary presented the bills (documents) to the bank knowing that they contained material misrepresentations of fact upon which the bank would rely and which they knew were untrue. Mere error, misunderstanding or oversight, however unreasonable, would not amount to fraud. Nor was it enough to show that the beneficiary’s contentions were incorrect. A party had to go further and show that the beneficiary knew it to be incorrect and that the contention was advanced in bad faith.

The remarks made by Lord Denning MR in Edward Owen Engineering Ltd v Barclays Bank International Ltd to the effect that performance guarantees are virtually promissory notes payable on demand and very similar to letters of credit was relevant. In that case, Lord Denning added:

A bank which gives a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the relations between the supplier and the customer; nor with the question whether the supplier has performed his contracted obligation or not; nor with the question whether the supplier is in default or not. The bank must pay according to its guarantee, on demand if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the bank has notice.”

Guardrisk contended that the demands under the guarantees were fraudulent as Kentz had not given Brokrew adequate notice within which to remedy the breaches alleged by it. It was argued that Kentz had terminated the Contract prematurely and unlawfully.

It was common cause that during March 2010, Brokrew had informed Kentz that unless the terms of the building contract were renegotiated, it could not perform its obligations in terms of the building contract. The Contract included a clause which states that the employer shall be entitled to terminate the contract if Brokrew:

abandons the Works or otherwise plainly demonstrates the intention not to continue performance of his obligations under the Contract . . . the Employer may, on notice to the Contractor, terminate the contract immediately.”

The Court found that Brokrew had clearly demonstrated its intention not to continue performing its contractual obligations and Kentz was entitled to cancel the building contract immediately, having reserved its rights in that regard previously.

The Court found that Guardrisk did not establish the fraud exception. In fact, what it sought to do is to have this Court determine the rights and obligations of the parties in relation to the construction agreement, which on the authorities, the Court was precluded from doing. The finding by the High Court that the appellants had not discharged the onus resting on them to establish fraud on the part of Kentz cannot be faulted. I agree with the reasoning of the high court that:

The evidence before court clearly demonstrates that Kentz held the view that it was entitled to lawfully pursue its claims under the guarantees. The mere fact that it pressed its claims knowing that Brokrew held a contrary view about the cancellation with which it disagreed is not fraudulent.”

As already pointed out, a valid demand on an unconditional performance guarantee creates an obligation on Guardrisk to make payment in accordance with the terms of the guarantee. Mindful of that principle, the guarantor nevertheless urged the Court to have regard to the decision of the majority in Dormell Properties 282 CC v Renasa Insurance Co Ltd & others NNO. It was submitted that the principles of practicality enunciated by the majority in that decision ought to be applied to the present matter and the issues concerning the rights and obligations of the parties to the construction contract should be determined as all the parties are before the Court and the disputes between Kentz and Brokrew have been crystallised and are capable of determination.

Our Courts, in a long line of cases, have strictly applied the principle that a bank faced with a valid demand in respect of a performance guarantee, is obliged to pay the beneficiary without investigation of the contractual position between the beneficiary and the principal debtor. One of the main reasons why Courts are ordinarily reluctant to entertain the underlying contractual disputes between an employer and a contractor when faced with a demand based on an on demand or unconditional performance guarantee, is because of the principle that to do so would undermine the efficacy of such guarantees. The Supreme Court of Appeal in Loomcraft referred to the fact that the autonomous nature of the obligation owed by the bank to the beneficiary under a letter of credit “has been stressed by courts both in South Africa and overseas”. The learned Judge referred to a number of authorities, both local and English to illustrate this point. Similarly, the Supreme Court of Appeal in Lombard Insurance, confirmed that the obligation on the part of the bank to make payment on a performance guarantee is independent of the underlying contract and whatever disputes may arise between the buyer and the seller are irrelevant as far as the bank’s obligation is concerned.

This principle is based on sound reason. The very purpose of the guarantee is so that the beneficiary can call up the guarantee without having to wait for the final determination of its rights in terms of accessory obligations. To find otherwise, would involve an unjustified paradigm shift and defeat the commercial purpose of performance guarantees.

For these reasons, the appeal was dismissed with costs.

Hendrik Markram – B.(Eng) Civil; LLB
Director – Markram Inc Attorneys
012 346 1278
083 675 3458

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Construction Law – Calling up Guarantees…or are they Suretyships?

Insurers, guarantors, contractors and employers should take note of two recent judgments from the Supreme Court of Appeal developing the law governing Construction Guarantees.

The first, Dormell Properties 282 Cc V Renasa Insurance Co Ltd And Others is a matter where the employer made a claim on the guarantee against the guarantor, following upon the employer’s cancellation of the building contract on the grounds of the contractor’s alleged breach of contract.

The guarantor refused to pay the guaranteed amount and the employer instituted action in a High Court against both the guarantor and the contractor for payment of the guaranteed amount. The court found against the employer.

In an appeal to the Supreme Court of Appeal by the employer it was held that the employer had properly demanded payment of the guaranteed amount and that payment should, in terms of the guarantee, have been effected within seven days of demand.

It appeared, however, that subsequent to the judgment in the High Court, the dispute between the employer and the contractor had been the subject of an arbitration in which it had been found that the appellant had not been entitled to cancel the building contract.

New evidence during appeal regarding the arbitration and its outcome was allowed which also convinced the Court that in the circumstances it would amount to an academic exercise without practical effect if the employer were to be granted the order it sought. The employer would immediately have to repay the full amount to the guarantor or the contractor. Such an order would, at best, cause additional cost and inconvenience to the parties, without any practical effect. It was held further that in terms of the Supreme Court Act 59 of 1959, the court should exercise its discretion against the employer. The Appeal was dismissed.

The second case is Minister of Transport and Public Works, Western Cape v Zanbuild Construction. In this matter the Department of Transport and Public Works contracted with Zanbuild to construct two pathology laboratories. Following certain issues with the work, the department supposedly cancelled the construction contracts. Zanbuild accepted the cancellation as a repudiation by the department and the contracts came to an end before the projects could be completed. The department then demanded payment from the bank that had issued two construction guarantees at the behest of Zanbuild.

The department did not allege or contend that it had an recognizable monetary claim against Zanbuild, but maintained that the guarantees stood independent from the construction contracts, in a manner comparable to irreversible letters of credit. The department thus merely had to claim on the basis of the event specified in the wording of the guarantee.

Zanbuild however contended that the guarantees were intimately linked to the construction contract in a manner akin to a suretyship agreement, in which case the bank’s liability would extend only as far as the department could demonstrate a claim against Zanbuild under the construction contracts.

The Court found that the language of the guarantees in this particular case was similar to language normally associated with suretyships, and that, construing the guarantees as a whole, they gave rise to liability on the part of the bank of the same kind as suretyships.

The Court also found that the guarantees contained a provision that reserved the right to the bank to withdraw from the guarantees after 30 days’ notice. The provision expressly limited the liability of the bank to the amount owing by the contractor under the construction contract. The bank’s liability in terms of this provision was clearly similar to that of a surety.

The Court also found that the 30 days’ notice provision was one typically found in suretyships for an indefinite period. The surety’s liability for amounts owing by the principal debtor before expiry of the period remained unaffected. The bank remained liable, as it always was during the currency of the guarantee, for the amounts due to the employer by the contractor under the construction contracts. Since the department had established no amount due to it by Zanbuild during the currency of the guarantees, it was not entitled to demand payment under the guarantees from the bank

Construction Law – Final Certification and Defences thereto

The issuing of a final certificate in terms of a building contract carries with it certain legal consequences for Employers and Principle Agents (normally Architects, Quantity Surveyors or Engineers). In the case of Ocean Diners (Pty) Ltd V Golden Hill Construction the Court clarified the legal position.

These consequences depend in the first instance on the proper interpretation of the applicable contractual terms. Where a building agreement provides that a final certificate shall constitute conclusive evidence as to the sufficiency of the works and materials, as well as of the value thereof, it is determinative of the respective rights and obligations of the parties in relation to matters covered by the certificate. The certificate therefore constitutes (in the absence of a valid defence) conclusive evidence of the value of the works and the amount due to the contractor.

STATUS OF THE FINAL CERTIFICATE

The Court found that the certificate embodies a binding obligation on the part of the employer to pay that amount and gives rise to a new cause of action (subject to the terms of the contract). The failure of the employer to make payment as contractually stipulated entitles the contractor to sue on the certificate.

If the effect of a building contract is to confer finality upon a certificate validly issued, it cannot be withdrawn or cancelled by an architect in order to correct mistakes of fact or value in it, unless the contract provides for it, alternatively such an arrangement is agreed to by the parties.

Therefore, once the architect has issued the final certificate, he is functus officio insofar as the certificate and matters pertaining thereto are concerned. That being so, the architect cannot withdraw or cancel the final certificate.

A final certificate is not even open to attack because it was produced on erroneous reports of the agent of the employer or the negligence of the employer’s architect. The failure of the employer’s professional team to properly scrutinise the claims put forward by the contractor and to rectify any errors, or their possible negligence in failing to satisfy themselves as to the correctness of the claims and valuations before issuing the certificate, will accordingly not provide a defence to an action on the certificate. It can also not provide a basis for the cancellation or withdrawal of the certificate by the architect.

PUBLIC POLICY

An undertaking by an employer in a building contract that a final certificate shall be conclusive evidence of the employer’s indebtedness is not in the least offensive to public policy. A party may also contractually agree to abandon his ordinary right to prove that an admission was wrongly made (on his behalf by his principle agent). Such a contractual term is not in itself against public policy.

The purpose of such a clause is to bring about finality in the respective rights and obligations of the parties. It also obviates the need for litigation over what are likely to be minor issues. To ensure this, the parties contractually bind themselves to accept as final and conclusive the certificate of a professional person they are entitled to expect will act fairly and impartially. Its provisions cannot therefore be said to be contrary to public considerations.

POSSIBLE DEFENCES TO THE CERTIFICATE

The certificate is, however, not indefensible. It is subject to all defences that may be raised in an action based on a final certificate. Any defence available to the employer, or on which the employer seeks to rely, ought to be pleaded.

All authorities indicate that negligent or innocent misrepresentation (relating to an architect’s certificate) would not be a valid defence to a claim on a final certificate. Possible defences to the certificate would be limited to considerations offensive to public policy, such as fraud.

EMPLOYER’S RIGHTS

When it is known that the final certificate is not entirely accurate in relation to either the valuation reflected therein or the amount due to the contractor, it would not be contrary to public policy to enforce it. Public policy is largely concerned with the potential for manifest unfairness or injustice within a given situation.

Where the employer has suffered damage through a negligent failure on the part of either his quantity surveyor or architect to act in his best interests, he would (subject to prescription) have an action for damages against the specific member of the professional team. The situation where the certificate is known to be inaccurate is therefore not one inherently fraught with unfairness or injustice as far as the employer is concerned.

Insurance Law – Removal or Weakening of Support, Collapse or Cracking of Structures

In the case of Hypercheck (Pty) Ltd v Mutual And Federal Insurance Company Ltd the Court assessed the liability of an insurer under a property protection policy to indemnify against accidental, physical loss resulting from “any cause” but not for loss resulting from settlement, bedding down, or cracking

It was specifically provided that the policy covered:

“the buildings (constructed of brick, stone, concrete or metal on metal framework …) including landlords’ fixtures and fittings therein and thereon, plant equipment, structures and other improvements of a permanent nature, walls (except dam walls) … all the property of the insured, and if so stated in the schedule, tenants’ fixtures and fittings.”

The insured property expressly included “structures and other improvements of a permanent nature“.

The policy further that specified perils covered by the policy extended to:

“Accidental physical loss or damage to the property insured by any cause not excluded by exceptions 1 to 9 appearing below…”

The accidental damage extension in terms of the policy therefore excluded indemnification for damages arising from contingencies specified in 9 clauses. One such clause (clause 6), excluded protection in terms of the policy for loss or damage to property arising from:

“Settlement or bedding down, ground heave, collapse or cracking of structures or the removal or weakening of support to any property insured”

The experts agreed that cutting away metal fins or hangers by tenants to attach signage to the property resulted in the removal and weakening of the support structure of the awning. In these circumstances, the experts also agreed that cutting away the steel plates increased the risk of the awning collapsing, which in turn caused the collapse of the awning.

M&F repudiated liability for Hypercheck’s claim in this respect on the basis of the provisions of exception 6 of the policy.

THE ISSUE

The Court was required to assess and determine whether, in these particular circumstances the loss fell under exclusion and therefore not covered. The Court interpreted exclusion clause as follows:

LEGAL FRAMEWORK

The general principles and rules relating to the interpretation of contracts can be summarised as follows:

  1. 1.  If the language is clear, the court must give effect to the language which the parties    have themselves used in the insurance contract. The words must be given their plain,     ordinary, popular and grammatical meaning, unless this would result in absurdity, or it is   evident from the context that the parties intended the words in question to bear a    different meaning. There is no room for a more reasonable interpretation than the plain     meaning of the words themselves convey, particularly so if there is no ambiguity.
  2. 2.  In order to establish the intention of the parties, the court must look at the insurance    contract as a whole rather than at isolated expressions, bearing in mind the language of    the policy.
  3. 3.  If the meaning of a word or clause in an insurance contract is not clear, or the word or   clause is ambiguous, the contra proferentem rule is applicable. This rule requires a written document to be construed against the person who drafted it. This approach was also    followed in the case of Allianz Insurance Ltd v RHI Refractories Africa (Pty) Ltd where the    court stated that “…an exception clause is restrictively interpreted against the insurer,    because it purports to limit what would otherwise be a clear obligation to indemnify”.
  4. 4.  In addition to the contra proferentem rule, Schreiner JA pointed out in the case of Kliptown Clothing that there is also the further related rule that if a warranty is ambiguous in an insurance contract, a court should incline towards upholding a policy against forfeiture on the part of the insured.
  5. 5.  Insurance policies should also be construed in such a way as to allow for business efficacy, and in accordance with sound commercial principles.
  6. 6.  Another rule of restrictive interpretation is premised upon the principle of eiusdem generis, which holds that where it appears that the language indicates a species, words or phrases should be restrictively interpreted to mean the same species as the associated words or phrases.

HYPERCHECK’S LOSS

The policy provided that M&F was not obliged to indemnify Hypercheck against any accidental loss or damage caused by settlement or bedding down, ground heave, the collapse or cracking of structures or the removal or weakening of support to any property insured.

On the basis of a literal interpretation of the stated contingencies in exception 6, the Court was of the view that the plain and ordinary meaning of unambiguous words and phrases such as “collapse“, or “cracking of structures“, or the “removal of support“, or the “weakening of support” in relation to the awning leaves no room for a more reasonable interpretation than the words themselves convey.

The Court found that, in the absence of a distinct species or class of causes or an identifiable link of general application between the stated causes, the eiusdem generis principle cannot apply. Even though the eiusdem generis principle is a useful instrument in certain cases where a clear class or species is identified, this principle must not be utilised as a means to substitute an artificial intention for the real intention of the parties, as evidenced by the plain language used.

CONCLUSION

In these circumstances, the accidental loss and damages sustained by Hypercheck fall within the provisions of exception 6 and was therefore not indemnified.

Alternative Dispute Resolution – Extinctive Prescription in Arbitration

Arbitration plays a major role in the construction industry as alternative dispute mechanism. Section 13(1)(f) of the Act states that the completion of prescription will be delayed if the debt is the object of a dispute subjected to arbitration.

What is a Reference to Arbitration?

In Murray & Roberts Construction (Cape) (Pty) Ltd v Upington Municipality 1982 3 SA 385 (NC) it was held that the referral to an engineer (in terms of a written agreement between the plaintiff and the defendant) was also “a dispute subjected to arbitration” for purposes of Section 13(1)(f) of the Act. This decision was upheld in the Appellant Division. It therefore follows that the completion of prescription was delayed until one year after the arbitration proceedings came to an end.

Proceeding with the Arbitration

It should also be noted that the mere existence of an agreement between parties for disputes between them to be referred to and decided by arbitration does not suffice for the purposes of delaying the running of prescription and that the words “subjected to arbitration” means that the parties are required to refer disputes to arbitration and to actually proceed with the arbitration proceedings.

Judgement Debt

In Primavera Construction SA v Government of Northwest Province & another 2003 (3) SA 579 (BPD) the settlement agreement and the resultant Court Order provided, inter alia, that the award by the arbitrator would operate as an Order of Court.

The arbitrator’s award therefore acquired the status of a judgment debt for purposes of Section 11(a)(2) of the Prescription Act, which meant that a 30 year prescriptive period would be applicable to the award.

 

Construction Law – Time-Barring Clauses…What is Reasonable and Fair?

In the construction and engineering industry time-barring provisions are often included as part of the standard terms in construction agreements. These provisions often require “strict” compliance with time periods and hold significant sanction which may impact adversely on claims or other entitlements under such agreements.  Contracting parties often query the fairness and reasonableness of such provisions once they face the consequences of being time-barred.

Our Courts have clarified the legal position in respect of clauses of this nature in the case of Barkhuizen v Napier. The brief facts of the case are:

1. Two years after Napier rejected Barkhuizen’s insurance claim, Barkhuizen issued a summons for payment in respect of what he regarded as “an insured event”;

2. Napier stated in its defence that it was not liable as Barkhuizen had failed to issue the summons timeously. Napier argued that the contract contained a specific provision that required Barkhuizen to issue a summons within 90 days from the date on which Napier rejected Barkhuizen’s insurance claim and that his failure to do so effectively time-barred him from enforcing any perceived entitlements;

3. Barkhuizen’s counter argument was that the time-barring clause was unconstitutional and unenforceable because it violated his right under the Constitution of the Republic of South Africa to have the matter determined by a Court.

Initial Ruling

The High Court initially upheld Barkhuizen’s contention and declared the time-limitation clause to be inconsistent with the Constitution and dismissed the Napier’s defence.

Court of Appeal

However, the Supreme Court of Appeal ruled that Section 34 of the Constitution did not prevent time-limitation provisions in contracts that were entered into freely. Although it found that, on the evidence, it could not determine whether the clause under consideration had been entered into freely and voluntarily, the Court nevertheless upheld Napier’s argument and excused the insurer from all liability.

Constitutional Court

Barkhuizen then approached the Constitutional Court for leave to appeal against the decision of the Supreme Court of Appeal. In response, Napier’s arguments included that the provisions of Section 34 of the Constitution could not be applied to constitutional challenges launched against agreed contractual terms.

The Constitutional Court held that public policy considerations should be evaluated to decide whether or not a contractual term which violates the Constitution and, as such, is contrary to public policy and thus unenforceable.  The Court held that the correct approach to constitutional challenges of this nature was to determine whether the term itself was contrary to public policy and South Africa’s constitutional values, in particular, those found in the Bill of Rights.  The Court held that Section 34 not only reflected the basic values that underlie the constitutional order, but that it also constituted a manifestation of public policy. The proper approach to the present matter was therefore to determine whether the time-limitation clause violated Section 34 of the Constitution and was thus contrary to public policy.

The Court held that, as a matter of public policy (subject to considerations of reasonableness and fairness) time-limitation clauses in contracts are indeed constitutionally allowable. The Court held further that the right to seek judicial redress (as guaranteed by Section 34) may be limited in circumstances where:

1. It is allowable by a law of general application; and

2. Such a limitation would be reasonable and justifiable.

Reasonableness

The test for reasonableness, the Court found, was whether or not the clause afforded the claimant an adequate and fair opportunity to seek judicial redress. If a contractual term provides, for instance, for an impossibly short time for a dispute to be referred to forum where it may be resolved, it may be contrary to public policy and unenforceable.

Fairness

The Court set out a two-pronged test to be applied in order to evaluate such provisions in respect of fairness.  The first was whether the clause itself was unreasonable. This entails a weighing-up of the principle of pacta sunt servanda and the right of all persons to seek judicial redress. If the clause was found not to be unreasonable, then the further requirement is evaluated.

The second requirement was whether or not the circumstances that prevented compliance provided the defaulting party with a justified excuse for its non-compliance with the time-barring provision. Satisfaction of this requirement requires proof by the defaulting party that it has good reason for its failure to observe the requirements of the time-limitation clause. In that regard, the relative equality or inequality of the bargaining positions of the parties is a relevant consideration.

In Barkhuizen’s case, the Court found that the ninety-day time limitation was not manifestly unreasonable. It was also held not to be manifestly unfair. There was no evidence that the contract had not been concluded freely between parties in equal bargaining positions. There was also no evidence that the clause had not been drawn to the applicant’s attention. In the circumstances, enforcement of the clause would not be contrary to public policy.

One of the specific requirements that Barkhuizen failed to address (which the Court regarded as inexcusable) was his failure to explain and motivate his non-compliance with the requirements of the time-limitation clause. His failure to do so placed the Court in a position where it could not evaluate whether or not the application of the clause would be unfair and, consequently contrary to public policy.

While the Constitutional Court, in this specific instance, found that the time-limiting clause was not in conflict with public policy considerations and that it was necessary to recognise the doctrine of pacta sunt servanda, the Court acknowledged that it may decline the enforcement of a time-limitation clause if its implementation would result in unfairness or would be unreasonable for being contrary to public policy.

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Construction Law – Reservation of Ownership Clause – JBCC Lump Sum Building Contract

In the Judgment of A D Pellow NO & S Williams NO vs Club Refrigeration CC the Supreme Court of Appeal had to consider the effect of a reservation of ownership clause in a contract between a building contractor and an employer that became insolvent prior to the works being completed.

The contractor submitted a tender that was accepted by the employer, of which certain clauses relevant to this article read as follows:

PRICES

Fixed price for all items as specified R10 991 000.00

PAYMENT TERMS

Interim progress payments during the site work schedule to up to 90% of the contract price, 10% on completion and before commercial use.

ACCEPTANCE

The price is fixed for a period of 28 days from the date of quotation.  All items of equipment remain the property of Club Refrigeration CC until they are paid for in full.

CONTRACT TERMS

As per JBCC principle building agreement, code 2101, July 2000

The employer was liquidated before the final outstanding amount due to Club was paid and Club submitted a claim consisting of movable goods.  Club’s claim was based on it’s ownership of the goods and not for payment in terms of the contract.

Afgri Operations Limited purchased the goods after the liquidators, Club and a third party who laid claim to the goods signed an agreement whereby they agreed that the proceeds of the sale will be held by the liquidators until a Court determined who was entitled thereto.

The liquidators (the Appellants) opposed the claim on inter alia the following grounds:-

  1. The contract between the employer and Club contained no reservation of ownership clause and that the JBCC agreement alone governed the contract between them, referring to clause 1.8 of the JBCC which stipulates that “This agreement is the entire contract between the parties…”, thus arguing that Club’s tender document did not form part of the agreement between Club and the employer;
  2. That since the contract was a lump sum contract, there was no mechanism whereby it could be determined which portion of the contract price pertained to which movable assets;
  3. That the value of the goods was not specified in a payment certificate and therefore Club was not entitled to payment in terms of the JBCC agreement.

On the first argument the Court found that Club’s tender was incorporated into the JBCC agreement.  Following Club’s tender submission it received a document entitled “Order” from the employer confirming acceptance of the tender, with various requirements. The order document defined “Agreement” to include the JBCC agreement and other contract documents; the definition of “Contract documents” included the lump sum document and other documents identified in the schedule.  The Court found that the tender document was attached to the employer’s order where it was referred to as a “lump sum document” in the schedule and the definition of “lump sum document” in the order document referred to the document that reflected the contract sum.

The second argument was also found to be inaccurate since the JBCC agreement provides in clause 31.4 that a reasonable estimate of the value of the work executed and value of materials and goods be separately specified in an interim payment certificate.  Further, in terms of clause 31.7 (which corresponds with the Acceptance clause above in the tender) the contractor remains the owner of goods until paid for and clause 31.9 provides that the employer becomes the owner once the goods are paid for.

The Court also rejected the third argument since Club did not rely on the JBCC agreement but on the agreement which it signed with the liquidators and a third party prior to the application being brought when the goods were sold to Afgri Operations Limited.

In its judgment the Court recognised that Club’s claim was based on its ownership of the goods and that it was therefore entitled to payment of the proceeds of the sale held by the liquidators since the goods never formed part of the employer’s assets in the first place.

Although the agreement between the employer and Club was a lump sum agreement, the order of the employer specifically required that payments be made in terms of the JBCC agreement and therefore it was possible to determine the value of the goods Club was not paid for.

The Court accordingly found in the contractor’s favour dismissed the appeal.

By specifying in its tender that unpaid items of equipment remained its property and incorporating the JBCC agreement into the contract with the employer, Club reserved ownership of the movable goods the employer failed to pay for due to it being liquidated.

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Insurance Law – Rejection of Claims…The Design Standard

Construction claims, the formulation of Insurance claims and the rejection thereof by Insurers have become one of the oldest battles in the Engineering and Construction industry.  This conflict has, to some extent, been the result of the difference between the risks being insured against in terms of Insurance contracts on the one hand, and the actual risks in Construction on the other.  What may be expected by Engineers and Contractors from Insurers when a claim is made and to what extent should the duties under the Construction contract be taken into consideration by their Insurers?

These issues were recently addressed by the Supreme Court of Appeal in the case of Mutual & Federal Limited vs. Rumdel Construction (Pty) Ltd.  The Court delivered a unanimous full bench decision in matter.

BACKGROUND

The background facts of the case are briefly as follows:

  • During the week of 21 to 28 February 1997 tropical cyclone Lizette struck in the Nampula Province in Mozambique.  The cyclone severely damaged various roads that Rumdel Construction had constructed and was about to hand over to its employer, the Mozambique Directorate of National Roads and Bridges.
  • Damage caused by the storm led to an insurance claim by the contractor which Mutual & Federal rejected.
  • The Insurer was unsuccessful in the High Court and was ordered to pay R2,500,000 in addition to what ever value added tax might have been paid by the contractor.
  • The Insurer then turned to the Supreme Court of Appeal and filed an appeal against this judgment.

THE CONTRACTOR’s ARGUMENT

The Contractor claimed under the Insurance policy for the repair cost of 101,88 kilometres of road that had sustained storm damage.  It argued that Insurers were obliged to indemnify both the contractor and the employer in respect of fortuitous physical destruction of or damage to the works that had to be undertaken by the contractor.  The Policy wording stated, inter alia, that:

“The company hereby agrees … that if … any part of the property Insured shall be lost destroyed or damaged as referred to in Part 1 hereof … the company will indemnify the Insured as provided herein after.”

Part 1 describes the indemnity:

“The company will … indemnify the Insured in respect of fortuitous physical loss or destruction of the property insured … whilst at the situation of the contract.”

The property insured was described in the schedule to the Insurance contract as:

“… opening of rural gravel roads and rehabilitation and construction of bridges in Nampula Province”.

THE INSURER’s ARGUMENT

The Insurer based its defence on two arguments, the first of which relates to a contractual interpretation.  The second argument was that the word “design” was used in the policy to indicate that the roads had to be fit for their intended purpose.

To further this rationale, the Insurer’s expert on road construction testified that various aspects of the design and construction of the road were “not fit for purpose”.  It was explained that various engineering principles were not incorporated into the design.  Flood returns had for instance to be calculated and incorporated into the design.  It was argued that, only if the design had incorporated the fundamental engineering principles, would the design not have been defective.

The evidence was presented on the basis that the Insurer’s obligation to indemnify the contractor was subject to the special exceptions contained in the insurance policy:

“The indemnity expressed in this part shall not apply or include:

4.  Loss destruction or damage to:-

…acts of the Insured or his competent or authorized agent or representative which are contrary to the recognized rules of engineering or to any legislation or regulations issued by an authority…

5. …defective design.”

THE COURT’s APPROACH

As the Insurer’s argument focussed on the suitability of the roads for their intended purpose, the court assessed the intended purpose of the roads as defined in the Construction contract.

It was clear that the employer required completion of the project for the emergency opening of roads in the particular Province.  It was intended that, what remained of the road links in the Province after the Civil War, should be rehabilitated.

The court also found that it was agreed between the parties that the essential characteristics of the roads were low cost, high risk, high maintenance, low volume and all weather roads.  The main purpose of the roads was “to get the people out of the mud”.  The roads were accordingly built to a design philosophy of “as low as you can go for a public road”.  The roads were also meant to be degraded by the weather and repaired and maintained on a regular basis.

Having established the purpose of the roads, the court re-visited the Insurer’s argument in relation to the design of the roads.  It was found that, in effect, the Insurer’s argument before the court was that, if the contractor hoped to be entitled to an indemnity under the policy, it was not good enough for it to construct, the works to the requirements and satisfaction of the employer.  It had to construct the works to the satisfaction of the Insurer.  There was no acceptable evidence before the court that the roads were in fact poorly designed.

There was also no suggestion that the Insurer did not know the nature of the unsophisticated contract works it was insuring.

The court would not allow the Insurer to, ex post facto and as a prerequisite to accepting liability, demand that the roads should have been of ‘n higher quality than the employer was prepared to pay for.  The contention by the Insurer that the design of the contract works was defective accordingly failed.  The Insurer was ordered to pay the Contractor’s claim.

CONCLUSION

Engineers and Contractors must ensure that their Insurers are made aware of the nature of the Construction contract (including the standard of design required in terms thereof) for which insurance is required.  Insurers must be placed in a position where it can assess the nature of the works and risks it is insuring.

Insurers should similarly have due regard to the standard of design required in terms of the particular Construction contract.  Insurers should also take these aspects into consideration when assessing claims under the Insurance contract.

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Construction – Considering Prescription – The Construction Law Perspectve

INTRODUCTION

As in all legal disputes, extinctive prescription is an important factor to be considered when evaluating the merits of a claim and formulating a defence. Construction law cases, in many instances, involve not only complex contractual relationships, but also difficult technical aspects. Determining the date on which prescription starts to run involves careful factual analysis and when the actions of the reasonable person are to be factored into the debate, things can get even more difficult.
 

PRESCRIPTION

The 1969 Prescription Act provides for four different basic prescription periods. The periods are 30, 15, 6 and 3 years respectively.

Most of the cases I will be referring to relate to debts which are subject to a 3 year prescription period. I will also refer briefly to a scenario towards the end of the presentation where the 30 year period finds application.
 

WHEN DOES PRECRIPTION BEGIN TO RUN?

Section 12 of the Act provides as follows:

(1) … prescription shall commence to run as soon as the debt is due…

(3) A debt shall not be deemed to be due until the creditor has knowledge of the identity of the debtor and of the facts from which the debt arises:

… a creditor shall be deemed to have such knowledge if he could have acquired it by exercising reasonable care.”

WHEN IS THE DEBT DUE?

The decision in Martin Harris & Seuns OFS (Pty) Ltd v Qwa-Qwa Regeringsdiens 2000 (3) SA 339 (A) provides an excellent illustration of when a debt becomes due for the purposes of Section 12(1) of the Act.

The facts of this matter are briefly as follows:

– The building contract provided that the appellant would be paid after a progress certificate was issued by an architect (the principal agent) in respect of work already performed. Such certificates were issued and the appellant was duly paid.
– Within three years after completion of the works as a whole, but more than three years after uncertified sections of work was done, the appellant instituted action for an outstanding balance in respect of “uncertified” work.
– The respondent alleged that the claim had prescribed because the entitlement/debt arose when each section of work had been completed.

The Court held in the contractor’s favour and I summarise the position as follows:
– The issuing of progress certificates was only a contractual mechanism to place the contractor in a position to finance the continuation of the completion of the works.
– The completion of each specific section of the work did not entitle the appellant to receive payment for the work.
– Only upon completion of the work as a whole would the appellant have such entitlement.
– The appellant’s claim would rest upon a certificate as a separate and self-supporting cause of action, where a certificate had already been issued.
– The would then be for payment of the percentage of the value of the works for which the architect had certified.
– Prescription of the appellant’s claim (for payment for all sections which had not appeared in any certificate) began to run at the earliest when the work as a whole was completed.

The debt had therefore not become due and respondent accordingly failed in its prescription argument.

In LTA Construction v The Minister of Public Works and Land Affairs 1992 (1) SA 837 (C) the court also shed more light on the same question.

The claimant claimed for losses sustained in consequence of the delay in the commencement of the works. The building contract provided for the completion of the works within 33 months from date of acceptance of the tender. A further term was that the employer would hand over the site within a certain period. The progress on site and completion of the project were adversely affected by:

The employer’s late handover of the site (7 working days delay).

Completion delayed due to causes beyond the contractor’s control (320 working days).

The defendant then raised a prescription argument and said that the plaintiff’s claim had become prescribed because the debt claimed for became due 33 months and 10 days (7 working days and 3 non-working days) after acceptance of the tender.

This argument resulted in 16 July 1986 being calculated as being the date on which the debt was to have become due.

Summons was served on 5 December 1989.

The defendant’s argument however did not take into proper consideration that a further term of the contract provided for the contract period to be extended in the event of delays due to causes beyond the contractor’s control.

This provision extended the date on which the debt became due with a further 320 working days. The defendant was unsuccessful.
 

KNOWLEDGE AND DEEMED KNOWLEDGE

As we have seen Section 12(3) of the Act provides that a debt is not deemed to be due until the creditor has knowledge or is deemed to have knowledge of the identity of the debtor, as well as of the facts from which the debt arises.

In Minister of Public Works and Land Affairs v Group Five Building Limited 1999 (4) SA 12 (SCA) counsel for the contractor contended that the employer’s claim had become prescribed in terms of Section 12(1) of the Prescription Act.

The employer had allegedly become aware of the relevant facts by 30 May 1991. The contract was terminated on 3 December 1991 and the employer’s counter-claim was delivered on 1 December 1994. The contractor had therefore to prove that prescription had begun to run.

In the instant case, the date on which the employer gained knowledge of the facts from which the debt arose (30 May 1991) was irrelevant as this particular contract contained a clause which entitled the employer’s engineer to require the contractor to remedy defective work. The very earliest stage when the employer’s damages could conceivably have become due was when the contractor, who had the duty to remedy the defective work, had the last chance to do so. This was the date on which the contract was cancelled (3 December 1991).

The employer’s counter-claim was delivered on 1 December 1994 and therefore fell within the three year prescriptive period. The contractor had accordingly failed to prove that prescription had run.
 

THE REASONABLE PERSON

In Drennan Maud & Partners v Pennington Town Board 1998 (3) SA 200 (SCA), the appellant was a civil engineering consultancy. It designed and recommended the construction of a reinforced concrete retaining wall as the Town Board wished to protect certain properties which became threatened by the Umzinto River in Kwa-Zulu Natal. The Town Board accepted design and proceeded to engage a contractor to build the wall.

During September and November 1989 heavy rains fell and the river came into flood. Sinkholes formed in the backfill material behind the wall during this period. These developed progressively and eventually became very substantial. By January 1990 the river was flowing freely under the whole length of the wall and the Town Board were back to where they had been before the appellant was consulted and claimed was for the wasted costs of building the wall.

It was alleged by the engineers that by no later than 13 November 1989 the Town Board had knowledge of the facts from which the alleged claim arose. It was later alleged that the Town Board acquired deemed knowledge in the light of the facts known to it by the above date. The Town Board should have exercised reasonable care.

In his judgement the Honourable Mr Justice Olivier made the following statement:

“… a creditor shall be deemed to have the required knowledge ‘if he could have acquired it by exercising reasonable care’. In my view, the requirement ‘exercising reasonable care’ required diligence not only in the facts underlying the debt, but also in relation to the evaluation and significance of those facts. This means that the creditor is deemed to have the requisite knowledge if a reasonable person in his position would have adduced … the facts from which the debt arises.”

It was clear from the subsidence of the backfill material behind the wall that the design had failed and could not withstand the scouring effect of the passing flood.

As the Town Board’s claim was for the wasted costs of building the wall, the loss claimed for had already occurred when the Town Board acquired deemed knowledge that the wall did not serve the purpose for which it was designed and built and that the related costs were wasted.

The consultant’s prescription argument was therefore well founded as the respondent’s summons was issued outside of the 3 year prescription period.

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Construction Law – Substance is key in Notifications of Claims

The leading role in the execution of the contract as “Engineer” (under the GCC) or “Principle Agent” (under the JBCC) requires frequent decisions and rulings on the activities on site.   This function is also often underestimated and can attract significant liabilities.

Professionals in the construction and engineering industry are often appointed as the Engineer or Principle Agent.  It is required of the professional fulfilling this critical function to be au fait not only with the terms of the contract, but also the execution thereof.

What are the implications of poor decision making by the Engineer or Principle Agent under these construction contracts?   One instance where the courts discussed the yardstick with which the Engineer or Principle Agent is to be measured is in the case of Hawkins Hawkins & Osborn (South) (Pty) Ltd V Enviroserve Waste Management.  The decision not only sets the current benchmark in this regard, but also sounds a warning to Engineers and Principle Agents to act in a reasonable manner when conducting themselves as the Employer’s representative on site.

In this case, as in many other instances in the construction and engineering industry, the Employer (Enviroserve Waste Management) concluded an oral agreement with the Engineer.  The Engineer was appointed to supervise and administer certain contract works.

The Employer then entered into a written agreement with a Contractor to do excavations on a particular site. The written agreement between the Employer and the Contractor incorporated the General Conditions of Contract for Works of Civil Engineering Construction – 6th edition.

The contractor raised a dispute in relation to a “notification” of potential claims communicated to the Engineer in a letter.  The Engineer did however not regard the letter as proper notification.  The result of the Engineer’s decision was a deadlock between the Employer and the Contractor which had to be resolved by an Arbitrator.  The Arbitrator ruled that the letter was indeed proper notification and that the contractor was entitled to claim as notified therein.

Resulting from the Arbitrator’s ruling, the Employer had to pay the Contractor’s claim, but then claimed damages for breach of contract from the Engineer in the High Court.  The Employer based its claim on an allegation that the Engineer breached the agreement by failing to construe the Contractor’s letter as an appropriate notice of the intention to claim payment for additional work as contemplated in clause 50(1) of the GCC.

The initial court determined that no breach of contract had occurred as the Contractor’s letter did not constitute proper notice as contemplated in clause 50(1) of the GCC.

However, it was held by the Supreme Court of Appeal that:

“…there was no reason why the notice contemplated in GCC 50(1) could not be in the form of a letter provided the letter was so framed as to communicate unequivocally to the addressee that the writer was invoking, or relying upon, the provisions of the contract which provided for the giving of notice. It could do so expressly or by implication. In the present case, the contents of the final paragraph of the Contractor’s letter were so closely related to the substance of clause 50(1) that it satisfied that standard.  The letter furnished the information required by clause 50(1) (a) and (b).”

 The Contractor’s letter therefore complied with the requirements of the the agreement in that it contained all the information that was needed to represent a notification as required by clause 50(1) of the GCC. The technical approach adopted by the Engineer in dealing with the “notification” by the Contractor was not regarded as reasonable by the Court on appeal.   On the contrary, the Court found that the Engineer’s conduct in this regard was not acceptable as measured against the standard of the “reasonable engineer”.

The letter therefore constituted a notice which any reasonable engineer would have construed as such.  The Engineer’s failure to do so therefore constituted a breach of the Engineer’s duty of care and, consequently the agreement with the Employer.  The Engineer was found liable to the Employer in the amount due and payable to the Contractor under the award of the Arbitrator in the initial arbitration between the Employer and the Contractor.

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Construction Law – Does Adjudication Work?

In the government white paper on Creating an Environment for Reconstruction Growth and Development in the Construction Industry in 1999, it was argued that the conventional mechanisms and procedures for final dispute resolution (normally arbitration or litigation) are too costly and time consuming.

In March 2001 government published a draft code of practice, entitled “Adjudication in Engineering and Construction Contracts in South Africa”, proposing a movetowards rapid and inexpensive dispute resolution mechanisms in said contracts.

The Construction Industry Development Board (“CIDB”) issued a draft Practice Guide for public comment in August 2003. This practice guide, published on the back of the white paper, also advocates the use of adjudication as a cost and time efficient alternative dispute resolution mechanism to arbitration and litigation.

The World Bank also advocates that adjudication procedures be used on projects which it funds.

The Principal Building Agreement of the Joint Building Contracts Committee (“JBCC”) published in March 2004, incorporated adjudication into the local construction industry even further.

ADJUDICATION – THE GENERAL PRINCIPLES

 While adjudication is presently being introduced locally, many members of the construction industry remain unclear as to what adjudication is and how it is applied. Although the terms of adjudication are contract specific, adjudication can, in broad terms, be defined as being:

“… an accelerated and cost effective form of dispute resolution. The outcome is a decision by a third party intermediary which is final and binding on the parties in dispute, unless the decision is reviewed by litigation and arbitration.”

The Process and Principles of Adjudication

 Any dispute arising from, or in connection with the contract should be capable of being referred to adjudication provided that the necessary terms are incorporated in the contract at the appropriate time. While the procedural requirements for referral of disputes and conducting the adjudication will vary from contract to contract, one is able to distinguish certain underlying principles:

– A party referring a dispute to adjudication must do so in writing, must submit the dispute within the time period stated in the contract with all necessary information, failing which it forfeits the right to dispute the matter.

– The terms and procedures of adjudication are agreed and detailed in the contract, which results in an informed, transparent and speedy decision. If successfully referred, each party must be given a reasonable opportunity to state their case (without a hearing), to know what the case against it is and also to be placed in possession of all evidence obtained by the adjudicator.

– Adjudicated disputes must be resolved within the contract period as the contract itself forms the basis for enforcing the decision of the adjudicator. As a general rule, all disputes are to be resolved within a 42 day period of being referred to adjudication.

– The role of an adjudicator is not that of an arbitrator. The adjudicator is tasked with settlement of the dispute within the contractual rights and obligations between the parties.

– Adjudicators must base their decisions on the subject of the dispute at hand only and must avoid conducting hearings to resolve disputes. Adjudicators should avoid individual contact with either party and may not discuss matters with a party without informing the other party of the discussion and the outcome thereof.

– It is essential to successful adjudication that adjudicators achieve a balance between an inquisitorial approach and adherence to the rules of natural justice in order to treat the parties fairly. An adjudicator may not for instance prepare his own critical path analysis and draw any conclusions from it, without affording the parties an opportunity of making submissions on the accuracy thereof.

– Adjudicators must answer all questions put to them and are normally required to provide written reasons for their decisions.

– It goes without saying that adjudication can only succeed if the adjudicator is impartial and does not have (or appear to have) any relationship with any of the parties, nor have an interest in the outcome of the adjudication.

– The adjudicator should also have the right, after notifying the parties, to refer to legal and technical experts for assistance in areas where the adjudicator recognises that he may not be adequately equipped. This provision is aimed at ensuring that justice is served, despite the fact that the adjudicator may not personally possess all the skills necessary to resolve a matter.

– The decision of the adjudicator is final and binding on the parties, unless it is reviewed by either arbitration or litigation. The decision becomes enforceable immediately, whether the dispute is to be referred for final resolution or not.

– Final resolution of the dispute may, in some instances, only be referred to arbitration or litigation after a “cooling down” period has elapsed allowing the parties to make this decision after careful consideration of the merits of their case.

 

CAN ADJUDICATION WORK?

Can adjudication work? One can only form a view on this with due regard of other jurisdictions where adjudication had been introduced, tried and tested.

In the United Kingdom, adjudication became mandatory on all prime contracts and sub-contracts in 1998, through the introduction of the Housing Grants Construction Regeneration Act (1996). From the following statistics (based on approximately 4 850 adjudications up to September 2001) it is clear that adjudication can provide a quick summary procedure for resolving disputes:

74% of disputes referred resulted in a decision, the balance being settled or abandoned;

76% of referrals were completed in less than 40 hours;

73% of disputes concerned non-payment; other significant issues were variations, loss / expense and points of law;

81% of adjudications involved a referral by a party lower in the construction chain;

Almost 50 % of all referrals were by sub-contractors against main contractors; and

68% of decisions were in favour of the referring party.

There can thus be little doubt that adjudication has had a marked influence on the construction industry in the United Kingdom.

The high percentage of adjudications relating to “non-payment” issues does seem to indicate that where disputes are more complex, such as negligent design or construction, and are likely to affect further contracts (such as insurance policies), parties may be more reluctant to resolve matters through adjudication.

A further point of concern is the immediate enforceability of decisions. A party facing an adverse award may for instance be obliged to make payment to a party in severe financial difficulty. Should the decision of the adjudicator then be determined as incorrect by a later forum, the party at the wrong end of the adjudicator’s decision then runs the risk that the recovery of monies paid may no longer be possible.

 

ADJUDICATION IN THE FUTURE

It is clear that adjudication can, and probably will, play a major role in the local construction industry as an additional alternative dispute resolution mechanism. A good working knowledge of processes, procedures and pitfalls under the various standard forms of construction contracts will be a pre-requisite in future negotiations of contracts.

Adhering to the procedural requirements for declaring, conducting and settlement of disputes will require some level of skill and specialisation to effectively protect a party’s rights under the contract.

The procedural and specific requirements of a number of the standard construction agreements, such as FIDIC, BIFSA, JBCC and NEC will form the subject matter of a series of future publications.

The Construction and Engineering Law team at Markram Inc has the expertise to assist clients involved in disputes where adjudication is the selected dispute resolution mechanism.

 

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