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.