THE INTERPRETATION AND APPLICATION OF DEMAND GUARANTEES: By Jason Smit

1. CONSTRUCTION &
ENGINEERING
SEMINAR
Jason Smit

2. THE INTERPRETATION AND
APPLICATION OF DEMAND
GUARANTEES
> 2 recent SCA cases:
> Coface South Africa Insurance Co v East London Own Haven
> Guardrisk Insurance Company Ltd v Kentz
> Both establish the basic premise that “on-demand”
guarantees are enforceable and payable on their terms alone
> Absent fraud, issues arising as between the holder of a
guarantee and the other party to an underlying contract are
irrelevant and will not be considered by the courts
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3. GUARDRISK – BASIC FACTS
> Kentz was involved as a contractor for the Medupi project
> Contracted, in turn, with Brokrew Industrial for the supply of
ducting
> An advance payment was made by Ketz to Brokrew and
Brokrew was required to obtain an advance payment guarantee,
issued in favour of Kentz, as well as a performance guarantee
> Guadrisk issued the guarantees
> Brokrew subsequently ran into difficulties and could not perform
in terms of the contract with Kentz
> Kentz ultimate cancelled the contract and called the guarantees
> Guardrisk resisted on the basis that Kentz’s claim was
fraudulent
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4. GUARDRISK – ISSUES CONSIDERED
> What was the nature of the guarantees?
> Were they “conditional” or “on demand”?
> The guarantees were held to be “on demand” instruments
> The guarantees recorded that they held the guaranteed sums, as the
disposal of the Employer, as security for Brokrew’s obligations
> The guarantees bound the issuer as principal and not surety
> Importantly, the guarantees stated that a dispute beween Employer
and Contractor would not prevent payment
> What is required to sustain a “fraud” allegation on the part of
the issuing institution?
> Where the party calling the guarantee does so in the knowledge
that it is not entitled payment
> The party alleging the fraud must prove it
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5. GUARDRISK – ISSUES CONSIDERED
> Did the manner in which Kentz engaged with the contractor
matter in relation to the enforcement of the guarantees?
> Kentz issued two notices to the Contractor.
> The first stated that Kentz was entitled to cancel the contract,
reserved Kentz’s rights to do so and then demanded the remedying of
certain defects
> The second cancelled the contract
> The court had no difficulty with this approach
> Does the court have any reference to the underlying agreement?
> No – this is not permissible
> At the stage where demand is made in terms of a guarantee, all other
disputes between Employer and Contractor are irrelevant
> Payment in terms of a performance / demand guarantee are
independent of the underlying contract
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6. COFACE – BASIC FACTS
> Coface issued a performance guarantee in favour of ELOH
> It undertook to pay in terms of the guarantee, on receipt of a
demand stating that the underlying contract between ELOH
and its contractor had been cancelled due to the contractor’s
default
> Coface contended that ELOH was not entitled to have
cancelled the underlying contract and that it (Coface)
therefore did not have to pay out under the guarantee
> Coface attempted to introduce issues relevant to the underlying
contract in order to avoid liability (design and errors in certification)
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7. COFACE – ISSUES CONSIDERED
> In what circumstances can “extraneous” issues be considered
when dealing with demand guarantees
> Fraud
> The introduction of underlying contractual disputes and the
joining of other parties (contractors) etc should be avoided
> As in the Guardrisk case, guarantees are enforceable on their
terms
> The previous SCA decision in the Dormell case was clearly
incorrect
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8. > Both judgments confirm that a demand / call bond
must be honoured on its terms
> If those terms are met, no other issues are relevant
for consideration by our courts
> Underlying disputes between Employer and
Contractor will not be considered
> The fraud defence will not be lightly inferred
> “Our courts, in a long line of cases and also relying on
English authorities, 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” (Guardrisk)
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GENERAL OBSERVATIONS FROM
GUARDRISK AND COFACE

9. STANDARD CONDITIONS DEALING
WITH INSOLVENCY / BUSINESS
RESCUE AND RESULTANT RIGHTS
> FIDIC Silver Book
> 15.2(e) – Employer is entitled to terminate if Contractor “becomes bankrupt
or insolvent, goes into liquidation, has a receiving or administration order
made against him, compounds with his creditors, carries on business under a
receiver”
> 16.2(f) – similar right for the Contractor
> NEC PSC
> 90.1 – “if the other Party has a winding up order made against it, has a
provisional liquidator appointed, has an administration order made against it,
has a receiver appointed, makes an arrangement with its creditors
> JBCC Series 2000
> 36.1 – cancellation by Employer where Contractor fails to comply with 15.1
(BoQ, security etc) or 15.3 (progress with skill diligence, regularity)
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10. THINGS TO CONSIDER
> Does the wording of security issued entitle the holder to
claim without reference to the underlying contract?
> Does the wording of the security issued entitle the holder to
claim if its co-contracting party goes into business rescue, as
opposed to being wound up?
> Can the underlying contract be cancelled if the co-contracting
party goes into business rescue?
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