A construction guarantee is just like a letter of credit Major construction works are currently under way in various cities and towns across South Africa.
Most of the contracts governing these works require the contractor to provide a construction guarantee to the owner (or employer) guaranteeing the contractor's performance undertaken burberry outlet england in terms of the construction contract, or principal building agreement (PBA). The Short Term Insurance Act defines a guarantee policy as "a contract in terms of which a person, other than a bank, in return for a premium, undertakes to provide benefits if an event, contemplated in the policy as a risk relating to the failure of a person to discharge an obligation, occurs".In a number of recent cases, the respondents endeavoured, unsuccessfully, to go behind the provisions of the guarantee with a view to finding reasons in the PBA why the guarantee should not be paid.The purpose of a construction guarantee is to create a primary obligation on the guarantor to make payment upon the occurrence of a certain event, and the obligation may be equated to an indemnity. In this event, the construction guarantee will operate independently of the PBA.This is illustrated in the recent matter of the Johannesburg Development Agency (JDA) versus Federated Insurance Guarantees Brokers. The applicant, the JDA, concluded a PBA, in the form of a standard JBCC Series 2000 contract, with a contractor. The respondent, Federated, issued a variable construction guarantee in favour of the applicant at the instance of the contractor. The applicant subsequently called upon the respon dent to make payment in accordance with the guarantee as a result of the contractor's default under the PBA. Despite compliance with the terms of the guarantee calling for payment, the respondent failed to make payment, and the applicant instituted proceedings in the High Court. The respondent contended that the applicant had been in breach of its obligations under the PBA and that its tardy payment of the amounts properly due to the contractor had precipitated the contractor's inability to perform the work properly.The court found in favour of the applicant and stated: "The guarantee alone generates liability, and... the guarantee constitutes a principal obligation and not one ancillary to the contractor's obligations in terms of the contract."On appeal by the respondent, the Appeal Court upheld the principle enunciated by the High Court (albeit three years after the matter had been instituted) and confirmed that the respondent was liable under the guaran tee, irrespective of the allegation that the applicant had been in default of the terms of the PBA. A further application by the respondent for special leave to appeal to the Supreme Court of Appeal burberry online store failed.In a recent decision by the Supreme Court of Appeal, the court came to the same conclusion when considering the terms of a construction guarantee similar to that issued by Federated Insurance Guarantees Brokers.In summary, the facts were that the appellant had issued a construction guarantee on behalf of a contractor in favour of the employer. The first respondent executed an burberry overnight bag indemnity in favour of the appellant in terms of which the first respondent undertook to indemnify (and keep indemnified) the appellant from and against all loss which the appellant may sustain by reason of it issuing the construction guarantee on behalf of the contractor. The employer called the guarantee and the appellant made payment in terms of the construction guarantee. It emerged that the principal agent had perpetrated a fraud, with the consequence, so it was alleged, that neither the appellant nor the respondents were liable for payment. The court found that the appellant had not colluded in the fraud perpetrated by the principal agent and decided the matter on the basis that the guarantee must be interpreted in conjunction with the PBA.On appeal, the Supreme Court of Appeal held that "the guarantee creates an obligation to pay upon the happening of an event [and that] the guarantee itself records that reference to the construction contract is solely for the purpose of convenience and there is no intention to create an accessory obligation or suretyship".The peculiar feature of this case is that, upon discovering the fraud alleged to have been perpetrated by the principal agent, the appellant could, presumably, have recovered the payment made to the employer. If this was so, why should the first respondent have been obliged to pay under the indemnity?Nevertheless, these decisions illustrate the fact that construction guarantees are not unlike irrevocable letters of credit issued by commercial banks in the context of international trade. The essential feature of a letter burberry online shopping sale of credit is the placing of a contractual obligation on the bank to pay the beneficiary upon presentation of documents, provided that the conditions specified in the letter of credit are fulfilled. The only basis upon which a bank can escape liability is to prove a fraud on the part of the beneficiary, that is, where the beneficiary, for the purpose of drawing down on the letter of credit, fraudulently presents to the bank documents that, to the beneficiary's knowledge, misrepresent the material facts. It follows that liability under a guarantee can also be avoided in cases of fraud on the part of the beneficiary.The cases referred to above reiterate the principle that a construction guaran tee, creating a principal obligation to pay, must be interpreted independently of the PBA. It follows that neither party to a construction guarantee should be entitled to raise issues arising out of the PBA as a defence to a claim made under the construction guarantee in the absence of an express provision to the contrary. The guarantor is bound by his autonomous, unconditional contract and the requirement of strict performance. The guarantor is, therefore, not affected by the terms and conditions of the underlying PBA.Since a construction guarantee forms an integral part of the construction documents underlying a construction project, it should not be automatically concluded that it must be interpreted with reference to the PBA. Drafting and interpreting construction guarantees remain a complex area of our law. Employers and guarantors, in the context of the construction industry, should, therefore, be mindful of the terms and conditions of the construction guarantee in order to ascertain whether the guarantee intends to create a principal obligation or an accessory obligation to the PBA, as failure to do so will almost inevitably result in complex litigation.The good news is that the Supreme Court of Appeal has enshrined the concept that a guarantee payable on demand is just that and that there is no right to go behind the provisions of the guarantee with a view to finding reasons for nonpayment of that guarantee based on arguments arising out of the PBA. The bad news is that an unscrupulous respondent can use the judicial system to delay payment for years.
When the application for leave to appeal by Federated was dismissed with costs three years after the commencement of motion proceedings in the Durban and Coast Local Division, Federated's attorneys wrote to the JDA's attorneys as follows: "We have taken instructions from our client with regard to your letter of 10th April 2009 [demanding payment under the guarantee]. We have been requested to convey to you that our client has fallen victim to the current economic meltdown and is not currently possessed of any resources from which to meet your client's claim.".
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