Strict wording makes a difference

When it comes to insurance matters, the outcome ultimately depends on strict interpretation of the guarantee, writes Chris Binnington.

In June 2007 I wrote an article for this publication entitled “Cash is King – Insurance is often a poor second”. In that particular article the Insurer had resisted a claim by the Contractor in respect of the re-instatement of damage to road works due to tropical cyclone Lizette which swamped Nampula Province in Mozambique and severely damaged roads which the Contractor was about to hand over to the National Roads Agency. Ultimately the Insurer was found liable and the court determined that it must settle the Contractor’s claim.

In February 2008 the Supreme Court of Appeal pronounced judgement in favour of Lombard Insurance Company Limited thus reversing the judgement in the High Court of South Africa, Cape Provincial Division, when Judge Davis determined that the Insurer should meet its obligations under a construction guarantee issued in favour of the Employer the Cape Metropolitan Council.
As with most court cases and in particular insurance matters, the outcome ultimately turned on the strict interpretation of the wording of the guarantee. The facts were as follows:

The Employer’s predecessor in title, the Cape Metropolitan Council, had issued a tender during December 1999 for Civil Engineering Construction Works for the control of odours and upgrading of the primary sludge removal system and associated civil works for the Cape Flats Waste Water Treatment Works. On 13 January 2000 a joint venture between Labor Construction Co (Pty) Ltd and S. A. Focus Projects submitted a tender to perform the works. On 9 February 2000 Gibbs Africa Consulting Civil Engineers acting on behalf of the Employer notified the Labor/S A Focus joint venture in writing that they had been successful in their bid and were appointed as the joint venture contractor for the works. The terms and conditions of contract required the submission by the joint venture of a typical performance guarantee as well as proof of insurance.

Lombard Insurance Company Limited had previously issued a guarantee on behalf of Labor in an earlier contract between themselves and the same Employer and Labor’s details were accordingly on record with Lombard. On 10 February 2000 Labor approached Lombard for the issue of the performance guarantee required in terms of the conditions of contract. This guarantee was issued in favour of the Employer on 17 February 2000 recording that Labor was “the contractor” and that Labor had entered into or was about to enter into a contract with the Employer and specified the contract number, WW38/99. The terms of the guarantee were that Lombard undertook to pay the sum of R297 806.16 in the event of Labor, amongst other things, failing to proceed with and complete the works or being placed under provisional final liquidation or judicial management.

On 26 May 2000 a written joint venture agreement was concluded between Labor and S A Focus to undertake the works under contract WW38/99. It was a term of the joint venture agreement that Labor would provide the financial resources for the execution of the work, including the performance guarantee and that S A Focus would provide the management team and labour resources for carrying out the work on site.

On 9 June 2000 the Employer and the joint venture concluded a written engineering contract and the works commenced shortly thereafter. Just over a year later on 22 June 2001 Labor was placed under provisional liquidation. The Employer demanded payment of the amount guaranteed by Lombard who denied liability on the basis that, according to Lombard, at all relevant times they were under the impression that the contract was entered into between Labor Construction Co (Pty) Ltd and the Employer and accordingly they were unaware of the fact that the contract was between a joint venture and the Employer. This said Lombard is demonstrated by the fact that the guarantee only referred to Labor. In view of the fact that the contract was not awarded to Labor but rather to a joint venture, Lombard contended that they were not liable in terms of the guarantee.

On receipt of this advice from Lombard the Employer issued summons in the Cape High Court claiming payment of the guaranteed sum and Lombard filed the same defence, namely that the contract WW38/99 was not entered into between Labor and the Employer but between the Employer and a joint venture. It further pleaded that it had issued a guarantee to cover Labor’s performance only and that it was accordingly not indebted to the Employer. The judge subsequently made a finding in favour of the Employer and stated as follows:

“In my view the wording of the contract for an institutional
guarantee concluded between Labor and the Defendant
[Lombard Insurance] is more than capable of a construction
to the effect that the intention of such an agreement was to
indemnify the obligations of Labor.  No legal principle was
raised by the Defendant which would run counter to this
conclusion. One of the express purposes of the guarantee
was to protect the Employer in the event that Labor was
liquidated or placed into judicial management. Given
that this interpretation of the contract is both plausible and
indeed reasonable, it is my view that Plaintiff [the Employer]
was entitled to payment in terms of the guarantee”

Lombard appealed the judgement and on appeal the Supreme Court of Appeal was called upon to determine the proper interpretation of the guarantee. The issue was of course whether the guarantee was enforceable where the Insurer was under the impression, according to the Insurer, that it had guaranteed the performance of Labor Construction Co only, and was unaware of the fact that a joint venture had contracted with the Employer. Counsel for Lombard also argued that the joint venture had not yet been formed when the guarantee was issued alternatively that the guarantee was void ab initio [from the outset] as there was no consensus between the parties. The opposing view was advanced by Counsel for the Employer whilst conceding it would have been preferable to obtain a guarantee covering the joint venture, there was no reason why the Employer could not rely upon the guarantee even thought the contract contemplated in the guarantee was not concluded between the Employer and Labor as sole contractor.

The question the Supreme Court of Appeal had to answer was in essence whether the guarantee was capable of being extended to cover a contract entered into between the Employer and the joint venture in which Labor was a partner. The court found the language of the guarantee was clear and unambiguous and that Lombard guaranteed due performance by Labor in the event of Labor being the contractor in a contract concluded with the Employer. What the Insurer therefore guaranteed was the performance of the contractor’s obligations in which the contractor was defined as Labor. The guarantee envisages that the contractor and (by implication) only Labor, would complete the works defined as contract WW38/99 and that the works would not be completed by another unnamed person. The court found that the guarantee covered Labor and not the joint venture. Whilst the cause of action was based on a guarantee being claimable in the event that Labor concluded a contract with the Employer the contract was concluded between the Employer and the joint venture in which Labor was simply a partner.

The Supreme Court of Appeal considered that the High Court should, as a starting point, have attempted to determine the intention of the parties to the guarantee. It was never the intention of Labor and the Employer to extend the guarantee to cover Labor’s performance as a partner in the joint venture. That said the court would be going beyond the language of the guarantee. In terms of the contract and in terms of the joint venture between Labor and S A Focus, it was Labor’s responsibility to obtain a performance guarantee on behalf of the parties to the joint venture, namely Labor and S A Focus. This Labor failed to do and instead provided a guarantee in respect of Labor itself. Lombard could never have intended to secure the obligations of a joint venture or of Labor as a partner in a joint venture. The guarantee covered Labor as a sole entity. The court accordingly found that Lombard were not liable for the obligation of the joint venture.

This is an important judgement for the construction industry given the large number of contracts which are let to contracting entities formed by joint ventures. Indeed the Supreme Court of Appeal also recognized the importance of this when it was considering the issue of costs. The court said:

“In my view this matter is of importance not only to the
insurance industry but to local authorities as well.
It raises issues on how to deal with guarantees of
this kind in future and there are public policy
considerations to be borne in mind.”

Joint ventures are accordingly cautioned that where they enter into such contracts they must ensure that any performance security or indeed any other guarantee issued on behalf of the joint venture should cover all the partners to the joint venture. Employers must similarly ensure, for their own protection, that the guarantees they receive clearly describe the actual contractual arrangements and reflect the details of the joint venture.

The devil is of course in the detail. It would seem, given Labor’s previous relationship with Lombard, that had Labor disclosed to Lombard at the time of the application for the guarantee that it was intending to enter into a joint venture with S A Focus, Lombard would have had no difficulty whatsoever in issuing a guarantee on behalf of the joint venture. When the opportunity came to avoid their obligations under the guarantee upon a proper construction of the guarantee could they be blamed for relying on a legal technicality?

As we have previously said insurance does not shift liability and from an Employer’s perspective cash is king. In this instance the Employer would no doubt have ended up as a concurrent creditor of Labor in the absence of its ability to rely upon the guarantee.

Chris Binnington