March 2013: Cash is king


Chris Binnington revisits the thorny issue of providing performance securities or bonds.

I have previously written in Civil Engineering Contractor about the amount of money which Employers waste insisting upon the provision of performance securities or bonds, for which the Employer ultimately pays within the contract price, simply because the accepted norm within the industry is for such a bond to be in place. I suggested a more selective approach would be more cost effective particularly where the Employer was in a position to select its bidders. Even where a bond is in place, of course, it is never going to be as effective as holding cash, since it requires the compliance of the Guarantor to respond to the demand for payment and for a variety of reasons some Guarantors may be reluctant to make such payments alternatively a Contractor advised of the fact that a demand has been made on the bond may well seek to interdict the Guarantor to prevent it from paying out to the Employer.

Contractors are of course not parties to the guarantee between the Guarantor and the Employer and the extent to which any intervention is possible will always be limited. It is also a question of the wording of the guarantee or bond as to whether or not the Employer may simply demand payment without any proof of default or quantum of the amount allegedly due to the Employer or whether the Employer must provide some form of substantiation to the Guarantor before the Guarantor is obliged to make payment.

In a recent case in the Supreme Court of Appeal (SCA) the SCA considered the issue of the extent to which a bond may be called “On Demand” and also considered the issue of whether the guarantee was inextricably interlinked with the construction contract or whether it stood independent from that contract in a manner comparable to irrevocable letters of credit.

The facts were as follows:
The Employer contracted with Zanbuild to construct 2 pathology laboratories. At some stage, due to certain issues with the work, the Employer purported to cancel the contracts. Zanbuild disputed the Employer’s right to cancel and alleged that the cancellation was in fact a breach without proper grounds and constituted a repudiation. If that were the case then in law it was entitled to accept the cancellation as a repudiation and Zanbuild did this and also purported then to cancel the contract. Neither contract had at that stage been completed and immediately following the Employer’s cancellation it demanded payment from ABSA Bank who had issued the 2 construction guarantees at the request of the Contractor.

When making the demand the Employer did not allege that it had an identifiable monetary claim against Zanbuild but simply maintained that the guarantees stood independent from the construction contracts and that the Employer merely had to claim from the bank on the basis an event described in the guarantee had arisen and accordingly ABSA”s liability to pay was established by demand.

Zanbuild however contended that the guarantees were in fact inextricably linked to the construction contract in a manner equal to a suretyship agreement, in which case the bank’s liability to pay would only arise to the extent the Employer could demonstrate it had a valid and quantified claim against Zanbuild under those construction contracts.

The Court went on to give useful guidance in regard to these issues and the Court’s judgment is worth discussing.

The 2 guarantees arose out of 2 separate construction contracts entered into under the JBCC Standard Form at the end of January 2007. Although clause 14 of the JBCC deals with the security to be provided that clause was superseded by the fact that the Employer, in its letter accepting Zanbuild’s tenders for the 2 projects, required a guarantee in accordance with the Employer’s Standard Form which was not equivalent to the options provided for in clause 14. However the Employer’s Standard Guarantee Form is also immaterial as the guarantees issued by ABSA were substantially different from the Employer’s Standard Form. In view of the fact that they were issued with the acquiescence of Zanbuild and accepted by the Employer these guarantees became the accepted guarantees. Each guarantee was for an amount equal to 10% of the value of the contract being approximately R1,181 million in the one contract and R1,106 million in the other. One of the relevant terms provided that the bank was entitled to withdraw the guarantee after the Employer had been given 30 days written notice of its intention to do so providing that the Employer had the right to recover from the bank the amount owing and due to the Employer by the Contractor on the date the notice period expired. This is in fact what ABSA Bank did on 28th August 2008 indicating that it wished to withdraw from the guarantees and consequently that those guarantees would be cancelled one month from that date namely on 28th September 2008. Two days before that stipulated expiry date, on 26th September 2008, the Employer demanded immediate payment of the full amount of both guarantees.

The letter of demand also went on to state that the Contractor had defaulted on both contracts and attached an annexure “A” in support thereof. It stated that the contracts had not yet been cancelled. Annexure “A” was a letter dated 4th August 2008 by the Principal Agent which informed Zanbuild that both the Employer and the Principal Agent were of the view that Zanbuild was in breach in that it had failed to execute the works with due skill and diligence, regularity and expedition and that Zanbuild was afforded 10 days to remedy its breach failing which the Employer may proceed to cancel the contracts.

As it happened the Employer purported to cancel the contracts on 9th October 2008 and Zanbuild disputed that it was entitled to do so but chose to accept the purported cancellation as a repudiation. The effect of this is that on either the Employer’s or the Contractor’s version, the contract did come to an end before either of the projects had been completed.

In its letter of demand to the bank the Employer did not contend it had an identifiable monetary claim although clause 33 of the JBCC provides for different potential claims for example, penalties for late completion and claims for loss and expense arising from the need to employ an alternative Contractor to bring the works to completion following a cancellation. However at the time when the demand for payment was made on 26th September 2008 the Employer did not allege any such claims. In fact the last payment certificate issued immediately prior to termination on 8th October 2008 showed a positive amount due to Zanbuild.

In the High Court the Judge had accepted the interpretation contended for by the Contractor namely that the guarantees were inextricably linked to the construction contracts in a manner equivalent to a suretyship agreement. If that were the case then ABSA’s liability under the guarantee was limited to the extent that the Employer could demonstrate a monetary claim against Zanbuild. Since the Employer did not even allege that it had any claims in terms of the construction contracts, so Zanbuild argued, it followed that the Employer had no claim against the guarantee and the demand was not a valid demand.

The Employer in the High Court had argued that the guarantees were completely independent from the construction contracts and accordingly the guarantees could be invoked without the necessity for any allegation or evidence of any claim against Zanbuild under those contracts. All the Employer had to do to obtain payment of the full amounts guaranteed was to submit a statement to ABSA that the Contractor was in default.

It was against this background and the finding in the High Court in favour of Zanbuild that the Employer appealed to the SCA. The SCA was therefore tasked with finally determining whether the guarantees were conditional bonds, as suggested by Zanbuild requiring certain conditions to be satisfied before the liability to pay arose; or “On Demand Bonds”, as suggested by the Employer in which case no allegation of liability on the part of the Contractor was required simply a demand for payment on the basis of an event specified within the bond itself.

In coming to its decision the SCA considered the earlier judgments dealing with these issues in the Dormell Properties case and the Landmark Holding case and the Basil Read case .
The Employer in fact had relied upon the decision in Lombard that:

“The guarantee by Lombard is not unlike irrevocable letters of credit issued by banks and used in international trade, the central feature of which is the establishment of 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 undertakes to pay provided only that the conditions classified in the letter of credit are met. The only basis upon which the bank can escape liability is proof of fraud on the part of the beneficiary”.

In addition the Employer also had sought to rely on certain statements in Dormell which endorsed the approach in Lombard.

Interestingly the wording in Lombard and Dormell of those guarantees was essentially identical to the wording of the standard guarantee which the Employer had originally called for in its letters accepting Zanbuild’s tenders but which ultimately fell away when the Employer accepted the guarantee from ABSA which contained different wording.

The consequences of those differences were, according to the SCA, that the ABSA guarantees could not be interpreted as the Employer sought to do with reference to the terms of the Employer’s Standard Guarantee or indirectly with reference to statements made in Lombard and Dormell cases.

The Court concluded that when construing the ABSA guarantees as a whole it found that it concurred with the High Court in that the wording of those guarantees supported the interpretation contended for by Zanbuild that they did not in fact constitute on demand bonds but gave rise to a liability on the part of ABSA equivalent to suretyship. What had persuaded the Court in this regard was the assertion that the guarantee provides “security for the compliance of the Contractor’s performance of its obligations in accordance with the contract” and, in the body of the document, the bank guarantees, “the due and faithful performance by the Contractor”. The SCA stated that this clearly accords with language associated with suretyships.

The SCA accordingly dismissed the appeal and upheld the High Court’s judgment. In terms thereof the bank was prevented from paying out since the demand made by the Employer was not compliant with the requirements of the wording of the ABSA guarantees; the 30 day period for withdrawal of the guarantees had by now long expired; the Employer’s right to payment from the bank was accordingly finally extinguished by the judgment of the SCA.

Although questions of interpretation of guarantees are frequently complex and guarantees are sometimes loosely worded, the importance of this SCA judgment is that it has now clearly established that only where a guarantee is obviously, on the face of the wording, “on demand” will it be paid against simple demand by an Employer. To the extent that the bond is described as being “on demand” but is also linked to wording which would tend to indicate a suretyship agreement then before payment can be obtained the demand itself must be accompanied by proper proof of breach and adequate substantiation of the quantum of the amount demanded.

At the end of the day cash remains king! The judgement also reflects poorly on the Professional Team employed by the Employer who should never have simply accepted the wording of the Absa Bank guarantee which was clearly not in accordance with the Employer’s standard wording.