Calling in an on-demand guarantee

A consortium comprising KC Cottrell Co Ltd, ELB Engineering Services (Pty) Ltd (in liquidation), ELB Educational Trust for Black South Africans, and KC Cottrell Co Ltd (collectively referred to as KC or the applicants) sought interim relief against Santam Limited (“Santam”) in the High Court, Johannesburg.[1]

The applicants sought to restrain Santam from paying out on an on-demand guarantee issued in favour of Ngodwana Energy RF Ltd (“Ngodwana”). The guarantee was issued to secure the performance of KC’s obligations under a construction contract (relating to the construction of a 25-megawatt biomass power plant).

Background

The construction contract made provision for instalment payments once Ngodwana certified that certain milestones were reached. As work progressed, Ngodwana certified that various milestones were reached. Consequently, Ngodwana paid substantial amounts to Ngodwana.

Thereafter Ngodwana took the view that the construction work defects it identified were serious enough to justify the reversal of payment milestones previously reached and to reclaim a substantial portion of the money it paid under the certified payment certificates.

Accordingly, Ngodwana in interim payment certificate 36 certified that KC is liable to it in the sum of ZAR 222?362?236.68. Ngodwana then notified its intention to make a call on the guarantee (which would mean that Santam, in turn, would claim such an amount from KC).

Ngodwana opposed the application but, in its opposition, did not submit:

• ????????that the defects it identified cannot be rectified;
• ????????that it will cost ZAR222 million to rectify such defects; or
• ????????that the defects caused it to suffer losses approximating the amount it intended to call up.

Instead, Ngodwana placed reliance on the terms of the guarantee - that it is entitled to call up the guarantee if KC is in breach of the construction contract (something which was common cause and not in real dispute).

KC accepted that while Ngodwana was probably entitled to call up the guarantee, given defective work, the amount Ngodwana threatened to call up was grossly disproportionate to any amount to which Ngodwana could honestly believe it was entitled. KC argued, on that basis, Ngodwana’s threatened call was fraudulent.

KC submitted therefore that it had a prima facie right to restrain Santam from paying out on the call.

High court

The law

The legal position, in respect of on-demand guarantees, was summed up as follows:

• ????????employers, in whose favour such guarantees are issued, are in an especially strong position;
• ????????employers may call up the guarantee in any amount on mere notification to the guarantor that an event specified in the guarantee has occurred;
• ????????the employer need not establish the nature and extent of the contractor’s liability to it; and
• ????????the employer need not allege that there is any specific amount due to it (unless the amount owing constitutes part of the event specified in the guarantee).

The following example, and exposition of the law, was given:

“… if a guarantee states that it may be called upon on a breach of contract, all the employer has to allege is that there is such a breach. In that event, the full amount due in terms of the guarantee becomes payable if that is what the employer demands. If, however, the guarantee states that the employer may call up the bond on breach only to the extent that it is necessary to remedy the breach, then the employer must allege both that there is a breach and the amount it considers necessary to remedy the breach. In neither case, however, is the employer required to establish that there is a breach, or the nature and extent of the amount necessary to cure it. The guarantee is called up on the mere say-so of the employer.

Accordingly, it does not matter to the guarantor whether there is actually a breach of contract, or whether the amount called up is necessary to cure the breach. The guarantor is not entitled to go behind the employer’s demand, so long as the demand conforms to the terms of the guarantee itself. The guarantor’s obligation to pay out on the guarantee is wholly independent of the underlying contract between the employer and the contractor. Any disputes between the employer and the contractor about whether there really is a breach, and the extent of the liability arising from it, is irrelevant to the guarantor’s duty to pay on demand from the employer.”

The only exception is fraud - if the employer makes a call knowing that the event, specified in the terms of the guarantee, has not occurred. In fraudulent circumstances, the guarantor need not pay out and the employer is entitled to an interdict restraining the guarantor from doing so.

Application to the facts

Turning to the facts in this particular case the court had to consider the following:

·????????whether the guarantee required that Ngodwana notify it of a breach (there is no serious dispute between the parties that there was a breach); or

·????????whether the guarantee required that Ngodwana further allege an amount needed to remedy the breach/defects identified. In such circumstances, it would be necessary to consider whether Ngodwana’s belief was honestly held (that it was entitled, given the defects in question, to the amount it threatened to call up).

The guarantee terms were that Santam undertook upon written notice, that KC had failed to comply with the terms of the construction contract without further proof or condition, demanding payment by way of an original letter (“Demand”) to immediately pay to Ngodwana (despite any KC objection) such amount as Ngodwana may in that Demand require (not exceeding the guaranteed sum).

KC contended that the italicised phrase may in that Demand require means an amount required to remedy the breach alleged.

Despite the high court’s sympathies (as the effect of the call appeared to be oppressive to KC), it concluded that KC’s argument was untenable (the court indicated that there was no difference between the word require and its synonym demand). The high court indicated that much more would need to have been set out in the text to have the limiting effect KC contended for.

Conclusion

The application was therefore dismissed with costs.

[1] Case number 2023/009986