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Supreme Court of Appeal of South Africa matter, Mutual & Federal v KNS Construction (208/15) [2016] ZASCA 87 (31 May 2016)

20 June 2016

Facts:

  • This appeal concerns the interpretation of a construction guarantee.
  • In 2011, South African National Roads Agency Limited (SANRAL) awarded to KNS Construction (Pty) Limited (“KNS” and further the 1st Respondent), a contract for the construction of road works at Ballito interchange, National Route 2, KwaZulu-Natal (the main contract).
  • On 22 March 2011, KNS appointed Aqua Transport & Plant Hire (Pty) Ltd (“Aqua”), as a sub-contractor and in terms of the sub-contract, Aqua was required to provide a performance guarantee (“the guarantee”) to the value of 15 per cent of the main contract, and the guarantee was not to have an expiry date.
  • The 1st Appellant, Mutual and Federal Insurance Company Limited (Mutual & Federal), as guarantor, issued the guarantee on behalf of Aqua for the due fulfilment of its obligation to KNS pursuant to the sub-contract.
  • The guarantee had the following terms:
    • Mutual & Federal would hold at their disposal the amount of R3 423 850.49 for the due fulfilment by Aqua of its obligations to KNS;
    • The Guarantor would undertake to pay KNS the said amount of R3 423 850.49 or such portion as may be demanded on receipt of a written demand from KNS which demand may be made by KNS if, (in your opinion and at your sole discretion) the said Contractor fails and/or neglects to commence the work as prescribed in the contract or if he fails and/or neglects to proceed therewith or if, for any reason, he fails and/or neglects to complete the services in accordance with the conditions of contract, or if he fails or neglects to refund to KNS any amount found to be due and payable to KNS or if his estate is sequestrated or if he surrenders his estate in terms of the Insolvency law in force within the Republic of South Africa‟
  • Pursuant to the issuing of the guarantee, KNS experienced financial problems and was not able to perform in terms of the main contract.
  • As a result, it could not continue with its obligations which it was required to perform before Aqua could render its services and its financial situation did not improve and it placed itself under voluntary winding-up in terms of a special resolution registered by the Master of the High Court on 13 December 2011.
  • By 14 December 2011 the site was closed. KNS’s insurers, who had issued a performance guarantee on its behalf to SANRAL, were informed of the dire financial situation. This led to SANRAL cancelling the main contract and issuing a new tender for the completion of the remaining earthworks.
  • On 24 January 2012, KNS was placed under provisional winding up at the instance of one of its creditors and the provisional order was made final on 5 March 2012.
  • On 14 December 2011, KNS placed itself under voluntary winding up, purported to cancel the sub-contract with Aqua, giving Aqua 14 days’ notice to rectify its performance, failing which it intended calling up the performance guarantee. The basis for the calling up of payment of the guarantee was alleged to be the failure to commence, proceed with or complete the project.
  • On 28 May 2012, Aqua launched an application in the South Gauteng High Court, Johannesburg interdicting Mutual & Federal from effecting payment in terms of the guarantee. By agreement between the parties, Mutual & Federal was interdicted from honoring the guarantee pending resolution of proceedings to be instituted within 30 days by KNS Construction. In due course, KNS Construction launched an application which came before the court a quo demanding payment of the guarantee on the basis that, as the guarantee was a “call or on demand guarantee‟ it had become payable.
  • Aqua on the other hand contended that the guarantee was a “conditional guarantee‟, inextricably linked to the sub-contract, and as Aqua was not in breach of the sub-contract, the guarantee was not due and payable.

Issue:

  • This appeal court dealt with concerns regarding the interpretation of the construction guarantee.
  • The main issue raised was that the guarantee was a “conditional guarantee‟ that is inextricably linked to the underlying contract, and therefore akin to suretyship and not an “on demand‟ or “call guarantee‟.

The court a quo:

  • The Gauteng Local Division of the High Court, Johannesburg held that the guarantee was a “call or on demand‟ guarantee, and that Mutual & Federal was on demand by KNS, obliged to pay.

The Supreme Court of Appeal concluded:

  • The language used in the guarantee and its purpose reveal the true intention of the parties. Clause 1 stated that it is issued for the “due fulfilment‟ by Aqua of its obligations to KNS in terms of the sub-contract.
  • Clause 3 of the guarantee stated that the guarantee amount is payable,… on receipt of a written demand from KNS, which demand may be made by KNS if (in your opinion and at your sole discretion) Aqua had failed and/or neglected to commence the work as prescribed in the contract or if Aqua had failed and/or neglected to proceed therewith or if, for any reason, Aqua failed and/or neglected to complete the services in accordance with the conditions of contract.
  • Although payment may be demanded “at any stage‟, the true purpose was to guarantee the due performance by Aqua. It was only payable if Aqua breached the sub-contract as expressly stated in the guarantee.
  • The court found further that on completion of the construction, the guarantee would be returned to Mutual & Federal (as in the case of suretyship) and once the principal debt was discharged, the surety would be released from its obligations.
  • KNS could not specify which breach Aqua is alleged to have committed. Thus it was not clear on what basis KNS alleged it was entitled to payment.
  • KNS did not and could not perform its own obligations in terms of the sub-contract and therefore it did not meet any of the conditions imposed, before payment can be held to be due and payable.
  • The fact that the guarantee depended on breach of the sub-contract by Aqua, lends credence to the fact that the guarantee is inextricably linked to the sub-contract and therefore akin to a suretyship.
  • The conclusion was therefore that the guarantee is akin to suretyship and thus a conditional guarantee and not a call or demand guarantee.
  • The court a quo erred in holding that the guarantee is a demand and not a conditional guarantee.