12 September 2011

"Guaranteed" discomfort for developers

 In the recent decision of Dormell Properties 282 CC v Renasa Insurance Company Limited [2011] 1 All SA 557 (SCA) and the joint liquidators of Synthesis Projects Cape (Pty) Ltd (in liquidation,) the Supreme Court of Appeal (SCA) dealt with interesting and practically relevant issues concerning liability under construction guarantees.

The Facts

Renasa had issued a standard JBCC construction guarantee in favour of Dormell for the performance of the works by the contractor Synthesis. The works comprised the construction of a shopping centre in Durbanville, Cape Town.

A dispute arose between Dormell and Synthesis, which led to Dormell cancelling the building agreement and, on the same day, calling up the guarantee. In doing so, Dormell complied fully with the steps prescribed in the guarantee.

Renasa refused to make payment under the guarantee. In addition, Synthesis alleged that Dormell's cancellation was unlawful and therefore, the calling up of the guarantee was flawed and could not sustain a claim for payment. Synthesis referred the issues to arbitration.

Before the hearing in the SCA, the arbitrator had found that Synthesis was not in breach and accordingly, Dormell's cancellation of the building agreement was indeed unlawful.

One of the issues the SCA had to decide on was whether the arbitrator's finding that Dormell's cancellation was unlawful absolved Renasa from liability under the guarantee.

The SCA finding

In a 3/2 split decision, the SCA found that Dormell's entitlement to payment under the guarantee had been negated by the arbitrator's finding. We view this aspect of the judgment alarming. It departs from the widely accepted approach in South Africa and the United Kingdom that a guarantee constitutes a separate, stand-alone agreement between the guarantor and the customer/employer. Nor is it concerned with the relationship and agreement between the customer/employer and the supplier/contractor, or any disputes arising out of such agreement.

Where the guarantee provides for a set of steps to be taken by the customer/employer in calling up the guarantee and those steps have been taken, the guarantor is obliged to honour the guarantee. To proceed otherwise undermines the commercial veracity of guarantees of this nature and the certainty they are intended to create.

The guarantor can be excused from making payment only where the customer/employer acts fraudulently in calling up the guarantee. There was no finding of fraud on the part of Dormell. The majority decision of the court was based on the reasoning that, as a result of the finding that the cancellation of the building agreement was unlawful, Dormell had lost its entitlement to access to the guaranteed funds in order to complete the works.

We agree with the minority view that the proceeds of a construction guarantee are not ring-fenced in this way, as this would mean that an employer who has validly cancelled the building contract could never use the proceeds of the guarantee as compensation for amounts due by the contractor before and at the time of cancellation.

We are concerned that the Dormell judgment will disturb the regime of provision of reciprocal guarantees under building contracts, which have become the accepted practice in major construction projects.

This enables the guarantor to enter into the arena of the performance or otherwise of the employer's and contractor's obligations under the building agreement. It is something very removed from the stand-alone agreement which the guarantee creates between the guarantor and employer.

We hope that the SCA will have occasion to reconsider and put right its approach in the not too distant future.

Nick Muller

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