24 June 2020 by and Dispute Resolution Alert

Can unfair or unreasonable contracts be set aside? The Constitutional Court provides clarity

When it comes to enforcing contracts, South African courts have grappled for some time with the competing values of fairness, reasonableness and good faith on the one hand and on the other, the notion of legal certainty and the notion of pacta sunt servanda (being the recognised principle that contracts freely entered into between parties must be honoured and, if necessary, enforced by the courts). Debate has raged on how the right balance between these competing values should be struck, how far the courts should go in interfering in contractual relationships and whether a party should be able to set aside a contract by relying on constitutional values or principles if it operates prejudicially towards such party.

On 17 June 2020, the Constitutional Court of South Africa gave its latest pronouncement on this debate and, in particular, the public policy grounds upon which a court may refuse to enforce contractual terms, particularly those terms which are alleged to operate unfairly, unreasonably or which are unduly harsh in the matter of Beadica 231 CC and Others v Trustees for the time being of the Oregon Trust and Others [2020] ZACC 13 (Beadica Case).

It is necessary to consider the litigation history of the Beadica Case in order to appreciate the findings made by the Constitutional Court on the question of when, and to what extent, the competing concepts of fairness and reasonableness and/or good faith may be invoked at the expense of legal certainty in order for the judiciary to exercise control over – and possibly interfere with – contractual arrangements.

Background

The applicants in the Beadica Case were four close corporations, whose businesses focused predominantly on the rental and sale of construction-related equipment, that had entered into franchise agreements with the second respondent (Sale’s Hire) as part of a black economic empowerment initiative financed by the National Empowerment Fund (the NEF, cited as the third respondent).

During 2011, Sale’s Hire entered into a co-operation agreement with the NEF, whereby the NEF would provide loans to black-owned entities to enable them to own and operate Sale’s Hire franchised businesses. Sale’s Hire was appointed as the coordinator of these funding transactions and it also undertook to train franchisees on operating their businesses and provide ongoing business support and mentorship.

Franchise agreements were also entered into with the applicants (whose members were former long-term senior employees of Sale’s Hire) during 2011 which were intended to operate for a period of ten years.

The applicants also entered into lease agreements during 2011 which contemplated that the franchises would operate from premises leased from the first respondent (Oregon Trust). These leases were intended to run for an initial period of five years, terminating on 31 July 2016, but incorporated options to renew the leases for a further period of five years. These options required the applicants to give six months’ written notice of their intention to renew the leases before the termination date, by 31 January 2016. Amongst other things, the franchise agreements gave Sale’s Hire the election to terminate the franchise agreements if the lease agreements were terminated.

The applicants did not exercise their renewal options by the 31 January 2016, but purported to exercise the options only thereafter. During July 2016, Oregon Trust demanded that the applicants vacate the leased premises, as their options to renew had lapsed and the lease agreements had terminated.

Litigation history

Fearful that their businesses would collapse, the applicants instituted an urgent application in the High Court against Sale’s Hire and Oregon Trust seeking an order declaring that their renewal options had been validly exercised, permitting them to remain in occupation of the leased premises and prohibiting Oregon Trust from evicting them. Oregon Trust, in turn, brought a counter-application for the applicants’ eviction.

Before the High Court, the applicants argued that South African contract law had become “infused” with the public policy notions of fairness and Ubuntu (which “emphasises the communal nature of society and social justice and fairness and envelopes the key values of group solidarity, compassion, respect and human dignity…”). The applicants also argued that, despite the strict terms of the franchise agreements, considerations of good faith and the broader purpose of both the franchise and lease agreements should be considered, particularly in circumstances where Sale’s Hire had undertaken to the NEF that it would support the historically disadvantaged franchisees’ operations and that the franchise agreements would endure for at least ten years.

The High Court noted that terminating the lease agreements would result in the applicants losing their businesses and cause an important black economic empowerment initiative to fail, which be a disproportionate sanction for the applicants’ failure to exercise their lease renewal options timeously. The High Court also noted that the argument for legal certainty, on its own, should not be a restraint on the clear intention of the parties – which was to advance historically disadvantaged persons – and the High Court held that the strict terms of the lease agreement should not be enforced, accordingly granting granted the applicants the relief sought.

Aggrieved, the respondents appealed to the Supreme Court of Appeal (SCA). In handing down judgment, the SCA adopted a more conservative approach and emphasized the importance of the principle pacta sunt servanda and the need for certainty, whilst noting that although fairness and reasonableness inform public policy, they are not self-standing principles. The SCA also held that while the courts may decline to enforce contractual terms which are deemed contrary to public policy, this power should be exercised “sparingly and only in the clearest of cases”.

The SCA rejected the concept of the “disproportionality” of sanction relied upon by the High Court, as it is not a recognised principle in South African law. Lastly, the SCA also cautioned that “the parties [must] know what their contract means and that they are entitled to rely on its terms, unless they are against public policy or their enforcement would be unconscionable”.

Regarding the renewal of the leases, the SCA held that while the applicants may not be “sophisticated business people” as they had argued, they were not “ignorant individuals”. There were no considerations of public policy that rendered the renewal clause unenforceable, particularly as the only limitation that was imposed on the parties was that the option to renew had to be exercised by the applicants in a particular manner and by a particular date. The SCA noted that the applicants had jeopardized their own businesses through non-compliance with the renewal clause, as they did not provide sufficient reasons why they had failed to renew their leases timeously.

The SCA accordingly upheld the appeal and replaced the High Court’s order with an order dismissing the application with costs and ordered the eviction of the applicants.

Majority judgment of the Constitutional Court

Judge Theron, who delivered the majority judgment (the First Judgment), held that parties cannot escape contractual terms on the basis that their enforcement would be disproportionate or unfair, particularly as the values enshrined in the Constitution of the Republic of South Africa, 1996, do not provide a free-standing basis upon which a court may interfere in contractual relationships. Rather, constitutional values form important considerations in the balancing exercise required to determine whether a contractual term, or its enforcement, is contrary to public policy.

The First Judgment held that the applicants failed to demonstrate that the enforcement of the renewal clause in question is contrary to public policy, particularly as they did not provide adequate reasons for their failure to comply, leading to the conclusion that the applicants neglected to comply with the renewal clause in circumstances where they could have done so. Furthermore, the applicants had not shown that the failure of their businesses, in these circumstances, would unjustifiably undermine substantive equality as they had attempted to argue before the Constitutional Court.

Judge Theron noted that constitutional values should be used creatively by courts to develop new constitutionally-infused common law doctrines, and that such developments must take place in an incremental fashion and yield clear and ascertainable doctrines to provide predictable outcomes for contracting parties. In the Beadica Case, however, the applicants had not sought to develop a clear and ascertainable doctrine to ameliorate a demonstrated problem of unfairness and, as a result, their case had to fail.

Judge Theron also noted that the judgment in Barkhuizen v Napier (2007 (5) SA 323 (CC)) (Barkhuizen Case) remains the leading authority on the role of equity in contract, as part of public policy considerations. As per the Barkhuizen Case, the Constitution requires the courts to “employ [the Constitution and] its values to achieve a balance that strikes down the unacceptable excesses of ‘freedom of contract’, while seeking to permit individuals the dignity and autonomy of regulating their own lives.” The First Judgment noted that it was clear that public policy imports values of fairness, reasonableness and justice. Ubuntu, which encompasses these values, is recognised as a constitutional value and informs public policy.

Lastly, Judge Theron emphasised that a court may not refuse to enforce contractual terms because the enforcement would, in the court’s subjective view, be unfair, unreasonable or unduly harsh. These abstract values have not been accorded autonomous, self-standing status as contractual requirements. Their application is mediated through the rules of contract law; including the rule that a court may not enforce contractual terms where the term or its enforcement would be contrary to public policy. It is only where a contractual term, or its enforcement, is so unfair, unreasonable or unjust that it is contrary to public policy that a court may refuse to enforce it.

Dissenting judgments in the Constitutional Court

The first dissenting judgment was handed down by Judge Froneman (the Second Judgement), who noted that he would have upheld the appeal with costs.

He held that the regulation of unfairness in contract law involves judges making an underlying moral or value choice within the objective value system of the Constitution, but noted that further guidance should be provided on how these objective values can be translated into practical application. He suggested that this should be done by describing reasonably certain, practical and objective legal principles and rules to guide contracting parties and that this approach would be best achieved by recognising that South Africa’s law of contract has always taken account of the reasonable expectations of the parties to the contract as well as those of the wider community. This can be done in a manner that ensures objective, reasonable practicality and certainty.

A second dissenting judgment was handed down by Acting Judge Victor (the Third Judgment), who agreed with the finding made in the Second Judgment that the adjudication of fairness in contract cannot be plucked from a set of neutral legal principles.

The Third Judgment held that Ubuntu is an important constitutional value which stands alongside other values such as good faith, fairness, justice, equity, and reasonableness. Acting Judge Victor held that characterising Ubuntu as an adjudicative value in reaching substantive fairness between contracting parties will achieve a constitutionally transformative result, and that the recognition of Ubuntu in interpreting contracts will not undermine the concept of certainty and contractual autonomy.

Conclusion

The Beadica Case confirms that whilst the values of fairness, reasonableness and good faith may play a role in tempering unreasonable prejudice in contractual relationships, these values are not standalone rules that can be applied freely to undermine commercial and legal certainty. Public policy demands that contracts, freely and consciously entered into, must be honoured as this is crucial to ensuring certainty and promoting economic development. However, this still does not mean that striking a balance between the competing values of fairness, reasonableness and good faith versus ensuring legal certainty will be an easy task.

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