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South Africa: Long-held legal position on construction performance bonds may not be cast in stone

22 June 2022 | Project Finance

A long-standing legal position in South Africa’s construction industry is that the terms of an underlying construction contract is irrelevant to a court when deciding interdict proceedings in relation to payment under an on-demand performance bond. This position may not be cast in stone indefinitely, say construction law experts from African law firm Bowmans.

‘The position may well change in the near future, specifically where the contractor is trying to interdict the employer from making a demand for payment against the on-demand performance bond,’ says, Lize-Meré Ludick, partner at Bowmans.

‘It is in this instance, where the contractor seeks to interdict the employer before it makes a call, that the courts seem amenable to look at the terms of the underlying contract to establish whether or not calling on the bond would be a breach of contract,’ she says.

Currently, the South African position is that a call on an-demand bond or payment under a bond can only be interdicted where the contractor is able to show fraud by the employer, and any contractual disputes under the construction contract are irrelevant to the court, Ludick says.

‘In recent cases, however, contractors have argued that an interdict can be granted in instances other than fraud, more specifically where the employer would be breaching the terms of the underlying contract in doing so.’

This is premised on the fact that a party may generally interdict another party from breaching a contract.  This position has been taken by Australian and English courts where the matter relates to payment under on-demand bonds, although in restricted circumstances.

Local contractors take a leaf from Australian and English books

South African contractors have also considered the argument that an employer can be interdicted from calling on an on-demand bond if it can be shown that the employer would be breaching its contractual terms when doing so.

A recent example is ASJV v SANRAL, on which the Supreme Court of Appeal ruled in November 2020.

In this matter, the contractor tried to interdict the employer from making a demand under the on-demand performance bond on the basis that there should be an exception to the autonomy principle (where the rights and obligations under an underlying contract remain separate from those under an on-demand performance bond). 

The contractor argued that the employer did not comply with the contractual requirements for calling on the performance bond and would be in breach of the contract if the call was made.

Although the Court tested this view by considering the terms of the underlying contract, ASJV lost the matter because it was unable to show that the terms of the underlying contract expressly and clearly prohibited the employer from making a call for payment under the performance bond.

The SCA noted that implied terms were not sufficient in these matters, meaning that a contractual prohibition on the employer from calling on the bond in certain circumstances must be in unambiguous language, showing a clear and unequivocal breach by the employer.

‘The Court did, however, intimate that where the right set of facts presents itself, the Court should be willing to consider the terms of the underlying contract when deciding whether to interdict the employer from calling on the bond,’ says Ludick. ‘This is, of course, still subject to the wording of the bond.’

What employers and contractors should know

The possibility that South African courts may be willing to look at the underlying contract in interdict proceedings against calling under an on-demand bond has implications for employers and contractors alike.

‘Both parties should carefully consider the contract clauses dealing with entitlements to call on a performance bond and ensure these are drafted in consideration of the approach by the SCA,’ says Diana Burger, senior associate at Bowmans.

The approach would be different for contractors and employers respectively, she says.

‘An employer will likely want as few restrictions on these entitlements as possible and some may want to take out these contractual clauses completely,’ Burger explains.

In other words, rather than have any clause in the construction contract dealing with entitlement to call on the performance bond, the employer might prefer the terms to be set out only in the performance bond itself.

‘On the other hand, a contractor may want to propose that specific terms be included to clearly state that an employer may not call on the bond under certain circumstances,’ she says.

An example may be that an employer may not call on a bond where it has terminated the contract and the contractor disputes the termination. ‘However, such restrictions must be drafted carefully because some forms of restrictions may be of such a nature that the on-demand bond ultimately becomes a conditional bond, which is not the aim of this type of security.’

Clauses restricting the employer’s entitlement should not be construed as an intention to create a suretyship or other accessory obligation, says Burger. ‘There is a fine line between providing the restrictions in the underlying contract and ensuring that the performance bond remains autonomous and unconditional.’