Local authorities beware: Scrutinise carefull the wording of the guarantees issued in your favour

The proper interpretation of a performance guarantee is the subject of a Supreme Court of Appeal judgment of 21 September 2007 which is of importance to the insurance industry and local authorities (Lombard Insurance Company Limited vs City of Cape Town). The guarantee was issued by Lombard Insurance Company Limited at the request of Labor Construction Company (Pty) Limited in favour of the Cape Metropolitan Council, the City of Cape Town's predecessor in title.

The sequence of events which led to the issuing of this guarantee was as follows:
During December 1999 the Council invited tenders for civil engineering construction works for the Cape Flats Waste Water Treatment Works, defined as contract number WW38/99.

On 13 January 2000 a joint venture consisting of Labor Construction and South African Focus Projects tendered to perform the works.

The tender was awarded to the Labor Construction/SA Focus Projects joint venture, subject to various conditions.

One of the conditions was the submission by the joint venture of an institutional guarantee.

On 10 February 2000 Labor Construction applied to the insurance company for the issue of an institutional guarantee in respect of the tender.

On 17 February 2000, the insurance company issued the guarantee in favour of the Council and undertook to pay the sum of R297 806,16, in the event of Labor Construction, among others, failing to proceed with and complete the works or being placed under provisional or final liquidation or judicial management.  In this guarantee Labor Construction was referred to as "the contractor" and the guarantee also recorded that Labor Construction had entered or was about to enter into a contract with the Council under contract number WW38/99. 

The joint venture parties concluded a written agreement between themselves on 26 May 2000.  Clause 5 of the joint venture agreement provided that Labor Construction would provide the financial resources for the execution of the work (including the institutional guarantee required in terms of the contract) and SA Focus Project would provide the management team and labour resources required on site.

During June 2000 the Council and the joint venture concluded a written civil engineering contract, where after the works commenced.  About a year later, Labor Construction was placed under provisional liquidation.  Consequently the Council demanded payment of the guaranteed amount from the insurance company.

The insurance company denied liability and the denial was in essence based on the following:

1.  The insurance company was under the impression that the council was going to conclude a contract with Labor Construction.
2.  The insurance company was not aware that the contract was in fact concluded with a joint venture.
3.  The guarantee only referred to Labor Construction and not to the joint venture and accordingly the insurance company contended that the

Council was not entitled to payment under the guarantee.

Faced with the denial of liability, the Council sued the insurance company, claiming payment of the guaranteed sum. 

The court had to decide whether the guarantee also covered the contract entered into by the Council and the joint venture in which Labor Construction was a partner.

The court concluded that the grammatical and ordinary meaning of the language of the guarantee was clear and unambiguous.  The insurance company guaranteed due performance by Labor Construction, in the event of Labor Construction being the contractor in a contract with the Council.  The court was in no doubt that the guarantee only covered Labor Construction and not the joint venture.  The court highlighted that the insurance company guaranteed the contractors obligations and the contractor was defined as Labor Construction.

The joint venture was in essence a partnership.  The court emphasised that the obligations of a partnership and those of the individual partners in their personal capacities are not, in the absence of an agreement, interchangeable. Even though the guarantee in question referred to a particular contract number (contract number WW83/99) and the joint venture concluded a contract with the Council under that contract number, that did not assist the Council.  The insurance company was providing a guarantee, in the event that Labor Construction concluded the contract.  Since the Councils contract was not with Labor Construction but with a joint venture, in which Labor Construction was just one partner, the conditions for payment under the guarantee were not triggered.

Black economic empowerment imperatives have resulted in more and more local authorities concluding contracts with joint ventures.  Local authorities (and other employers under building contracts) need to be careful that when they are provided with a guarantee, the guarantee is issued on behalf of the specific contracting party such as the joint venture or makes it clear that if it is issued on behalf of one of the joint venture partners the guaranteed amount becomes payable if that particular partner goes into liquidation.

Insurance companies also need to carefully read the guarantee policies that they issue when a claim is made.  If they make payment under a guarantee when the conditions for payment under the guarantee have not been triggered, the insurance company will not have any recourse against the client at whose instance the guarantee policy had been issued.

Aslam Moosajee, Director, Deneys Reitz Inc.