The Supreme Court of Appeal recently considered the case of Coface South Africa Insurance Co Ltd v East London Own Haven t/a Own Haven Housing Association regarding the consequences of the cancellation of a construction contract where a construction guarantee has been executed.

The Respondent instituted an action against the Appellant, an insurance company, claiming payment of an amount owing in terms of a construction guarantee.

This followed the cancellation of a construction contract by the Respondent, ostensibly because of default on the part of a building contractor.

The construction contract had been concluded between the Respondent and the contractor and provided for the completion of building works.

By convention, the construction contract required the contractor to execute a construction guarantee in favour of the Respondent, in terms of which a guaranteed sum would be paid to the Appellant upon cancellation of the construction agreement on the basis of default by the contractor.

Such a guarantee was executed by the Appellant in favour of the Respondent and in terms thereof the Appellant guaranteed payment by it to the Respondent of the guaranteed sum. The Appellant undertook to make payment upon receipt of a first written demand.

The Respondent’s cancellation of the construction contract called up the construction guarantee. The Appellant refused to honour it claiming that the cancellation was not the result of the default of the contractor but that of the Respondent.

The court held that the construction guarantee had to be honoured save in cases where it had been established that the claim was tainted by fraud on the part of the claimant. The claim was therefore completely independent of any dispute that might exist in terms of the principal construction contract. The court consequently found that the Appellant was liable to make payment to the Respondent.

This decision confirms the principle that on-demand guarantees oblige the guarantor to make payment upon demand in terms of the guarantee.  The guarantor may, therefore, not avoid or delay payment citing a dispute between the contractor or supplier and employer in whose favour the guarantee was issued.

The importance of this decision is also seen in that it applies to all guarantees and not only construction guarantees and in this regard affirms general contractual certainty.

Written by Molisa Cheda.