Typically in construction projects, the construction contractor appointed by the developer to construct the project works will be required to provide security in favour of the developer for the performance of its obligations under the construction contract. The security so provided is inter alia in the form of a construction guarantee issued by a bank or financial institution in favour of the developer, on behalf of the construction contractor.

A construction guarantee is essentially a written undertaking by the issuer to pay money on presentation of a written demand for payment, together with such other documents as may be specified in the guarantee.

The Supreme Court of Appeal has, on numerous occasions in recent times, been called upon to consider the legal nature of construction guarantees in South African law, and was again called upon to consider the legal nature of two construction guarantees in the matter of The Minister of Transport and Public Works, Western Cape v Zanbuild Construction (68/2010) ZASCA 10 (11 March 2011). The facts of the matter, briefly stated, were as follows: two independent, substantially similar, guarantees were issued by Absa Bank Limited (Absa) in favour of the Western Cape Department of Transport and Public Works (Department), as security for the obligations of Zanbuild Construction (Proprietary) Limited (Zanbuild) under two separate construction contracts entered into between Zanbuild (as the construction contractor) and the Department (as the developer) (Contracts). The Guarantees provided inter alia that, "the bank [Absa] reserves the right to withdraw the guarantee after the employer [the Department] has been given 30 (thirty) days written notice of its intention to do so, provided the employer shall have the right to recover from the bank the amount owing and due to the employer by the contractor [Zanbuild] on the date the notice period expires."

Absa notified the Department in writing that it wished to withdraw the Guarantees, and that each of the Guarantees would be cancelled thirty days from the date of the written notice, whereafter no further claims or payments would be considered by Absa. Upon receipt of Absa's notice, the Department demanded immediate payment of the full amount of both Guarantees citing, as its basis for such demand, that Zanbuild was in default under both Contracts.

Zanbuild, in the Western Cape High Court, applied for an interdict preventing the Department from claiming, and Absa from paying, the amounts claimed under the Guarantees. The interdict was granted with leave to appeal to the Supreme Court of Appeal.

On appeal, Zanbuild's contention was the Guarantees were not "on-demand guarantees" but rather "conditional guarantees" and argued that Absa's liability under the Guarantees was akin to a suretyship relationship in that the Guarantees were inextricably linked to the Contracts. As such, Zanbuild argued, Absa's liability under the Guarantees was limited to the extent that the Department can demonstrate a monetary claim against Zanbuild under the Contracts prior to the withdrawal of the Guarantees. The Department, on the other hand, argued that the Guarantees were in fact on-demand guarantees and that all that was required from the Department in order to obtain payment of the full amount of the Guarantees, was to demand payment under the Guarantee and provide a statement to Absa that Zanbuild was in default under the Contracts.

The pertinent question before the Court was thus whether or not Absa's liability under the Guarantees was limited to Zanbuild's liability under the relevant Contract, or whether Absa's liability was for the full amount of the Guarantees, payable on demand by the Department.

The Court remarked that the question as to whether or not a guarantee is conditional or on-demand is dependent on the interpretation of the terms of the guarantee concerned, and found that, on its interpretation of the terms of the Guarantees, the Guarantees were not on-demand but rather conditional guarantees. The reasons for the Court's finding were inter alia as follows: firstly, the Court held that the language and content of the Guarantees were akin to suretyships in that the Guarantees provided that they were provided as "security for the compliance of the contractors [Zanbuild] performance of obligations in accordance with the contract" and the "due and faithful performance by the contractor [Zanbuild]," and secondly, the Guarantees provided that "with each payment under this guarantee the bank's [Absa's] obligation shall be reduced pro rata". As such, the Court held, this was a clear indication that the Department's interpretation of the Guarantee (i.e. that any default of Zanbuild under the Contracts irrespective of liability on the part of Zanbuild would render the full amount of the Guarantees payable) was clearly incorrect, as if this interpretation were correct, there would be no need for multiple draw downs on the Guarantees.

The Court consequently held that as the Department had failed to establish that, prior to the withdrawal of the Guarantees by Absa, the amounts claimed by the Department from Absa were due to it by Zanbuild, the Department was not entitled to demand payment under the Guarantees from Absa and dismissed the Department's appeal.

Regardless of whether or not the Court's interpretation of the Guarantees is correct, it is likely that that the decision in the Zanbuild case will cause some confusion as to the legal nature of construction guarantees in South African law, and in light of this decision, prudent developers should ensure that the language of the documents purporting be on-demand construction guarantees do in fact entitle them to claim amounts owing by construction contractor employed by them, on demand. A failure to do so could potentially result in them having no claim under the construction guarantee concerned.

Written by Mike Mclaren, Senior Associate and Kerry-Lee Carew, Associate, Finance, Projects and Banking Practice, Cliffe Dekker Hofmeyr