A contractor’s guarantee is a specialised written undertaking in favour of the party who has employed a contractor to work on a construction project.
Essentially, a financial institution such as an insurance company or a bank, will guarantee to make certain payments on behalf of a contractor if the contractor fails to perform its obligations to the employer in terms of the construction contract. This kind of guarantee is often required by construction contracts so that the employer can use the payout from the guarantee to fund the completion of the building project, if the contractor is unwilling or unable to complete their work. Construction guarantees create a triangular relationship. The employer signs a construction contract with the contractor, which is guaranteed by a financial institution. In exchange, the contractor provides security to the financial institution in case it has to pay out the guarantees to the employer.
Various kinds of guarantees
There are various kinds of guarantees that can be used:
• Performance guarantees, which allow the employer to recover costs incurred if the contractor fails to perform their tasks in terms of the building contract
• Retention guarantees, which act as a safeguard against latent defects and to incentivise completion of the contract
• Advance payment guarantees, which are used when the main contract provides for advance payment to be made to the contractor. This guarantee ensures that the employer’s advance payment will be refunded if the contractor fails to complete its work.
In many occasions, examples of multiple guarantees can be found together, such as in the case of Joint Venture between Aveng (Africa) (Pty) Ltd and Strabag International GmbH v South African National Roads Agency SOC Ltd and another [2019[ 3 All SA 186 (GP), where the contractor was required to obtain guarantees both for performance
and retention money. In this case, the contractor cancelled the contract claiming that it was impossible to complete the contract due to external circumstances. The court found that the employer, SANRAL, was correct to view this cancellation as backing out of the contract (as it was not impossible to complete the contract under the circumstances) and SANRAL was permitted to call up the guarantees.
Trigger events that enforce the guarantee
The contractual terms of the guarantees entered into between the contractor and the financial institution are different depending on the terms of the original construction agreement signed by the employer and the contractor. Often the guarantee will depend on certain “trigger events” that will give the employer the right to enforce the guarantee. An example of this can be found in the case of Lombard v Landmark and others [2009] All SA 322 (SCA), where the guarantee would be triggered by either the liquidation of the contractor or the contractor defaulting to the extent that the employer cancelled the construction contract. In this case, the contractor was liquidated and the guarantee was paid out. Another point worth noting from the SANRAL case (cited above) is the confirmation that if there is no fraud involved, a contractor cannot challenge a construction guarantee being paid out by the financial institution. Even if there are outstanding contractual disputes between the contractor and the employer in terms of the main construction contract, the financial institution is obliged to make payment in terms of the guarantee once it has been triggered.
While the content of the original construction contract will, in most cases, be useful in interpreting the guarantees, the construction guarantees are separate, stand-alone agreements. For example, in Lombard Insurance Company Limited v City of Cape Town [2008] 2 All SA 400 (SCA), a contract was awarded to a joint venture of two contractors through a tender process. A condition of this construction contract was an institutional guarantee. A guarantee was requested by and issued to only one of the contractors without informing the insurer of the existence of the joint venture. When the second contractor was liquidated, the employer tried to claim in terms of the guarantee, but the insurer successfully argued that the wording of the guarantee did not cover the actions of the uninsured joint venture partner as the second contractor was never mentioned.
A financial institution issuing a construction guarantee will usually request a guarantee from the contractor (often including a suretyship from its members or directors) to recover any funds paid out to the employer in terms of the guarantee. In Lombard v Landmark (cited above), the insurance company, Lombard, paid out the guarantee after the contractor’s liquidation and then called up its own security against Landmark and two sureties, which was disputed. The court found that once the “trigger” liquidation occurred, Lombard had an obligation to pay the employer in terms of the guarantee and once this happened, the parties who undertook to indemnify Lombard were liable to make payment to Lombard.
Contractor’s guarantees do not need to be complicated, but they are fundamental to any building project. All parties involved in the project must ensure that they understand their rights and obligations so that the proper guarantees can be put in place. PJ Veldhuizen is an attorney at Gillan & Veldhuizen Incorporated and Peter Williams is a director and
chartered insurance practitioner at Phoenix Risk Solutions.
By: PJ Veldhuizen is an attorney at Gillan & Veldhuizen Incorporated and Peter Williams is a director and chartered insurance practitioner at Phoenix Risk Solutions.
