ENSafrica Construction ENSurance
recent influential court decisions and what they may mean for your business
Introduction
We are delighted to present you with this booklet on Construction Insurance topics with reference to judicial decisions made in 2019 and 2020. Although many of these decisions originate in the United Kingdom, Australia and Canada these are worth paying attention to as they may prove to be influential on future decisions made by South African courts.
We have selected five topics and we provide our expert analysis and commentary in respect of each one. The five topics and the judicial decisions to which they relate, serve to demonstrate the significant interconnectedness between the fields of construction and insurance law. The selected topics are:
- The status of interim payment certificates on cancellation of a construction contract and implications for construction guarantees and guarantee insurers.
- Coverage implications for insurers in a construction contract in circumstances where the construction all risks insurance policy and the reinsurance policy are not back-to-back.
- Contractual liability exclusion clauses in liability insurance cover, including construction all risks covers.
- The rectification of an on-demand construction performance guarantee issued by an insurer and the doctrine of strict compliance.
- The controversial defective workmanship exclusion in construction all risks insurance policies.
While this is not intended to be a reference work, we do hope that it will be useful to those in the construction and insurance industries.
Part One | The status of interim payment certificates on cancellation of a construction contract and implications for construction guarantees and guarantee insurers
In a recent 2019 decision of the South African Supreme Court of Appeal (SCA) in Intech Instruments v Transnet Limited t/a South African Port Operations, the court ruled that the cancellation of a construction contract rendered interim or provisional payment certificates, issued in terms of the construction contract, to be of no force and effect. In doing so, the court recognised and followed a previous decision it made some 32 years ago in the matter of Thomas Construction (Pty) Limited (in liquidation) v Grafton Furniture Manufacturers (Pty) Limited.
The SCA held: ‘Where a client lawfully terminates a construction contract, as is the case here, the Contractor’s claim for retention monies and unpaid invoices are not self-standing claims, separate and independent from the remainder of the contract. And, upon such termination, the interim certificates ceased to be of any force and effect. They cannot sustain a basis for payment where there can be, in view of the cancellation, no further expectation of a completion of the works’.
Comment and analysis
The decision is based on the principle, well described by the SCA, in the 2016 decision of Nurcha Finance Company (Pty) Limited v Oudtshoorn Municipality, in the following terms: ‘… that payment ultimately depends on the delivery of a finished product of work’ such that ‘Cancellation of the contract strikes at the very foundation of the claim and therefore debars a claim based upon the interim payment certificate’.
The principle will apply in all instances, subject to any contrary provision in the underlying construction contract between the employer and the contractor. For instance, a clause to the effect that an interim certificate will remain of force and effect, notwithstanding a cancellation of the contract. In this matter, the contract was based on the standard form General Conditions of Contract wording, which does not serve to preserve the enforceability of an interim payment certificate beyond a cancellation of the underlying construction contract. The position is the same in relation to the standard form JBCC contract.
This principle and the consequence of a cancellation of an underlying construction contract in relation to the validity and enforceability of an interim payment certificate, is often forgotten. However, it has important consequences for contractors following the cancellation of a construction contract.
This principle means that, following a cancellation of a construction contract, a contractor is not able to sue the employer based on the interim certificate, and the contractor’s only available remedy is to sue the employer for contractual damages.
Implications for guarantees
This principle also has implications for insurers in relation to demands for payment in terms of on-demand insurance construction guarantees, as such demands very often follow a cancellation of an underlying construction agreement. By virtue of the operation of this principle, a guarantor, faced with a demand from the employer in terms of a performance guarantee, is unable to take cession of a contractor’s claims for payment under interim payment certificates, in order to defend the claim on a performance guarantee on the basis of set-off.
An interesting question arises in this context in relation to on-demand payment guarantees (as opposed to performance guarantees). In terms of a payment guarantee, the guarantor undertakes to pay the contractor the sum certified as payable in terms of a payment certificate issued to the contractor pursuant to an underlying agreement. What then is the guarantor’s obligation to the contractor following a demand for payment by the contractor, when the employer cancels the underlying construction agreement?
The South African law, as it currently stands relative to on-demand guarantees, is that the obligation established in a guarantee is wholly independent of the underlying contract (known as the autonomy principle), and it is only where fraud is involved that the guarantor may decline liability. Accordingly, a court would be likely to disregard the cancellation of the underlying construction agreement, and to order payment in terms of the payment guarantee, notwithstanding this established principle.
This scenario also brings to the fore the following broader and contentious issues (which coincidentally have become relevant considerations in recent matters):
THE CONTINUED VALIDITY OF A PERFORMANCE GUARANTEE – NO EXPIRY DATE
The continued validity of a performance guarantee having no expiry date (as is very often the case), in circumstances where the underlying construction contract is completed such that the parties have, in terms of that contract, no further rights and obligations relative to performance. In some instances demands for payment are being made a number of years after the completion of a contract. The implication for guarantee insurers is that they are then compelled to reopen reserves in order to provide for such claims long after the completion of projects. This in the context of some guarantee insurers and reinsurers having discontinued the product, which has reduced the capacity of the insurance market to supply the guarantee product.
THE VALIDITY OF A GUARANTEE – THE UNDERLYING CONSTRUCTION CONTRACT
The validity of a guarantee in circumstances in which it becomes apparent that the underlying construction contract was subject to an initial impossibility of performance, and as such is void or unenforceable. This question arose in a recent 2019 decision of the South Gauteng High Court in Transnet SOC Limited v ABSA Insurance Company Limited and Others. After emphasising the principle that a performance guarantee is wholly independent of the underlying contract, the court ruled that ‘Whether or not the underlying contract exists in an enforceable form or not and whether or not a beneficiary is actually entitled to be paid under the underlying construction contract has no bearing on the matter’. In the court’s view ‘the only concern … is to determine whether or not in terms of the demand document, the allegations required by the performance guarantee are contained in the document’.
Serious consideration ought to be given to whether these circumstances should not serve, as is the case with the fraud defence, as exceptions to the autonomy principle. The question is, more specifically, whether it is reasonable and in conformance with public policy that in these instances the autonomous nature of on-demand guarantee should continue to trump commercial reality? There is, in this regard, authority that may be drawn on not only in the English law in relation to letters of credit, but also in the South African law in relation to negotiable instruments, such instruments not being unlike on-demand guarantees.
In our view, this is an issue that needs to be carefully considered and decided upon by the SCA.
By Rob Scott and Zara Sher
Published in its entirety with the kind permission of ENS Africa, Mr Rob Scott and Ms Zara Sher. The entire Booklet in its original format is also available on ENS Africa’s web page at:
https://www.ensafrica.com/uploads/newsarticles/0_ensafrica%20insurance%20newsletter%20final.pdf
