Co-authored by Jos Fogle – Candidate Attorney
On 4 June 2024, the Supreme Court of Appeal held that a settlement agreement between a beneficiary and a guarantor does not give the principal debtor the right to challenge the guarantor’s payment to the beneficiary.
Construction work was subcontracted to a contractor by the beneficiary. The contractor was required to provide an on-demand performance guarantee in favour of the beneficiary. A few years later, the beneficiary demanded the full guaranteed amount from the guarantor. The first demand was based on a higher and incorrect contract amount and the guarantor refused to pay.
The beneficiary sued for the amount. The guarantor’s primary defence for not honouring the demand was that the demand was fraudulent because the guaranteed amount should have been reduced. Affidavits were exchanged and, based on the strength of the beneficiary’s claim, and the indemnity executed in favour of the guarantor by the contractor; the guarantor decided to serve third party notices on ten third parties who gave indemnities for the debt. The third parties opposed the relief claimed against them and sought to prevent the guarantor paying.
The contractor was subsequently liquidated and would no longer actively pursue the claim against the beneficiary. The guarantor determined that it was in its best commercial interests to compromise and settle the beneficiary’s claim because it could not advance a fraud defence that it had no personal knowledge of. and the party that did have personal knowledge, the contractor, was no longer opposing the main application.
The third-party indemnity providers had not taken any procedural steps to advance their defences against the claims against them to reimburse the guarantor when the settlement agreement was reached and made an order of court. The third parties contended that the settlement agreement deprived them of their right to defend the validity of the beneficiary’s claim.
The court explained that fraud only affects a contract where the fraud is raised by one of the parties to the contract. The guarantor’s claim against the third parties was based on the indemnity executed by the third parties who did not allege or prove fraud on the part of the guarantor in relation to the indemnities claims. The performance guarantee was a contract between the beneficiary and the guarantor and not with the contractor or the third parties.
The court held that the third parties were vested with certain procedural rights when they were joined as third parties, and they should have invoked those rights. One of these rights provided the third parties with the opportunity to contest the claim of the beneficiary; because the third parties failed to pursue this right there was no connection between the third parties and the beneficiary. As third parties, they had no right to contest the guarantor’s agreement to pay the beneficiary.
Claims against the third parties to indemnify the guarantor were granted in favour of the guarantor.
The judgment demonstrates that a compromise between a beneficiary and guarantor will not prejudice the procedural rights of a third party to contest the right of the beneficiary to claim under the guarantor if fraudulent. Third parties are vested with procedural rights when they are joined as third parties and they must make use of their right to challenge the beneficiary’s right to the proceeds of the guarantee, timeously. Failure to do so may result in a similar outcome as this judgment.