SOUTH AFRICA: SUPREME COURT OF APPEAL ACTS TO PROTECT LENDING TRANSACTIONS WITH ORGANS OF STATE

By Claire Tucker Wednesday, October 19, 2022
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The post-State Capture era in South Africa has seen a large number of ‘self-reviews’ by organs of state.  These involve the organ of state concerned approaching the courts to set its own past decisions aside on the basis that these were unlawfully concluded by past incumbents of senior positions.

While such ‘self-reviews’ are an important corrective action for past abuses, they raise concerns for those in the private sector, including lending institutions, who contracted innocently with these institutions.  

Innocent third parties

The Supreme Court of Appeal (SCA) was again called upon to consider the ‘just and equitable’ remedy in such contexts in Central Energy Fund SOC Ltd and Another v Venus Rays Trade (Pty) Ltd and Others (Case no 119/21) [2022] ZASCA 54 (13 April 2022) – a successful application by the Central Energy Fund SOC Ltd (CEF) and the Strategic Fuel Fund Association NPC (SFF) to the Western Cape High Court to review and set aside certain decisions taken in 2015 and 2016. The decisions concerned the rotation of South Africa’s strategic stock of some 10 million barrels of crude oil (strategic stock) and the transactions undertaken by SFF and the CEF.

These transactions were undertaken without proper internal authority and involved the sale of the strategic oil stock to various third-party oil companies. While certain of the third parties were shown to have engaged in corrupt activities related to the transactions, the matter before the SCA concerned the position of those who were shown to have been entirely innocent of any wrongdoing.  The High Court, in setting aside the relevant transactions had ordered that SFF/CEF to pay ‘out of pocket’ expenses incurred by these innocent parties.  The CEF/SFF took this portion of the judgement on appeal to the SCA.

The out-of-pocket expenses in question were, for the most, part financing and hedging costs which were incurred by the oil companies in opening lines of credit to support their purchases and hedging their exposures.  The SCA was scathing in assessing the argument put forward by the CEF/SFF against it being ordered to pay these expenses:

‘As the appellants would have it, innocent third-party financiers such as Contango and Natixis, are required to incur significant losses when the State acts unlawfully, even when they are given assurances by the state entity concerned, and take steps to secure the loans. If these are indeed the risks involved in providing credit, then there is a real danger that it will have a chilling effect on financing, which may become prohibitively expensive. International banks and finance institutions would be reluctant to finance major transactions – crucial to the economy – not only in oil but also in infrastructure and capital projects. Accordingly, the compensation order in this case… serves the broader public interest.’

The SCA confirmed that the approach to innocent third parties is that, although innocent parties are not entitled to benefit from an unlawful contract, they are not required to suffer any loss as a result of the invalidation of a contract.

The SCA also specifically considered the public interest to be served by ensuring that innocent financial institutions supporting state lending should not be adversely affected if the decisions supported are set aside: ‘The public interest is adversely affected if creditors cannot safely finance transactions with organs of state, and are constantly at risk of incurring losses if it turns out that the State acted unlawfully.’

Other case law

This approach by the SCA confirmed the position In Altech Radio Holdings (Pty) Limited and Others v City of Tshwane Metropolitan Municipality 2021 (3) SA 25 (SCA), where the conduct by the state parties (in delaying bringing the self-review as well as their assurances that they intended to honour the transaction concerned and that all internal formalities had been complied with) was considered important in considering the just and equitable remedy and ensuring no loss was suffered, particularly by third party financial institutions relying on the assurances.

In City of Tshwane Metropolitan Municipality v RPM Bricks (Pty) Ltd [2007] ZASCA 28; 2008 (3) SA 1 (SCA) paras 11-12, the SCA also confirmed the principle previously enunciated by it that a person contracting with an organ of state in good faith is entitled to assume that the latter has complied with its internal arrangements and formalities.

The importance of warranties

These judgements confirm the importance of seeking warranties in relation to authority from state parties and of seeking specific assurances from state parties where this appears uncertain in a transactional context.  This is notwithstanding the fact that, as a pure contractual matter, the warranties may be set aside when the contract itself is set aside. Such assurances assist in obtaining a just and equitable outcome from the courts if the contract is ultimately set aside due to unlawfulness on the part of the state parties.