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Performance Guarantees in Shipbuilding Agreements

13 May 2014
– 2 Minute Read


A common feature of shipbuilding agreements is the requirement that parties provide guarantees from third-party institutions – such as banks or insurers – as security for the performance of their respective obligations under the contracts in question. The legal nature and practical effect of this type of security are routinely a source of dispute and litigation internationally, often as a result of the uncertainty introduced by the way in which contracting parties choose to name the instrument (eg, bonds, guarantees or performance security). The recent Supreme Court of Appeal case of Guardrisk Insurance Company Ltd v Kentz (Pty) Ltd provides a fresh opportunity to summarise the approach of the South African courts.

What must be determined first is whether the guarantee is ‘conditional’ or ‘on demand’. The essential difference between the two is that the party making a claim under a conditional guarantee is required, at a minimum, to allege and – depending on the terms of the guarantee – establish liability on the part of the non-performing party for the same amount. An on-demand guarantee requires no allegation of liability on the part of the non-performing party. All that is required for payment is a demand by the claimant, stated to be on the basis of the event specified in the guarantee.

The guarantee type depends on the terms of the document, as interpreted by the courts. For example, a guarantee will normally be found to be on demand where it records that the guarantor’s liability, as principal, is absolute and unconditional and cannot be construed to create an accessory or collateral obligation. Another relevant factor is whether the guarantee records that the guarantor may not delay in making payment by reason of a dispute between the parties to the underlying contract.

An exception to the guarantor’s obligation to pay arises in the event of fraud. If a beneficiary makes a call on a guarantee knowing that it is not entitled to payment, the courts will step in to protect the provider of the guarantee and refuse to order its enforcement.