Can a guarantee payable on demand be called up even though the contractual debt forming the basis of the guarantee has become prescribed? The Pretoria High Court decided this question in Investec Bank Ltd v Lombard Insurance Company and Another (2019) ZAGPPHC (251), in June 2019.
Investec Bank Ltd (“Investec”) entered into an agreement for the sale of immovable property to Esor Uitvlugt (Pty) Ltd (“Esor”). The agreement required Esor to improve the property by installing internal services to the value of R20 million by certain dates (“the obligation”). To secure Esor’s performance, the agreement required that Esor provide a guarantee payable on demand (“demand guarantee” or “performance guarantee”), in favour of Investec, for the due and proper performance of Esor’s obligation.
A demand guarantee or performance guarantee is a form of security for one party to a contract, to guarantee due performance by a second party. In the event that the second party does not perform according to specifications in the contract, the first party can call upon the guarantor to pay a certain amount as compensation. The second party contracts with the guarantor to issue the guarantee and undertakes to repay the guarantor should the guarantee be called up.
Esor had approached Lombard Insurance Company Ltd (“Lombard”) to issue a performance guarantee in favour of Investec (“the Guarantee”). The Guarantee provided that Lombard undertook to pay Investec the guaranteed sum upon receiving written notice from Investec that Esor had defaulted in performing its obligation.
When Investec demanded payment under the Guarantee from Lombard, on 14 August 2018, more than three years had elapsed after Esor’s default on its obligations under the contract. This default had triggered Investec’s right to call for payment of a portion of the guaranteed amount. The argument on behalf of Lombard was that Investec’s right to call up that portion of the guaranteed amount had become prescribed three years after Esor’s default on its debt under the contract, in other words that prescription of Lombard’s debt under the Guarantee and prescription of Esor’s debt under the contract ran simultaneously.
The Court held that the Guarantee was a true demand guarantee and not a suretyship, as argued on behalf of Lombard. Lombard’s debt under the Guarantee existed independently from Esor’s debt under the contract. Esor’s right to rely on the defence of prescription in respect of its debt under the contract was therefore not available to Lombard.
The running of prescription is determined by s12(1) of the Prescription Act, No 68 of 1969, which provides that prescription will commence to run as soon as a debt is due. Lombard’s debt under the Guarantee became due when Investec gave notice to call for payment under the Guarantee. Because the parties had agreed that the giving of notice is a condition precedent for a claim, the running of prescription only commenced when Investec gave notice that it is claiming payment from Lombard under the Guarantee.
The Court also considered the following provision in the Guarantee:
“This guarantee … shall remain valid until the Purchaser’s obligations in terms of Clause 7 have been fulfilled under the Agreement or upon payment of the Guarantee in terms of this agreement.”
The Court held that this means the Guarantee would only lapse when one of two scenarios occurred, either when Esor had discharged its obligation, or when Lombard had made payment under the Guarantee.
Consequently, the Court held that the claim under the Guarantee had not become prescribed, despite the fact that more than three years had passed since the date when Esor defaulted on its obligation under the contract.
It should be noted that the specific contractual terms of a guarantee will be decisive. If it is clear that the parties had agreed that payment under the guarantee only becomes due upon demand, the date of demand is when prescription will begin to run in respect of the guarantor’s obligation to pay.