The National Credit Act regarding suretyships And Reckless lending pn stoop



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the National Credit Act REGARDING Suretyships And Reckless LENDING

PN Stoop*

M Kelly-Louw**



  1. Introduction

The provisions that prohibit reckless credit granting form part of the measures that were introduced by the National Credit Act1 with the aim of resolving the problem of over-indebtedness and preventing reckless credit lending. In terms of section 81(2) of the National Credit Act a credit provider may not enter into a credit agreement with a consumer without first taking reasonable steps to assess the consumer’s debt re-payment history, existing financial means, prospects and obligations, his understanding of the risks and costs of the proposed credit, and his rights and obligations under a proposed credit agreement. The credit agreement will be reckless in terms of the National Credit Act if the credit provider fails to conduct this assessment, irrespective of the outcome of the assessment. It seems that a practice of not conducting this assessment has evolved amongst certain credit providers where the credit agreement involved is a suretyship agreement. This article investigates whether or not a suretyship agreement is a credit agreement for the purposes of the National Credit Act; what the definition of a credit guarantee set out in section 8(5) encompasses; and if a section 81(2) assessment should be conducted in the case of a suretyship agreement.

2 Is a suretyship agreement a credit agreement in terms of the National Credit Act?

2.1 What is a credit guarantee?

The National Credit Act provides, subject to certain exemptions, that the Act generally applies to every credit agreement (eg, money-lending transactions irrespective of the amount) between parties dealing at arm’s length and made or having an effect in South Africa.2 The National Credit Act defines the word "credit" when used as a noun as: "a deferral of payment of money owed to a person, or a promise to defer such a payment; or a promise to advance or pay money to or at the direction of another person".3 The Act also defines a "credit agreement" in section 8 and states that it includes a "credit facility"4 or a "credit transaction";5 or a "credit guarantee";6 or any combination of these.7

It is imperative to know whether a suretyship agreement is a credit agreement in terms of the National Credit Act because a suretyship agreement is an important tool that credit providers use in limiting the risk of granting credit – a third party provides surety to pay where the original (principal) debtor fails to pay.8 Non-compliance with the provisions of the National Credit Act in respect of suretyship agreements can have serious consequences for credit providers, if the Act does, in fact, apply to such agreements.

It is therefore essential to analyse the definition of a "credit guarantee". A "credit guarantee" is defined as follows in section 8(5):

An agreement, irrespective of its form but not including an agreement contemplated in subsection (2), constitutes a credit guarantee if, in terms of that agreement, a person undertakes or promises to satisfy upon demand any obligation of another consumer in terms of a credit facility or a credit transaction to which this Act applies.

In terms of subsection 2, referred to in the definition, no agreement is a credit agreement if it is a policy of insurance or credit extended by an insurer solely to maintain the payment of premiums on a policy of insurance, if it is a lease of immovable property, or if it is a specific stokvel transaction.9

It may be argued that the definition of a credit guarantee is not reconcilable with the definition and characteristics of a common-law suretyship (ie an accessory guarantee), but that it refers rather to a primary guarantee, such as a demand guarantee or letter of credit, and that the National Credit Act therefore does not apply to a common-law suretyship.10 Contrary to accessory guarantees (eg, suretyships), primary guarantees, such as demand guarantees and letters of credit, create primary obligations which are not dependent on the existence of a principal debt.11 Therefore, the definition and nature of a contract of suretyship (ie, accessory guarantee) and primary guarantees should be examined.

2.2 What is a suretyship?

2.2.1 General

"Guarantees are usually taken to provide a second pocket to pay if the first should be empty".12 Guarantees and indemnities, which are also described as "securities", are distinct arrangements in terms of which a third party – the surety (guarantor) – agrees to assume liability if the debtor defaults or causes loss to the creditor. The former arrangement is a traditional guarantee (suretyship) and the latter involves an indemnity.13 Therefore, a guarantee is usually issued to cover a credit agreement or transaction; in other words, the guarantee is issued as financial security by a third party in favour of the creditor.14

In South African law the words "guarantee" and "suretyship" have often been referred to as synonyms and have been referred to interchangeably by legal writers and courts alike. For instance, sometimes the word "guarantee" or variants of the word are used when suretyship is meant. At other times the word "guarantee" is meant to be used as a verb and the meaning is then more straightforward. In recent years this practice of using the words "guarantee" and "suretyship" synonymously and interchangeably has been criticised. However, the practice is ingrained in the South African law reports and will be difficult to eradicate.15 It is not our intention to attempt to describe the exact differences between the words "guarantee" and "suretyship", nor is it our intention to distinguish between the "suretyship" and the "indemnity contract".16 The generic term "guarantee" can comprise two very different devices: (1) the primary guarantee (ie, the demand guarantee, which is also known as the performance guarantee/bond or the independent guarantee) or letter of credit, and (2) the secondary (or accessory) guarantee (ie, the suretyship guarantee or the traditional guarantee). However, as demand guarantees and letters of credit (including standby letters of credit) are also sometimes regarded as either forms of guarantees, particularly contracts of suretyship,17 or closely related to them, but with distinct characteristics,18 it is important for current purposes to distinguish the demand guarantee, the commercial letter of credit and the suretyship guarantee from one another. From the discussion below, it will be seen that the demand guarantee is unique in character and actually stands between the suretyship guarantee (where the undertaking to pay is secondary both in intent and in form - ie, it is accessory to the principal debt) and the commercial letter of credit (where the undertaking to pay is primary both in form and intent), in the sense that, it is secondary in intent but primary in form (ie, the guarantor has a secondary intent to pay, but the payment obligation is primary in form).

It should also be borne in mind that it is always a question of construction, whether a particular contract is an accessory (secondary) guarantee (eg, suretyship) or a primary guarantee (eg, a demand guarantee or letter of credit).19

2.2.2 Defining the accessory guarantee (suretyship guarantee)

The Roman law and the Roman-Dutch common law required no formalities regarding contracts of suretyship.20 Initially, it was not necessary, for a contract of suretyship to be valid, that it should take a specific form or be embodied in writing.21 This position was later changed by legislation. Today, section 6 of the General Law Amendment Act22 requires that the terms of a contract of suretyship must be embodied in a written document signed by, or on behalf of, the surety, in order for it to be valid and enforceable in the South African law.23

Unfortunately, section 6 neglected to define what a contract of suretyship was.24 The early and classical jurists also did not clearly define the contract of suretyship.25 Although some Roman-Dutch jurists tried to offer a definition, none of them could offer an exact definition of the suretyship.26 The lack of a legislative definition or any other proper definition of the suretyship led to disagreements among South African jurists.27 The courts also tried to formulate definitions.28 For instance, in Corrans v Transvaal Government and Coull’s Trustee29 Innes CJ said that the definitions of the old authorities came to this, namely

that the undertaking of the surety is accessory to the main contract, the liability under which he does not disturb, but it is an undertaking that the obligation of the principal debtor will be discharged, and, if not, that the creditor will be indemnified.

Eventually, Forsyth and Pretorius provided a well-drafted definition of the suretyship. They define the suretyship as an

accessory contract by which a person (the surety) undertakes to the creditor of another (the principal debtor), primarily that the principal debtor, who remains bound, will perform his obligation to the creditor and, secondarily, that if and so far as the principal debtor fails to do so, the surety will perform it or, failing that, indemnify the creditor.30

Their definition of suretyship has since been supported by the Appellate Division (as it was known then).31 According to them, the fact that the surety’s obligation is an accessory obligation, simply means that in order to constitute a valid suretyship between surety and creditor, there has to be a valid principal obligation between the debtor and the creditor. The suretyship is said to be accessory to the transaction that creates the obligation of the principal debtor. In other words, every suretyship is conditional upon the existence of a principal obligation. Therefore, in the absence of a valid principal obligation, the surety is generally not bound and the surety can raise any defence that the principal debtor can raise.32

In the English law a "guarantee" is defined as a promise to be liable for the debt, or failure to perform some other legal obligation, of another person.33 The person to whom the promise is made, for example a bank, may be called the "creditor", the person who makes the promise is the surety or guarantor, and the other whose obligation is guaranteed, for example, the bank’s customer, is the principal debtor.34 A true guarantee obligation (eg, suretyship) is secondary and accessory to the obligation, the performance of which is guaranteed; and the surety (or guarantor) undertakes that the principal debtor (the bank’s customer) will perform his (the principal debtor’s) obligation to the creditor (the bank) and that he (the guarantor or surety) will be liable to the creditor if the principal debtor does not perform. The guarantor’s (the surety’s) liability for the non-performance of the principal debtor’s obligation is therefore co-extensive with that obligation. This means that if it turns out that the principal debtor’s obligation does not exist, is void, discharged or diminished, the guarantor’s (the surety’s) obligation in respect thereof is also. This is contrary to the situation where a primary or direct undertaking, such as a demand guarantee or letter of credit, has been given to perform the customer’s obligation. If the undertaking is of this nature, then the promise will be enforceable whether or not that of the principal debtor is enforceable.35

When a bank advances money to its customer, it often requires security from a third party by way of a contract of guarantee (ie, a contract of suretyship) to secure the money advanced to the customer.36 It has been stated that a "suretyship" is the generic term given to contracts in terms of which one person (the surety) agrees to answer for some existing or future liability of another (the principal) to a third person (the creditor), and by which the surety’s liability is in addition to, and not in substitution for, that of the principal.37 A suretyship guarantee is secondary both in intent and in form. The intention of the parties is that the surety will be called upon to pay (or, instead, to perform the principal debtor’s obligations under the underlying contract) only if the principal debtor defaults in performance, and then only to the extent of the principal debtor’s liability and subject to any defences available to the principal debtor. This intention is reflected in the form of the suretyship guarantee, which is expressed to become payable only upon the principal debtor’s default.38

2.2.3 Accessory guarantees (suretyship guarantees) v primary guarantees (letters of credit and demand guarantees)

In contrast to the above, the demand guarantee and letters of credit create another kind of duty that is a primary duty which is not materially, that is, substantively conditional on bringing proof of the breach or failure of the primary obligor under the transaction. These instruments are in this regard materially independent, and they may become due and payable before any such duty arises under the transaction or even entirely regardless of whether or not any such duty matures now or later on.39

A demand guarantee in contrast can be described as a personal security under which a guarantor (eg, a bank) promises payment to a beneficiary (creditor) if a principal (the bank’s customer and also the debtor) defaults in the performance of his obligation (eg, the construction of a building). The bank pays if the documents presented with the demand for payment (where applicable) comply with the documents that are mentioned in the text of the demand guarantee. The bank’s obligations are independent (autonomous) of the underlying contract (eg, building contract) between the beneficiary and the principal, which means that, in principle, the bank must pay if proper complying documents are presented, even if the beneficiary and the principal have not stipulated that there is a default under the original underlying contract.40

Contrary to the accessory guarantee (ie, the suretyship guarantee), the commercial letter of credit is a credit in which the bank’s undertaking to pay is primary both in form and intent. The classic case is a commercial letter of credit covering the price of a shipment of goods under a documentary sale transaction (particularly international sale transactions). The agreed method of payment of the price is not payment by the buyer, but payment by the bank pursuant to its independent undertaking. The bank is the first port of call for payment, and the buyer’s direct payment obligation under the contract of sale is suspended pending presentation of the documents and payment by the bank. Only if the documents are properly presented and the bank declines to pay, does the buyer’s own duty of payment revive.41 If the credit is honoured, that duty is extinguished; while if the bank refuses to pay because of the seller’s failure to tender conforming documents, the buyer is entitled to withhold payment and, indeed, to treat the contract of sale as repudiated in the absence of a fresh and conforming tender within the period of the credit.42

In this scenario, the intention of the parties to the underlying contract (ie, to the contract of sale) is that the bank issuing the letter of credit is to be the first port of call for payment and this is the effect of the agreement between them. Whereas in the case of an accessory guarantee (ie, suretyship guarantee) the creditor (beneficiary) cannot make a call for payment on the guarantor without establishing default by the principal debtor, the opposite is true of the letter of credit, where the parties have elected payment by the bank (guarantor) as the primary method of payment. Only if this fails without fault on the part of the beneficiary is he (the beneficiary) entitled to resort to the buyer (principal) under the underlying contract of sale.43

The demand guarantee stands between the accessory guarantee (ie, suretyship guarantee) and the commercial letter of credit in the sense that it is secondary in intent but primary in form. Performance in terms of the underlying contract is due, in the first instance, from the principal and the demand guarantee is intended to be resorted to only if the principal has failed to perform. Although this is the intention of the parties, the demand guarantee is not in form linked to default under the underlying contract, nor is there any question of performance of that contract by the guarantor. The only purpose of the demand guarantee is to hold the beneficiary risk-free up to the agreed maximum amount; and the only condition of the guarantor’s (eg bank’s) payment liability is the presentation of a demand and of all the other documents (if any) specified in the guarantee in the prescribed manner and within the period of the guarantee.44

The demand guarantee is unique in its character. The guarantor (eg the bank) is not concerned with the underlying contract, and if the demand is duly presented, payment must be made – in spite of allegations by the principal that he (the principal) has fully performed in terms of that contract – in the absence of established fraud or another event constituting grounds for non-payment under the applicable law.45 The guarantor (bank) of a demand guarantee therefore promises or gives a primary or direct undertaking to perform the principal’s obligation, irrespective of whether or not the principal’s (principal debtor’s) obligation is enforceable.46

So the fundamental difference between an accessory guarantee (suretyship guarantee) and a primary guarantee (eg, demand guarantee and letter of credit) is that the liability of a surety of an accessory guarantee is secondary, whereas the liability of the guarantor (or issuer) of a primary guarantee is primary. A surety’s liability is co-extensive with that of the principal debtor and, if the surety disputes default by the principal debtor, the creditor must prove such default. Neither statement applies to a primary guarantee, such as a demand guarantee or letter of credit. The principle that underlies demand guarantees and letters of credit is that each contract is autonomous. More specifically, the obligations of the guarantor/issuer of a demand guarantee or letter of credit are not affected by disputes under the underlying contract between the beneficiary and the principal. If the beneficiary of a demand guarantee or letter of credit makes an honest demand, it does not matter whether it is between himself and the principal, he is entitled to payment.47 The guarantor/issuer must honour such a demand, the principal must reimburse the guarantor/issuer, and any disputes between the principal and the beneficiary, for example, any claim by the principal that the drawing was a breach of the contract between them, must be resolved in separate proceedings to which the guarantor/issuer will not be a party.48 Therefore, if actual proof of breach or non-performance is required under the guarantee, the facility is not a primary guarantee, but an accessory guarantee (suretyship).

2.3 Does the National Credit Act include suretyships?

One has to decide on the basis of the above definitions if a common-law suretyship falls within the ambit of the definition of a credit guarantee as set out in the National Credit Act. Accordingly, the definition of credit guarantee has to be interpreted by giving the words their ordinary meaning in the context of the statute read in its entirety. If the definition then remains ambiguous, regard must be had to indicators of the legislature’s intention.

In terms of the definition of a "credit guarantee" in section 8(5), a credit guarantee exists when "a person undertakes or promises to satisfy upon demand any obligation of another consumer in terms of a credit facility or a credit transaction to which this Act applies". On the one hand, one might ask if a common-law suretyship indeed falls within the ambit of this definition, taking into consideration that a suretyship can arise only when the principal debtor is in default and not as stated in the definition merely "upon demand". A suretyship also has a conditional and secondary nature.49 On the other hand, the definition also requires the existence of an obligation of another consumer and it therefore seems as if the existence of a "credit guarantee" in terms of section 8(5) is dependent on the existence of a principal debt. This could imply that the definition refers to an accessory guarantee. As already indicated, in an accessory contract, such as a suretyship, an underlying valid principal obligation between another party and the credit provider is required. The phrase "obligation of another consumer" in section 8(5) therefore possibly indicates that a "credit guarantee" in terms of the National Credit Act has an accessory nature. The issue, therefore, is if the definition of "credit guarantee" in terms of the Act encompasses guarantees that are unconditional and primary in nature (eg, demand guarantees and letters of credit) and/or guarantees that are conditional upon the breach of a contract (ie, a contract of suretyship).

In order to gain clarity, it should be investigated whether or not a surety will arise only when the principal debtor is in default. In other words, can a surety arise merely upon a demand to satisfy an obligation? In terms of the general definition of suretyship provided by Forsyth and Pretorius,50 quoted above and accepted by the Appellate Divisions (as it was then known),51 default of the principal debtor is a requirement to trigger a suretyship, and not a mere demand.

From the definition provided by Forsyth and Pretorius it is clear that the two most important characteristics of a suretyship are, firstly, that it is an accessory contract, and secondly, that it is triggered only once the principal debtor is in default.52 This means that the surety can be enforced only once the principal debtor commits breach of contract and not upon a mere demand.53 In Carrim v Omar54 Stegmann J held (relying on Lubbe’s opinion) that a promise by a third person to the effect that the principal debtor will perform his obligation to the creditor may serve as partial evidence that the third person intended to bind himself as a surety, but that such a promise will amount to a suretyship only if it is accompanied by a conditional undertaking on the part of the third person to perform or otherwise indemnify the creditor.

So at this stage it may seem to be debatable as to whether or not a suretyship does, in fact, fall within the definition of a "credit guarantee", since the definition merely states that a consumer promises or undertakes to satisfy the principal debtor’s obligations upon demand. No reference is made to default of the principal debtor.

The words "upon demand" used in the definition of a credit guarantee must, however, not be read too literally, be over-emphasised or given any special meaning.55 In our view, these words in the Act simply mean that in terms of this type of agreement the person (surety) undertakes/promises to satisfy (pay) any obligation of another person (the principal debtor) when the credit provider asks (calls upon) him to do so - in other words when the credit provider has informed him that the principal debtor has defaulted and payment is now demanded from him. This is in accord with how traditional suretyship guarantees work in practice – sureties become liable to perform or indemnify the creditor only where the principal debtor has defaulted and the surety is then called upon/requested by the credit provider (eg, bank) to perform on the principal debtor’s behalf. So until a creditor demands/requests from the surety to perform in terms of the suretyship, the surety might not even be aware of the default of the principal debtor and that his obligation to perform or indemnify has now arisen. The words "upon demand" used in section 8(5) do not, in our view, carry the same meaning as they would when dealing with primary guarantees, such as demand guarantees.

In addition to the above, cognisance must also be taken of section 4(2)(c) of the Act. Section 4(2)(c) of the Act also provides that the Act will apply to a credit guarantee only to the extent that the Act applies to the underlying credit facility (eg, credit-card facility) or credit transaction (eg, mortgage agreement) in respect of which the credit guarantee is granted. Therefore, if the Act does not apply to the credit facility or credit transaction (ie, the primary debt) in respect of which the credit guarantee is granted, the Act will not apply to the guarantee. From section 4(2)(c) the deduction can be made that the term "credit guarantee" clearly refers only to accessory/secondary guarantees, such as suretyships, because a clear reference is made to the primary debt (ie, the underlying contract) and if it were to also include primary guarantees, such as letters of credit or demand guarantees, there would not have been any reference to the primary debt (ie, the underlying contract) as these latter guarantees are not concerned in the least with the underlying contract. The deduction is also further strengthened by the fact that accessory/secondary guarantees are normally subject to the same substantive law and the same jurisdiction or arbitration clause to which the underlying transaction (ie, primary debt) itself is subject56 and section 4(2)(c) of the Act makes it clear that the Act will apply to the credit agreement only to the same extent that it will apply to the primary debt.

So it would appear as if the definition of "credit guarantees" caters for the accessory nature of a contract of suretyship by referring to another person’s (consumer’s) obligations. However, a contract of suretyship is also, as stated above, conditional upon a breach of contract. The definition seems to imply that the existence of a principal obligation is required but it is not clear whether the definition makes provision for the conditional nature of a contract of suretyship. It could thus easily seem as if the National Credit Act does not apply to contracts of suretyship. However, on the face of it, it appears that a common-law suretyship is covered by the definition of "credit guarantee" since the existence of another consumer’s obligation is required. Unfortunately, the use of the phrase "upon demand" could unnecessarily lead one to the wrong conclusion that the definition of "credit guarantee" does not cater for the conditional nature of a contract of suretyship.

In Firstrand Bank Ltd v Carl Beck Estates (Pty) Ltd57 one of the things the court had to decide was whether or not a surety and co-principal debtor (second respondent) was a consumer to whom a notice in terms of section 129 of the National Credit Act (ie, default notice) was required to be given. The second respondent entered into a suretyship agreement in terms of which he undertook to bind himself in his personal capacity in favour of the plaintiff (the bank) for all the first respondent’s (the principal debtor’s) debt (concerning a mortgage agreement) to an unlimited amount and he signed the undertaking as "surety and co-principal debtor". The first respondent was a private company (a juristic person). The court held that in terms of section 8(5) of the National Credit Act a credit guarantee will be regulated in terms of the Act only if the underlying credit facility or credit transaction (ie, the principal credit agreement) is also regulated in terms of the Act.58 The court held that on the merits of the case the Act did not apply to the mortgage agreement (ie, the principal debt) and therefore did not apply to the suretyship.59 The court, however, remarked that:60

There is no doubt that the suretyship obligations of the second respondent theoretically fall within the definition of a credit agreement which encompasses a credit guarantee... in terms whereof – ‘a person undertakes or promises to satisfy upon demand any obligation of another consumer in terms of a credit facility or a credit transaction … .

The court therefore in this obiter remark accepted that the National Credit Act could apply to a suretyship agreement and that it clearly fell within the definition of a "credit guarantee" as set out in section 8(5). This case also confirms that the Act will apply to a credit guarantee only to the extent that the Act applies to the underlying credit facility or credit transaction (the principal debt) in respect of which the credit guarantee is granted.61 Where the principal debt is not a "credit agreement" that falls within the scope of the Act, the suretyship will fall under the common law and the surety will not be entitled to raise any of the defences or provisions of the National Credit Act.62 Also where the principal debtor in terms of the underlying credit agreement is not a "consumer" falling within the ambit of the Act,63 the surety (even if he is also a co-principal debtor and in his own right constitutes a "consumer" for the purposes of the Act) will also not be entitled to rely on the protection afforded by the Act.64 Although the obiter view expressed by the court has been supported by the majority of jurists,65 there are still some that disagree that suretyships fall within the definition of "credit guarantee".66

Even though the court (as per Van der Merwe AJ) in Nedbank Ltd v Wizard Holdings67 did not specifically deal with the issue of whether or not the definition of a "credit guarantee" also included a suretyship agreement, it dealt with the matter before it as if it did. Van der Merwe AJ also confirmed that the National Credit Act did not apply to the suretyship agreement if the principal/primary debt did not arise from a credit agreement which fell within the scope of the Act. It follows from the Nedbank Ltd v Wizard Holdings case that even if it is a natural person that has signed a suretyship the National Credit Act will still not apply if the principal debt does not fall within the ambit of the Act.




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