Caveat subscriptor: understanding the consequences of giving Performance security

Caveat subscriptor is a Latin maxim which essentially translates to “let the signer beware”. The maxim applies in South African law and is the name given to the principle that once you sign a contractual document the law accepts, unless proven otherwise (due to, for instance, fraud or duress) that you have read the contents of that document and have consented to be bound by the terms thereof.

The maxim, and the consequences thereof, are of particular importance when it comes to issuing performance security in the construction industry.

Performance guarantee

To illustrate the above point, I will briefly discuss performance guarantees which are often required to be obtained by contractors in terms of building agreements. The rationale of a performance guarantee is sensible – an employer wants to be certain that a contractor will be capable of finishing any given project or, if the contractor is unable to do so or defaults on its obligations in terms of the agreement, that the employer will be placed in a position to appoint an alternative contractor to do so.

A performance guarantee is a document issued by a third party (hereinafter referred to as “the guarantor”), usually a financial institution, in terms whereof the guarantor undertakes (usually[1]) to pay to the employer a sum of money should the contractor default in terms of the contract.

The contract between the employer and the contractor obliges the contractor to obtain a performance guarantee from a suitable guarantor.

In order to comply with this obligation, the contractor must apply to a guarantor for the issuing of a performance guarantee, usually in exchange for the payment of a premium and the contractor providing some collateral to the guarantor.

The guarantor will then issue the performance guarantee in favour of the employer who will be entitled, should the contractor default in the manner as specified in the guarantee, to claim the sum guaranteed in terms of the guarantee.

The above process seems simple but the concerns, for the contractor, arise when you consider the following:

1. the guarantor always requires that the contractor provide it with an indemnity in terms whereof the contractor undertakes to pay to the guarantor any sum which the guarantor pays to the employer in terms of the guarantee; and
2. the contractor has very little control over when and how the employer lodges a claim with the guarantor in terms of the guarantee.

This may lead to a situation in which the employer can allege that the contractor has defaulted in terms of the agreement between the contractor and the employer, and thereafter claim the sum from the guarantor under the guarantee, without the contractor being able to prevent this – even if the contractor disputes that a default has actually occurred. The guarantor must make payment, without considering the contractor’s claims relating to the default, or lack thereof, when the terms of the guarantee are satisfied. Once the guarantor has made payment in terms of the guarantee the contractor is liable repay such sum to the guarantor in terms of the indemnity referred to above.

Due to the fact that contractors are not able to exercise much control over how the employer claims in terms of the performance guarantee, as mentioned above, contractors should accordingly always be weary when applying for performance guarantees and should carefully consider the terms of any such guarantee and consult with an attorney before doing so.

[1] It is possible that a performance guarantee provides that the third party will step into the shoes of the contractor and complete the relevant project but this is rare in light of the fact that guarantors are usually financial institutions and so guarantees are almost always limited to the payment of money

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)