TOOLS OF THE TRADE – MARCH 2022
An esteemed Life Fellow of the Association, Advocate Patrick Lane SC, recently published the following scholarly article in The International Construction Law Review. The article is hereby reproduced with the kind permission of Patrick Lane SC and The International Construction Law Review. It makes for interesting and educational reading for ADR practitioners who are, particularly in construction dispute resolution context, often confronted with the apparent conflict between two principles relevant to the law of contract namely good faith and pacta sunt servanda.
THE TENSION BETWEEN THE APPLICATION OF
GOOD FAITH AND PACTA SUNT SERVANDA
PATRICK M M LANE SC
The Maisels Group
ABSTRACT
The law of contract in South Africa has until recently regarded “good faith” as an underlying principle. A different approach to the application of “good faith” has followed the advent of the Constitution and the approach adopted by the Constitutional Court. There is, however, tension between this approach and that subsequently adopted by the Supreme Court of Appeal. This paper examines these different approaches and the impact that the judgments of the Constitutional Court will have on the law of contract.
INTRODUCTION
The principle of “Good faith” as underlying principle of the South African law of contract has traditionally acted as an element of fairness in South African Law. Agreements must be obtained properly, there is a requirement of legality, and the process of interpreting contracts takes cognizance of it.[1] More recently the Constitutional Court has applied a much broader application of the principle of “good faith”. Tension has, however, arisen between the approach adopted by the Supreme Court of Appeal and that adopted by the Constitutional Court to the application of the Constitution to the law of contract and in particular the extent to which the principle of pacta sunt servanda is affected thereby.
THE LAW BEFORE BARKHUIZEN V NAPIER
“Good faith” was held by the Supreme Court of Appeal in Brisley v Drotsky[2] as only being applicable as an underlying, general and supplementary value which operated in conjunction with other established rules. In other words, it was not considered as actionable in isolation. However, the dissenting judgement of Cameron JA marked a potential change of attitude in relation to the part that the principle of good faith, directed by constitutional values, should play in relation to contracts. This approach was later to be followed by the Constitutional Court.
The stance adopted by the majority judgment was, however, reiterated in
Price Waterhouse Coopers Inc v National Potato Co-operative:[3]
“At common law agreements that are contrary to public policy are void and not enforceable. While public policy generally favours the utmost freedom of contract it does not take into account the necessity for doing ‘simple justice between man and man’. Therefore, when a court finds that an agreement is contrary to public policy it should not hesitate to say so and refuse to enforce it. However, the court should exercise this power only in cases where the impropriety of the transaction and the element of public harm are manifest. It is an important consideration that there be certainty of agreements.”
THE APPROACH OF THE CONSTITUTIONAL COURT
The first indication that the Constitutional Court would adopt a broader approach was in Barkhuizen v Napier.[4] Although respecting the significance of the continued application of the principle of pacta sunt servanda it held that the principles of public policy insofar as contracts were concerned, would be determined in terms of the Constitution. The case involved the application of a time barring provision in an insurance contract. It was contended that the time barring clause was unconstitutional and unenforceable.
At paragraph 30 the court held:
“In my view the proper approach to the constitutional challenges to contractual terms is to determine whether the term challenged is contrary to public policy as evidenced by the constitutional values, in particular, those found in the Bill of Rights. This approach leaves space for the doctrine of pacta sunt servanda to operate, but at the same time allows courts to decline to enforce contractual terms that are in conflict with the constitutional values even though the parties may have consented to them. It follows therefore, that the approach that was followed by the High Court is not the proper approach to adjudicating the constitutionality of contractual terms”.
and at paragraph 51:
“In general, the enforcement of an unreasonable or unfair time-limitation clause will be contrary to public policy. Broadly speaking the test announced in Mohlomi is whether a provision affords a claimant an adequate and fair opportunity to seek judicial redress. Notions of fairness, justice and equity, and reasonableness cannot be separated from public policy. Public policy takes into account the necessity to do simple justice between individuals. Public policy is informed by the concept of ubuntu. It would be contrary to public policy to enforce a time-limitation clause that does not afford the person bound by it an adequate and fair opportunity to seek judicial redress. In my judgment the requirement of an adequate and fair opportunity to seek judicial redress is consistent with the notions of fairness and justice which inform public policy. There is no reason in principle why this test should not be applicable in determining whether a time- limitation clause in a contract is contrary to public policy.”
The court, however, found that the clause in question did not prevent the claimant from a fair and adequate opportunity to seek judicial redress. The concept of “ubuntu” embraces solidarity, humanness, inter connectedness, mutual respect and compassion.[5] The principle, therefore, of what constitutes “public policy” now extended to the values recognised in the minority judgement of Cameron JA referred to above.
The application of “good faith” or ubuntu by the Constitutional Court went a step further in Everfresh Market Virginia (Pty) Ltd v Shoprite Checkers (Pty) Ltd.[6] The case involved a clause in a contract of lease which provided for an option to renew at a rental to be agreed. The court of first instance held that the clause was unenforceable and upheld the prayer for an eviction order. The SCA refused leave to appeal and the matter was then brought to the Constitutional Court. It held:
“Had the case been properly pleaded, a number of interlinking constitutional values would inform a development of the common law. Indeed, it is highly desirable and in fact necessary to infuse the law of contract with constitutional values, including values of ubuntu, which inspire much of our constitutional compact. On a number of occasions in the past this court has had regard to the meaning and content of the concept of ubuntu. It emphasises the communal nature of society and ‘carries in it the ideas of humaneness, social justice and fairness and envelopes ‘the key values of group solidarity, compassion, respect, human dignity, conformity to basic norms and collective unity’. Were a court to entertain Everfresh’s argument, the underlying notion of good faith in contract law, the maxim of contractual doctrine that agreements seriously entered into should be enforced, and the value of ubuntu, which inspires much of our constitutional compact, may tilt the argument in its favour. Contracting parties certainly need to relate to each other in good faith. Where there is a contractual obligation to negotiate, it would be hardly imaginable that our constitutional values would not require that the negotiation must be done reasonably, with a view to reaching an agreement and in good faith.”
The Constitutional Court in Botha v Rich[7] was again confronted with the enforcement of a term of a contract which would have resulted in the Contract being cancelled, the claimant evicted and forfeiting payments made by her in excess of 50 per cent of the purchase price of a property by virtue of a default to pay instalments. The property was owned by a trust which instituted action for cancelation and eviction. The purchaser counterclaimed for transfer of the property pursuant to a statutory provision[8] that entitled a purchaser who had paid more than 50 per cent of the purchase price to take transfer of the purchased property against the security of a bond and payment of the arrears. She failed, however, to tender the arrears. The court of first instance granted an order cancelling the Contract which was upheld on appeal. She then petitioned the Constitutional Court. It held:
“At the heart of the case is whether Ms Botha was entitled to transfer of the property in terms of section 27(1). The determination of the issue depends on a proper interpretation of that section. The issue at stake entails the constitutionality of the enforcement of a cancellation clause in a contract of sale of immovable property in circumstances where more than half of the purchase price was paid, and demand for transfer of the property in terms of section 27(1) was refused by the seller. Also, at issue is the question regarding restitution of the amounts paid if Ms Botha is not entitled to transfer, in particular whether forfeiture of the amounts paid is contrary to public policy and thus unconstitutional. Public policy requires that parties should in general comply with contractual obligations that have been freely and voluntarily undertaken. There can be no doubt that the matter raises constitutional issues.
All law, including the common law of contract, derives its force from the Constitution and is thus subject to constitutional control. It is of public importance to determine whether cancellation of a contract, governed by the Act, and the resultant forfeiture of the payments — of more than half of the purchase price of the property — are fair and thus constitutionally compliant. The prospects of success, albeit not decisive, are good. It is therefore in the interests of justice to grant leave to appeal.”
And in upholding the appeal:
“To the extent that the rigid application of the principle of reciprocity may in particular circumstances lead to injustice, our law of contract, based as it is on the principle of good faith, contains the necessary flexibility to ensure fairness. In Tuckers Land and Development Corporation it was pointed out that the concepts of justice, reasonableness and fairness historically constituted good faith in contract. The principle of reciprocity originated in these notions. This accords with the requirements of good faith.
The Act seeks to ensure fairness between sellers and purchasers. Its provisions are in accordance with the constitutional values of reciprocal recognition of the dignity, freedom and equal worth of others, in this case those of the respective contracting parties. The principle of reciprocity falls squarely within this understanding of good faith and freedom of contract, based on one’s own dignity and freedom as well as respect for the dignity and freedom of others. Bilateral contracts are almost invariably cooperative ventures where two parties have reached a deal involving performances by each in order to benefit both. Honouring that contract cannot therefore be a matter of each side pursuing his or her own self-interest without regard to the other party’s interests. Good faith is the lens through which we come to understand contracts in that way. In this case good faith is given expression through the principle of reciprocity and the exceptio non adimpleti contractus.”
The case marked a fundamental divergence from the principles which were entrenched by the Supreme Court of Appeal and introduced into the law of contract the concept of “good faith” as a primary right capable of enforcement as of itself. Whereas, the South African law of contract had previously considered that public policy, as an underlying principle, could dictate that a court would not enforce a contract which it found to be contrary to public policy, the Constitutional Court elevated the principle of public policy into a self-standing principle of law. Public policy as a basis for nullifying agreements offensive in themselves had always been a principle of South African law. It had proved a sufficiently flexible and tested concept to achieve rights that could be achieved by the concept of good faith and to achieve them in a predictable way.[9] The Constitutional Court, however, introduced the principle that, under constitutional dispensation, a court can refuse to give effect to the provisions of a contract on the basis that the enforcement would be unreasonable and unfair.
THE SUBSEQUENT TREATMENT BY THE SUPREME COURT OF APPEAL
The first indication that the Supreme Court of Appeal would challenge the approach adopted by the Constitutional Court emerged in the judgement in Trustees, Oregon Unit Trust and Others v Beadica 231 CC and Others.[10] The case turned on the question whether the Beadica had complied strictly with the provisions of a lease between it and Oregon. It was conceded by Beadica that it had not complied with the Contract. It contended that, however, when the Contracts were concluded both sides envisaged that certain franchise agreements entered into by them would endure for 10 years, that Beadica’s businesses would be located in leased premises, and that after five years the it would have a right (an unqualified right) to renew its leases and that the termination of the lease was unreasonable and unfair.
The court of first instance held that the normative framework of the Constitution allowed a court to examine the substance of an agreement and to conclude that the sanction that might follow a strict application of a formal rule was insufficient to justify the relief sought where the key intention of the parties could be inferred from their agreement — in this case the lease and franchise agreements read together. The sanction sought to be invoked by the Oregon was disproportionate, given the parties’ intention, when signing the agreements, to promote the economic interests of the Beadica as historically disadvantaged persons.
The court of first instance accordingly found that the Beadica had, through its emailed communications, validly exercised the option to extend the leases and that the Oregon was prohibited from evicting the applicants until the end of the extended leases.
The case was taken on appeal by Oregon. The Supreme Court of Appeal[11] upheld the appeal and in doing so restated the law as it had found in Brisley (supra):
“Harms DP pointed out that the principle of pactum sunt servanda, although fundamentally important in the law of contract, is not a ‘holy cow’ — para 37. It is, however, as Ngcobo J said in Barkhuizen (supra para 19, para 87), ‘a profoundly moral principle, on which the coherence of any society relies’. Ngcobo J continued: ‘It is also a universally recognised legal principle. But the general rule that agreements must be honoured cannot apply to immoral agreements which violate public policy.’
The reason for the continued application of the principle embodied in the maxim pacta servanda sunt is the need for certainty in commerce.”
It reiterated that a rule of law based solely on the exercise of judicial discretion and a sense of reasonableness and fairness may be no rule at all and may be destructive of the rule of law. The principle of pacta sunt servanda, it pointed out, was not a “holy cow” insofar as a general rule that agreements must be honoured cannot apply to immoral agreements which violate public policy. The parties will know what their contract means and that they are entitled to rely on its terms, unless these are against public policy or their enforcement would be unconscionable. Self-autonomy, or the ability to regulate ones own affairs, even to ones detriment, it reiterated is the very essence of freedom and a vital part of dignity. It held:
“Thus, although fairness and reasonableness inform policy, they are not self-standing principles. And there are competing policy considerations, in particular, the need for certainty in commerce. Professor Dale Hutchison in a paper entitled ‘From Bona Fides to Ubuntu: The Quest for Fairness in the South African Law of Contract’ 2019 Acta Juridica (not yet published) describes the competing considerations as ‘the most burning issue in the modern South African law of contract’. The competing goals of certainty and fairness give rise to what he terms ‘intractable problems in contract law’. Hutchison writes:
‘Certainty is a rule of law concern in commercial dealings: contracts being planned transactions, the application of the law must produce predictable outcomes. On the other hand, unless these outcomes are generally considered acceptable by fair and reasonable people in the particular context, contract law will lose its legitimacy.”
The court in commenting on Botha v Rich (supra) criticised the reliance by the court of first instance on the concept of disproportionality and adopted the description by Hutchinson of the decision in Botha as being “embarrassingly poor”. It emphasised that by adopting the principle, a person who breaches a contract and is faced with a legitimate contractual termination may resist cancellation on the basis that it is a disproportionate reaction to the breach, that a party can never know whether they are entitled to cancel. How does a party know what his rights are or an attorney advise his client of his contractual remedies? It concluded:
“Quite so. The notion, that a sanction for breach, or failure to comply with the terms, of a contract, agreed on by the parties, is disproportionate and therefore unenforceable, is entirely alien to South African contract law. And to recognise it would be to undermine the principle of legality. That does not mean that a sanction that is contrary to public policy, or that is unconscionable in the circumstances, is to be enforced. The question is really one that centres on policy — the legal convictions of the community, rooted now in the Constitution.”
THE IMPLICATIONS
It is clear that a tension exists between the approach adopted by the Constitutional Court and the Supreme Court of appeal. The Supreme Court of Appeal has reinstated the importance of the doctrine of pacta sunt servanda. Unfairness and disproportionality do not constitute of themselves a right to refuse to enforce the Contract. Principles of public policy remain the cornerstone in the traditional sense. Pacta sunt servanda, however, is a constitutional value that must also be protected as much as it is necessary to have certainty in the law of contract.
The tension between the different approaches is demonstrated by Atlantis Property Holdings CC v Atlantis Exel Service Station CC.[12] The issue was whether a party claiming cancellation was obliged to act in good faith as a self- standing requirement. The majority decision, following Beadica (supra) held that the law of contract imposed no such obligation and that the test remained whether public policy or an identifiable constitutional value or principle had been offended. The decision was not unanimous. The minority judgement dissented on the basis that there was a fundamental difference in the approach adopted by the Constitutional Court and the Supreme Court of Appeal and that the court was bound to follow the judgement in Botha v Rich (supra):
“What is clear though is that Everfresh has left a deep imprint on this terrain of the law. Contract law, as enunciated by the SCA in Brisley (the majority judgment); Afrox Healthcare; Napier; and to a lesser extent Bredenkamp, was transformed. In their stead the approaches of Jansen JA in Tuckers Land and Development Corporation; and Bank of Lisbon; as well as that of Olivier JA in Brisley — that contractual parties were required to act in good faith towards each other — were endorsed by the CC. Good faith according to those judgments incorporated the concepts of ‘reasonableness and fairness’; the CC agreed.”
And:
“In my reading, the CC in Botha crystallised what it had already stated in Barkhuizen and in Everfresh. It, therefore, in my view, did not endorse Harms DP’s interpretation of its judgment in Barkhuizen.”
These differing approaches are yet to be reconciled and accordingly the position remains unsettled. There now exists uncertainty as to which approach will be followed which has introduced uncertainty into the law of contract and to the application of pacta sunt servanda which centuries of precedent has attempted to avoid.
A recent example of a case in which the application of the public policy was effectively applied is Nyandeni Local Municipality v Hlazo[13] which dealt with a contractual non-variation clause. The written contract between the parties required disputes to be referred to arbitration and provided that no variation or modification of any provision of the agreement would be of force or effect unless confirmed in writing and signed by the parties. Hlazo, the municipal manager by his conduct consented to a departure from the dispute resolution procedure which, by implication, amounted to a variation to the arbitration clause.
The Appellate Division in SA Sentrale Ko-op Maatskappy Bpk v Shifren en Andere[14] had dealt with policy considerations which govern the entrenchment provisions in contracts. It considered the need to avoid disputes, evidential difficulties often associated with oral agreements, the need for certainty and clarity in the commercial environment, and the infringement of the right to contractual freedom to allow a departure from the elementary principle of pacta sunt servanda in enforcing non-variation clauses. The court in Nyandeni, after considering these principles and accepting the principle that good faith cannot be elevated to an independent principle in terms of which contracting parties may escape their obligations on the grounds of reasonableness and equity as found in Brisley (supra), held that the application of public policy may in certain circumstances trump a contractual term concluded animo contrahendi is firmly established in SA law.[15]
The court distinguished a constitutional attack on the validity of a contract or a term thereof from an attack on the basis of public policy. In the latter case the concept of public policy is informed by the underlying values and principles of the Constitution. In a direct constitutional attack, the constitutional right must be identified, and such right must then be found to be limited by “a law of general application”.
In the light thereof it considered whether “public policy” prevented the respondent from relying on the non-variation clause and found that on the facts Hlazo did not have a bona fide defence and had invoked the non- variation clause not for the legitimate purpose of vindicating his rights, but for the ulterior motive of delaying his dismissal, to his financial benefit and to the detriment of the municipality. In the result the court decided that Hlazo could not rely on the non-variation clause and upheld the appeal.
The recognition of the distinction between the application of “public policy” and an attack on the basis that the Contract is unconstitutional preserves the principles of pacta sunt servanda and that good faith cannot be elevated to an independent principle of law. If the court in Botha v Rich had considered this approach it might have come to the same conclusion but on the application of the appropriate principle.
If, however, Botha v Rich (supra) is followed and the line between the application of public policy and the application of the Constitution is not maintained, there will be no certainty that contracting parties will be held to their bargain. Should the enforcement of the express or implied rights and obligations of the parties be determined on the basis of ‘disproportionality’ which would, in effect defeat the freedom of parties to contract on agreed terms, only chaos can result.
THE POTENTIAL CONSEQUENCE
The impact of the implementation of the approach of the Constitutional Court on the construction industry could be fundamental. The time barring provisions so common to the standard form contracts might well be considered, in certain circumstances, unenforceable. What of demand guarantees and “unconscionable” demands? Would “disproportionality” now inform the application of section 3 of the Conventional Penalties Act[16] which would impact on the imposition of liquidated damages?
Barkhuizen’s case (supra) considered a time barring clause but warned that the decision was made on the facts of that case. A different approach might be adopted, on the approach of the Constitutional Court in Botha v Rich (supra), if the time periods and provisions are more draconian or if an undefined value judgement of “proportionality” is applied. Is it now open to a party to contend that the application of the time barring provision of the Contract is unfair or disproportionate or that the demand is unconscionable?
In relation to demand guarantees the SA courts have upheld the principle of autonomy.[17] In principle, demand guarantees will be enforced provided the demand conforms to the requirements of the Contract. Limited defences are generally available, for example, in the event of fraud.[18] There is, however, an open question as to whether unconscionable conduct could be a ground for resisting the call on a demand guarantee. Reference to the potential of such defence was made in Sulzer Pumps Ltd v Covec-MC Joint Venture[19] and in Group Five Construction (Pty) Ltd v Member of the Executive Council for Public Transport Roads and Works Gauteng[20] where the court made reference to the absence of good faith as having received some judicial support.
Whilst there is a risk, it is more likely that the courts will continue to enforce the terms of the Contract and that, unless the time barring clause is so unreasonable, will uphold such clauses. In relation to unconscionable demands on guarantees, Karl Marxen[21] opines that:
“… it is suggested that a separate unconscionability exception is not at the moment, and is not likely in the future to be, part of the law in SA, England or Germany. The existing concepts of fraud and Rechtsmissbrauch are probably sufficient to deal with unconscionable conduct, while maintaining legal certainty and thus preserving the merits of demand guarantees.”
In terms of section 3 of the Conventional Penalties Act[22] a court may, if it appears that the penalty is out of proportion to the prejudice suffered by the creditor, reduce the penalty to an equitable amount. The section provides that in determining the extent of the prejudice suffered by the creditor the court must take into account not only his proprietary interest but every rightful interest which may be affected by the breach. The application of the principles of “good faith” or ubuntu could well now inform the courts discretion.
These examples highlight the problems associated with adopting “good faith” as a right or obligation which is self-standing and not as an underlying principle linked to unconscionable conduct determined on the basis of the convictions of the community at large. The freedom to contract and the binding consequences of the terms of the Contract which bring about commercial and personal certainty should not be sacrificed to an undefined sense of fairness or proportionality. The approach adopted by the Supreme Court of Appeal achieves a healthy balance which gives effect to the entrenched values of the Constitution and gives effect to public policy and the legal convictions of the community.
AUTHOR’S POSTSCRIPT
Since writing this article the Constitutional Court has attempted to bridge the gap between itself and the SCA and to explain the approach to judicial enforcement of contractual terms. In Beadica 231 CC and Others v Trustees for the Time Being of the Oregon Trust and Others [2020] ZACC 13 the court examined the development of the law of contract in the new constitutional era which has resulted in the tension between the principle of pacta sunt servanda (certainty) and constitutional values. These values include fairness, reasonableness, good faith, and the complex concept of ubuntu.
The Court recognized the need for certainty and at the same time, that it must be balanced with the requirements of public policy. It has sought to prescribe the necessary considerations.
[1] Contract general Principles van der Merwe, van Huyssteen, Reinecke and Lubbe, page 274.
[2] Brisley v Drotsky 2002 (4) SA 1 (SCA), paragraph 22.
[3] [2004] 3 All SA 20 (SCA)
[4] 2007 (5) SA 323 (CC).
[5] Dikoko v Mokhatla 2006 (6) SA 235 (CC), paragraph 66.
[6] 2012 (1) SA 256 (CC).
[7] 2014 (4) SA 124 (CC).
[8] Alienation of Land Act 68 of 1981, section 27.
[9] Christie, Law of Contract in South Africa, 7th Edition, page 18.
[10] 2019 (4) SA 517 (SCA).
[11] 2019 (4) SA 517 (SCA).
[12] 2019 (5) SA 443 (GP).
[13] 2010 (4) SA 261 (ECD).
[14] 1964 (4) SA 760 (A).
[15] Page 276, para D.
[16] Act 15 of 1962.
[17] Lombard Insurance Co Ltd v Landmark Holdings (Pty) Ltd 2010 (2) SA 86 (SCA).
[18] Phillips v Standard Bank of SA Ltd 1985 (3) SA 301 (W); Loomcraft Fabrics CC v Nedbank Ltd 1996 (1) SA 812 (A); Demand Guarantees in the Construction Industry, Karl Marxen, pp126ff.
[19] [2014] ZAGPPHC 695.
[20] [2015] ZAGPJHC 55.
[21] Supra, page 211
[22] Act 15 of 1962.