Arbitration clause in a contract does not survive termination of contract as a result of fraud

March 1st, 2021

Namasthethu Electrical (Pty) Ltd v City of Cape Town and Another (SCA) (unreported case no 201/19, 29-6-2020) (Mbha JA (Navsa, Molemela, Plasket, and Nicholls JJA concurring))

Does a clause requiring the parties to submit any dispute between them to arbitration or other adjudication process, bind the aggrieved party in an instance where the contract has been induced by fraud? This issue came before the SCA in this matter. The appeal turns on the question whether a dispute resolution clause in a contract survives the termination of that contract on the ground of fraudulent misrepresentations made during a tender process. There is another ancillary issue, which arose but has been overlooked for the purpose of this article. The court a quo is the Western Cape Division of the High Court, Cape Town (Boqwana J) found that the contract had been induced by fraudulent misrepresentations by the appellant (Namasthethu) and held that a dispute resolution clause in a contract did not survive the termination of the contract for fraud. Thus it set aside a determination made by the second respondent, Mr James Garner (Garner), following an adjudication process in terms of the dispute resolution clause in the contract. Namasthethu, appealed against these findings.

On 7 March 2014 the first respondent, the City of Cape Town (the City), advertised a tender for the supply, retrofit and installation of energy efficient luminaires at the Cape Town Civic Centre. On 25 August 2014, the City awarded the tender to Namasthethu. The tender had an estimated value of R 29 263 401,75 (excluding VAT), and its execution was contemplated to take 18 months. During November 2014 a written agreement following on the tender was concluded between the City and Namasthethu.

On 17 September 2014 an unsuccessful bidder, Citrine Construction (Pty) Ltd (Citrine), a company that competed in the tender process, appealed the award of the tender to Namasthethu and called on the City to set it aside. Citrine complained that Namasthethu and its directors had been convicted of fraud and corruption on 13 August 2013. The basis of the complaint – so the City was informed – was that Namasthethu and its directors were sentenced to a fine of R 200 000 coupled with a wholly suspended sentence of five years’ imprisonment, and that in its tender submission, Namasthethu had completed the official tender document declaring that neither it, nor any of its directors, had in the past five years been convicted of fraud by a court of law. If the allegations by Citrine were true, it would mean that Namasthethu was guilty of a fraudulent misrepresentation. In terms of the contract, the City was entitled to terminate the contract where Namasthethu had committed a corrupt or fraudulent act during the procurement process, or in the execution of the agreement.

On 25 November 2014, the City sent a letter to Namasthethu, stating that it had come to its attention that Namasthethu and/or its directors had been found guilty on charges relating to fraud and corruption during August 2013. Namasthethu responded by letter dated 27 November 2014, written by the CEO, one Shamla Chetty (Mrs Chetty), stating that neither it nor its sole director, Mrs Chetty, had been convicted of fraud and corruption during August 2013.

On 3 December 2014 the City replied to Namasthethu, stating that it had now received information, which indicated that Namasthethu and/or its directors had on 13 August 2013 been found guilty, in terms of a plea and sentence agreement, on various charges of fraud and corruption and that Namasthethu and/or its directors were sentenced to a fine of R 200 000 plus five years’ imprisonment, the latter of which was suspended on certain conditions. Namasthethu was notified that the matter would be referred to the City’s Forensics, Ethics and Integrity Department (FEID) for further investigation and it was requested to furnish a response within seven days.

On 12 December 2014 Namasthethu replied to the City’s letter, stating that at the time of the tender Mrs Chetty was the sole director of Namasthethu and also referred to a letter attached to the reply, apparently written by one Colonel K Naidoo of the South African Police Service (SAPS) Anti-Corruption Task Team, which recorded that no criminal conviction was obtained against Namasthethu or Mrs Chetty in the criminal proceedings and that Mrs Chetty was not an accused at the finalisation of the criminal matter.

The forensic investigation by the FEID was completed around the beginning of 2016. In its report to the City Manager, dated 26 February 2016, FEID confirmed that there had been a number of false misrepresentations and other fraudulent conduct on the part of Namasthethu, which included, inter alia, that:

  • Namasthethu and its directors (Mrs Chetty and Ravan Chetty (Mr Chetty), who were husband and wife) were criminally charged with fraud and corruption and Namasthethu and Mr Chetty were convicted in the Commercial Crimes Court in Pietermaritzburg on 7 November 2013, less than a year prior to the date of the tender application.
  • Mrs Chetty made a prima facie misrepresentation to the City when she stated in the negative on the tender declaration to the question whether any of the directors or the company/entity has been convicted by a court of law for fraud or corruption during the past five years. This amounted to fraud.
  • Mrs Chetty in her tender submission provided the City with a local business address for Namasthethu was discovered to be false. Furthermore, it was established that the service provider operated from three containers located at the Civic Centre parking area.

As a result of these findings, the FEID recommended the termination of the contract.

On 15 March 2016, the City wrote to Namasthethu informing it that the contract was being cancelled with immediate effect. Namasthethu disputed the cancellation and focused on insisting that the dispute surrounding the City’s cancellation of the contract be adjudicated in accordance with the dispute resolution procedure specified in the contract.

The City, however, persisted in contending that the contract was validly cancelled on 15 March 2016, and that Namasthethu’s insistence on referring the matter to adjudication, in the face of its fraudulent conduct, was inappropriate. Thereafter, Namasthethu approached the Association of Arbitrators (Southern Africa) (the Association), which then appointed Garner, a construction consultant and surveyor, as adjudicator.

The dispute, which Namasthethu purported to refer to adjudication, and in respect of which the Association was asked to appoint an adjudicator, concerned the validity of the City’s cancellation of the contract and a claim for damages. Garner prepared a determination on the basis of the Statement of Claim, and the documents sent to him by Namasthethu, but without hearing evidence. In that determination, he upheld various claims by Namasthethu and found the City liable to Namasthethu for damages in a total amount of R 2 499 440,44 (including VAT).

In the SCA, Namasthethu contended that, on a proper construction of the contract, the parties contemplated that the disputes regarding the cancellation of the contract, including those involving allegations of fraud during the tender process, were subject to the dispute resolution process agreed to by the parties and submitted that the dispute resolution clause is widely worded so as to encompass disputes of whatever nature.

The City, on the other hand, submitted that the contract was void, alternatively voidable, as a result of specified fraudulent misrepresentations and non-disclosures by Namasthethu and that on being satisfied that there had in fact been fraud on the part of Namasthethu, on the strength of a comprehensive forensic investigation, the City elected to terminate or rescind the contract and validly did so.

It is trite law that fraud is conduct, which vitiates every transaction known to the law. In affirming this principle, the SCA, in Esorfranki Pipelines (Pty) Ltd and Another v Mopani District Municipality and Others [2014] 2 All SA 493 (SCA) at para 25, referred with approval to Lord Denning’s dicta in Lazarus Estates Ltd v Beasley [1956] 1 QB (CA) at 712, when he said: ‘No court in this land will allow a person to keep an advantage, which he has obtained by fraud. No judgment of a court, no order of a Minister, can be allowed to stand if it has been obtained by fraud. Fraud unravels everything. The court is careful not to find fraud unless it is distinctly pleaded and proved; but once it is proved it vitiates judgments, contracts and all transactions whatsoever’.

As regards an arbitration or similar adjudication clause contained in an agreement, which was found to have been induced by fraud, the SCA has emphatically ruled that once the agreement had been rescinded by an aggrieved party, the said arbitration clause cannot stand. The reason, the SCA stated per Cameron JA in North West Provincial Government and Another v Tswaing Consulting CC and Others 2007 (4) SA 452 (SCA) para 13, was because ‘the arbitration clause was embedded in a fraud-tainted agreement the province elected to rescind’ and ‘cannot survive the rescission’, for ‘to enforce the arbitration agreement, the tainted product of [the guilty contractor’s] fraud, would be offensive to justice’.

In North East Finance (Pty) Ltd v Standard Bank of South Africa Ltd 2013 (5) SA 1 (SCA) the SCA had occasion to again consider the question of fraud in relation to an arbitration clause and reiterated that the effect of fraud that induces a contract is, in general, that the contract is regarded as voidable. This means that the aggrieved party may elect whether to abide by the contract and possibly claim damages, or to resile from it and regard the contract as void from inception. The court held that the arbitration clause could not survive in the face of allegations of fraud by one party, even though it expressly included the phrase ‘any question as to the enforceability of this contract’. Thus, disputes regarding the validity or enforceability of contracts induced by fraudulent misrepresentation and non-disclosures were not generally intended to be arbitrable.

A simple reading of the arbitration clause reveals that it merely provides that one party may give notice to the other to resolve a disagreement in the event of there being a disagreement ‘arising out of or concerning this agreement or its termination’. Clearly, this clause contemplates a dispute arising out of the agreement when it was accepted to be valid from the outset. There is no suggestion that it covers fraud, nor that it involves an exception to the general rule. The giving of ‘notice’ as stipulated would clearly not apply to a situation of a contract which the aggrieved party has already validly terminated or cancelled as a result of fraud.

As the SCA emphasised in North East Finance (Pty) Ltd, in order for the validity of a contract terminated for fraud to be determined by reference to adjudication, the contract must specifically say so, or otherwise clearly indicate as much. In this case, the contract unquestionably does not. It follows that the referral of the dispute to Garner for adjudication was invalid and unlawful and that the court a quo was correct in setting aside his determination following on an unlawful adjudication process. Clearly, Garner was not clothed with any authority to adjudicate the dispute. There can be no question of waiver on the part of the City.

The position might only change if the parties specifically made provision in the contract for such a dispute being referred to arbitration. It may require very clear language to effect the result. So the question that must be answered is whether there is clear and unequivocal language in the contract or even the arbitration clause itself, providing for this kind of dispute to be addressed by arbitration or adjudication.

Tshepo Mashile LLB (University of Limpopo) is a legal practitioner at Mkhonto and Ngwenya Inc in Pretoria.

This article was first published in De Rebus in 2021 (March) DR 28.