Survival of alternative dispute resolution clauses in the event of fraud

February 1st, 2021
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Picture source: Gallo Images

Verbal and written contracts are an essential part of everyday life. Contracts embody the security that parties rely on, to enforce the performance of obligations arising out of the contracts. Parties enter into contracts for a myriad of reasons, which are informed by impressions, undertakings or even formal representations made by the parties. A classic case of misrepresentation occurs when a party enters into a contract on the basis of an impression that later turns out to be false. This renders the contract voidable at the instance of the misled party.

As with many contractual impasses, more and more parties are opting for alternative dispute resolution methods, such as arbitration and adjudication to settle contractual disputes. Clauses that make provision for these alternative dispute resolution mechanisms have become prevalent in agreements as they offer parties an alternative, expeditious dispute resolution process, which is independent and in terms of which the progression of the matter is largely in the control of the parties to the agreement. These clauses typically contain survival provisions which endure after the cancellation of the agreement. In the recent case of 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)) the Supreme Court of Appeal (SCA), had to decide whether a survival provision would survive the cancellation of a contract which was cancelled due to fraudulent misrepresentation.

Factual background

Two contractual provisions were at the heart of the dispute in this case. First, a termination clause that entitled the City of Cape Town municipality (the City) to terminate the contract in the event that Namasthethu Electrical (Pty) Ltd (Namasthethu) committed a corrupt or fraudulent act during the procurement process or in the execution of the contract. This provision is common among contracts of significant value, especially in the public sector where corruption is considered rife. Second, a dispute resolution clause in terms of which the parties were to refer disputes concerning the agreement or its termination to adjudication in terms of the Joint Building Contracts Committee’s (JBCC) Adjudication Rules, failing which they may resort to litigation.

In August 2014, Namasthethu was successful in its bid for a tender issued by the City for the installation of luminaries in the City’s Civic Centre. Consequently, in November 2014, the City and Namasthethu entered into a contract valued at R 29 263 401,75 excluding VAT, with an estimated completion time of 18 months.

An unsuccessful bidder and competitor sought to have the tender set aside on the basis that Namasthethu and its directors, were convicted of fraud and corruption in 2013, they were fined R 200 000 and given a suspended sentence of five years’ imprisonment. The application for the tender required Namasthethu to declare that neither it, nor any of its directors, had been convicted for fraud by a court of law within the past five years.

Following an exchange of correspondence between the City and Namasthethu in which Namasthethu denied the allegations, the City launched a formal investigation into Namasthethu through its Forensics, Ethics and Integrity Department. The Forensics, Ethics and Integrity Department confirmed that Namasthethu and its two directors, S Chetty and R Chetty were convicted by the Commercial Crimes Court in Pietermaritzburg in November 2013 and also established that Namasthethu provided a fictitious local address in its tender documents. Subsequently, the City terminated the contract with immediate effect based on the fraudulent conduct by Namasthethu during the tender process.

Namasthethu challenged the cancellation indicating that the cancellation should have been dealt with in terms of the dispute resolution clause in the contract. By this it meant the matter was to be referred to the JBCC for adjudication first, then arbitration failing which litigation. It did not address the allegations forming the basis of the cancellation and contended that those were issues to be decided at adjudication. To this end, the names of potential adjudicators from the Cape Bar were suggested by Namasthethu.

The City maintained that the agreement was terminated validly and that Namasthethu’s referral to adjudication was inappropriate given that the contract was terminated for fraud. Namasthethu claimed that the City had repudiated the contract and based on this repudiation, it then cancelled the contract and was entitled to damages. The adjudicator appointed decided the matter without hearing evidence and found that the City was liable to pay Namasthethu damages. This formed the basis of the City’s application to the High Court.

The High Court

The main issue before Boqwana J was whether the dispute resolution clause in the contract survived the cancellation of the contract by the City, on the basis of fraud. Put succinctly, whether the cancellation due to fraud vitiated the survival of any provision in the agreement.

The City’s stance was that the contract was void or voidable due to the fraudulent misrepresentation and non-disclosure by Namasthethu. Pursuant to being satisfied of the existence of fraud by Namasthethu, the City exercised its election to cancel the contract validly. Therefore, the need for adjudication did not arise as it had already terminated the contract.

Namasthethu argued that on a proper construction of the contract, all manners of disputes (including fraud) relating to the termination of the contract was intended to be subject to the dispute resolution clause. It also argued that there was no basis in the contract or in law permitting the judicial review of the adjudicator’s determination. That is, the matter should have proceeded to arbitration and then litigation. Namasthethu maintained that the allegations of fraud were a material dispute of fact.

The High Court held that having considered the conduct of Namasthethu during and after the tender process, there was indeed fraudulent misrepresentation perpetrated by Namasthethu, which allowed the City to terminate the agreement. Namasthethu appealed to the SCA.

The SCA

The SCA held that the High Court was correct in its findings and proceeded to answer the question of whether ‘fraud is conduct which vitiates every transaction known to the law’. In answering in the affirmative, the SCA referred back to its earlier decision in Esorfranki Pipelines (Pty) Ltd and Another v Mopani District Municipality and Others [2014] 2 All SA 493 (SCA) quoting Lord Denning in Lazarus Estates Ltd v Beasley [1956] 1 QB 702 (CA) where he held that:

‘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.’

By aligning itself with this reasoning, the court’s attitude to the question was clear. In this manner the court appeared to have applied, in not so many words, the Latin maxim ‘ex turpi causa non oritur actio’. This simply means, ‘from a dishonourable cause, an action does not arise’. That is, an applicant or plaintiff cannot pursue a legal remedy if it arises in connection with their own wrongdoing. In this instance, Namasthethu’s fraudulent conduct during the tender process cut the legs out from under a legal course.

The SCA considered the context in which the contract was concluded and held that on a commercial sensibility interpretation, the arbitration clause demonstrated that all an aggrieved party needed to do was give notice to the other in order to resolve a dispute relating to the agreement or its termination. However, such an obligation to give notice would not arise in circumstances where a party terminates the agreement due to fraud. Additionally, the termination clause was of no assistance to Namasthethu in that it related to termination for failure to satisfy contractual obligations, whereas fraud is a distinct and separate ground for termination which a notice of default could not be expected to cure.

Once an agreement is terminated by a party due to the fraud of the other, the arbitration or adjudication clause becomes legally barren. The SCA stated that given that the dispute resolution clause was embedded in a fraud-tainted agreement that has since been terminated, the arbitration clause could not survive the termination and to enforce it would be ‘offensive to justice’. The corollary is that no clause contained in an agreement marred by fraud will survive the termination of that agreement. This is so because to enforce any such provision would legitimise the agreement and as such, offend justice.

Accordingly, the SCA held that the referral of the dispute to arbitration was invalid, unlawful, and that the adjudicator was devoid of authority to adjudicate on the dispute. Interestingly, the SCA emphasised that courts have recognised the corrosive effect of widespread fraud and corruption on society. The SCA upheld the High Court’s finding that Namasthethu’s conduct justified a punitive cost order.

Conclusion

The necessity of drafting a dispute resolution clause in a way that ensures its survival of the contract cannot be overstated. These clauses contemplate various circumstances leading to the termination of the contract and necessitates the survival of the dispute resolution clause. Parties must be mindful of their conduct leading up to and during the contract to ensure that the legality and validity of the contract is not an issue, as this will affect the survival of clauses such as dispute resolution clauses, which are meant to assist and protect the parties beyond termination. While the SCA has held that a dispute resolution clause does not survive termination of a contract due to fraud, it does not mean the court would not enforce such a provision in circumstances where parties have expressly agreed to it.

It would be interesting to see how the courts will deal with the survival of other clauses contained in agreements rescinded as a result of fraud. One such a clause would be a confidentiality clause where the respondent is privy to the confidential information of the applicant, who has since cancelled the agreement due to fraud. Would that respondent not be bound by those confidentiality provisions and if they were to breach those provisions, would the applicant be without a remedy where the agreement has been cancelled due to fraud? It remains to be seen how the courts would approach such matters.

Tshepo Mokoana LLB (UJ) is a candidate legal practitioner at Fasken in Johannesburg. This article was supervised by legal practitioners Muhammad Moti and Thethe Mokele.

This article was first published in De Rebus in 2021 (Jan/Feb) DR 26.

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