DealMakers - Q2 2020
Fairness and reasonableness win the day: the Beadica judgment
by Michael Katz, Dale Hutchinson and Julius Oosthuizen
The power of a court to strike down or refuse to enforce a contract that it considers to be unfair, unduly harsh or unreasonable has been a controversial one in South African law for some time.
It has long been accepted that a court may do so where the contract or its enforcement is contrary to public policy. However, this has traditionally been in respect of harm to the general public rather than individual contracting parties, and courts would also only exercise such powers in the clearest of cases.
This approach traditionally emphasised the fundamental notion of sanctity of contract – that contracts freely entered into between parties should be enforced. However, this raised questions about the role of good faith (which embraces notions of fairness, justice and reasonableness) in South African law of contract, and particularly, the defence of bad faith (exceptio doli), which many thought still to be available when a party sought to enforce a contractual right in unconscionable and inequitable circumstances. In 1988, the then Appellate Division found the exceptio doli to be an anachronism that had never formed part of South African modern law. Subsequent judicial attempts to treat good faith as an informing principle of contract law were stymied by a judgment of the Supreme Court of Appeal (SCA) in 2002. This judgment held that good faith – an abstract value that underlies the law of contract – finds expression in the various rules and doctrines of contract law, and shapes and controls its development, but does not give a court the discretion to strike down or refuse to enforce an otherwise valid contract term.
The question arose as to whether this conservative approach was consistent with the spirit and values of the Constitution, and particularly, the value of Ubuntu?
The first opportunity for the Constitutional Court to pronounce on this issue came in the 2008 case of Barkhuizen, which involved a challenge to a time-limitation clause in a short-term insurance contract. A majority in the court ruled that the Constitution applies indirectly to contract through the common law, and that the vehicle for introducing greater equity into the law of contract was public policy rather than good faith. In addition, such public policy is rooted in the values of the Constitution and imports the notions of fairness, justice and reasonableness, which are reflected in the value of Ubuntu and must be weighed against the “profoundly moral principle” of sanctity of contract when deciding on its enforcement.
A two-stage test was adopted. First, a clause in a contract which is, on its face, so unreasonable as to be contrary to public policy will be struck down. Second, if the clause survives that test and is accordingly valid, a court might still refuse to enforce it if such enforcement would be contrary to public policy in the particular circumstances of the case.
The Constitutional Court again emphasised the need to infuse contract law with the values of Ubuntu, fairness and reasonableness in subsequent cases. In the 2014 case of Botha v Rich, it refused to allow cancellation of a contract for the purchase of immovable property on instalments, in circumstances where the purchaser had paid nearly 80% of the purchase price and then defaulted on payment, holding that to allow cancellation would be a disproportionate sanction for the breach. Meanwhile, the SCA remained steadfast in its view that, until the Constitutional Court expressly ruled otherwise, a court could not refuse to enforce an otherwise valid contract term merely on the ground that, in its subjective opinion, to do so would be unfair. It continued to state that values such as fairness, justice and reasonableness are not in themselves self-standing requirements for the validity or enforcement of contracts, and that to hold otherwise would introduce an undesirable level of uncertainty into contractual relations.
This divergence in approach between the SCA and the Constitutional Court caused confusion in South African courts. An unequivocal judgment of the Constitutional Court on the issue was sorely needed, and presented itself this month in the case of Beadica CC v Trustees for the time being, of the Oregon Trust. In this case, the National Empowerment Fund had entered into an agreement with a franchisor, Sale’s Hire CC, to fund the acquisition of franchise businesses by former long-time senior employees of Sale’s Hire CC, as a broad-based black economic empowerment (B-BBEE) initiative. The employees established close corporations which concluded 10-year franchise agreements with Sale’s Hire CC, as well as lease agreements with the Oregon Trust, of which Mr Sale (the sole member of Sale’s Hire CC) was a trustee. The leases were for a period of five years, with a renewal option for a further five years which (as is usual in such contracts), had to be exercised in writing no later than six months before the expiry of the first lease. The lessees failed to exercise their renewal rights timeously, and were subsequently given notice to vacate the premises shortly before the expiry of their leases. They then brought an urgent application before the Western Cape High Court seeking an order declaring that the renewal options had been validly exercised, and prohibiting the Trust from taking steps to evict them.
Relying on Botha v Rich, Davis J granted the order, holding that termination of the leases would result in the collapse of the applicants’ businesses and the failure of the B-BBEE initiative – a disproportionate sanction for the failure of the lessees to comply with the strict terms of the renewal clauses. This decision was overturned by the SCA, which denied that South African law recognised such a principle of disproportionality, and held that there were no considerations of public policy that rendered the renewal clauses unenforceable.
The Constitutional Court granted leave to appeal but, by a majority of seven to three, ruled against the lessees. The majority judgment, delivered by Theron J, squarely addresses the issue of the proper constitutional approach to the enforcement of contracts, specifically the public policy grounds on which a court may refuse to enforce a contract term and the role of Ubuntu in the law of contract. This approach delivers a much greater degree of harmony and certainty in the law of contract, by effecting a reconciliation of the seemingly divergent approaches of the SCA and the Constitutional Court on these issues. The majority does so by essentially endorsing the approach of the SCA, but with certain qualifications, and by limiting the effect of the decision in Botha v Rich. The key principles that emerge from the judgment are the following:
The freedom of contracting parties to regulate their own affairs, even to their detriment, is founded on the constitutional values of freedom and dignity; and the associated principle of sanctity of contract is the bedrock of economic activity and vital for economic development. The rule of law requires that the law be clear and ascertainable, so that parties can regulate their conduct accordingly, with confidence that the application of the legal rules will produce reasonably predictable outcomes.
Like all law, contract law is subject to the Constitution and must conform to its rights and values.
The Constitution applies indirectly to contract through the common law requirement that a contract must be in accordance with public policy, which today is rooted in the Constitution and the values it espouses. As stated previously in Barkhuizen, a contract term that is contrary to public policy will be declared invalid. Even if the term is valid, the court may refuse to enforce it if to do so would be contrary to public policy.
A careful balancing act is, however, required: the principle that contracts freely entered into must be honoured is not the only, nor even the most important, principle informing the judicial control of contracts; it cannot be privileged over other constitutional rights and values. Ubuntu, which encompasses the values of fairness, reasonableness and justice, is now recognised as a constitutional value, and in the scales of public policy, might sometimes outweigh sanctity of contract.
However, abstract values such as good faith, fairness and reasonableness do not provide a free-standing basis upon which a court may intervene in contractual relationships. A court may not refuse to enforce a contract term simply on the basis that enforcement would, in its subjective view, be unfair, unreasonable, or unduly harsh. It is only where a contract term, or its enforcement, is so unfair, unreasonable or unjust that it is contrary to public policy, that a court may refuse to enforce it.
The case of Botha v Rich was concerned with a particular statutory regime – the protection of persons who buy land under instalment sale contracts, governed by the Alienation of Land Act, 1981, and did not introduce a generally applicable test of disproportionality as a ground for refusing to enforce a contract.
The power of the court to refuse to enforce a contract on public policy grounds should be exercised only in worthy cases, but the statement that it should be exercised with “perceptive restraint” should not lead courts to shrink from their constitutional duty to infuse public policy with constitutional values. The idea that public policy is concerned only with harm to the general public, rather than to the individual parties, is alien to South African law of contract.
The party who attacks the contract or its enforcement on public policy grounds bears the onus of establishing the facts. Where the party has failed to comply with a valid contract term, it must provide an adequate explanation for such non-compliance.
Courts are bound by section 39(2) of the Constitution to promote the spirit, purport and objects of the Bill of Rights when developing the common law. The values embraced by Ubuntu can play a vital role in developing the common law of contract to ensure its harmonisation with the requirements of the Constitution, but the courts must exercise resourcefulness and restraint in so developing the common law. Prudent and disciplined reasoning is required to ensure certainty of the law.
In the circumstances of the case, and in dismissing their appeal, the Constitutional Court placed particular emphasis on the fact that the applicants had not provided an adequate explanation for their non-compliance with the renewal provisions of their leases. We will, therefore, watch with interest to see how the courts will apply the above principles in circumstances where an applicant has, in fact, advanced reasons for its non-compliance.
Katz is Chairman, Hutchinson and Oosthuizen Executives with ENSafrica