It is imperative when negotiating a contract to ensure that carefully drafted default provisions are included. These provisions should clearly describe and outline the process to be followed should either party breach the agreement and they should clearly set out each parties’ respective rights and obligations in these circumstances. It is also imperative when issuing any breach notice in terms of a contract, that the relevant provisions and processes stipulated in the underlying contract are complied with so as to avoid any potential disputes about when a party is actually in default and what constitutes a default in terms of the relevant contract.
The need for properly drafted default provisions was highlighted in a recent judgement handed down by the Supreme Court of Appeal (“SCA”) in the case of Enforced Investment (Pty) Ltd and Others v Verifika Incorporated and Another (599/2021) [2023] ZASCA 5 (25 January 2023). In this case, the SCA held that a letter of demand which did not unequivocally state the consequences of a defaulting party’s non-performance and the other party’s intention to cancel the agreement, did not render the demand defective or invalid. This decision was informed primarily by the default provisions in the underlying loan agreement, which did not require the non-defaulting party to provide notice to the defaulting party in the event of a default.
FACTUAL BACKGROUND
On 06 June 2019, Mr Laferla (“Laferla”) purchased 100% of the shares in Verifika Incorporated (“Verifika”) from Mrs Torres (“Torres”) for an amount of R2 000 000, inclusive of a deposit of R100 000. On the same date, Verifika entered into a loan agreement with Enforced Investments (“Enforced”), in terms of which Enforced advanced an amount of R1 900 000 to Verifika (“Loan Agreement”), for the purposes of expanding its business operations. As security for the loan, Laferla ceded all of his shares in Verifika to Enforced. It was common cause, however, that Laferla misappropriated the R1 900 000, which he used to pay Torres for her shareholding in Verifika.
The default clause in the Loan Agreement read as follows:
“11.1 An Event of Default shall occur if any of the following events, each of which shall be several and distinct from the others, occurs …
11.1.1 the Borrower fails to pay to the Lender any amount which becomes payable by it pursuant to this Agreement strictly on due date, and the Borrower fails to remedy such default within 3 (three) Business Days of written demand;
11.2 If an Event of Default occurs the Lender shall be entitled, without notice [emphasis added] to the Borrower accelerate or place on demand all amounts owing by the Borrower to the Lender under this Agreement, whether in respect of principal, interest or otherwise so that all such amounts shall immediately become due and payable, and call up the Security.”
The payment schedule in the Loan Agreement provided that the loan was payable in three instalments over a three year period and that interest was payable monthly on the outstanding balance of the loan.
By 31 July 2019, interest in an amount of R32 343.19 was due by Verifika. On 8 August 2019, Enforced issued a letter of demand indicating the outstanding amount owing by Verifika and indicated that the amount needs to be settled immediately and that a failure to pay is an act of default. On 18 October 2019, a second letter of demand was addressed by Enforced to Verifika followed by a third letter of demand which was sent on 24 January 2020.
Following the transmission of these letters of demand, Enforced called up the security by registering Torres as the holder of all of the shares of Verifka. On 31 January 2020, another letter was addressed to Laferla demanding the payment of all outstanding amounts owing by Verifika to Enforce under the Loan Agreement. Laferla only made his first payment for arrear interest on 24 February 2020. Subsequent to the perfection of the security by Enforced, a special resolution was adopted by the shareholders of Verifika, to wind up Verifika.
HIGH COURT APPLICATIONS
The following applications were brought in the Gauteng Division of the High Court, Johannesburg (“High Court”):
- (i) an application for an order that the entire shareholding of Verifika be restored to Laferla and for the cession perfected by Enforced, in terms of the Loan Agreement, be set aside; and
- (ii) an application seeking to set aside the resolution to place Verifika in voluntary liquidation.
In a combined hearing on 18 January 2021, the High Court ordered, inter alia, that Laferla’s entire shareholding in Verifika be restored and that the voluntary winding up of Verifika be set aside. In coming to its decision, the High Court held that the first letter of demand sent by Enforced to Verifika was defective as it did not unequivocally indicate what the consequences of the failure to pay timeously would be and it also did not indicate Enforced’s intention to cancel the Loan Agreement, and was therefore not incompliance with the lex commissoria (the cancellation clause of the Loan Agreement). Enforced and Torres then took the decision of the High Court on appeal to the SCA.
ON APPEAL TO THE SCA
The main question that the SCA had to determine was whether any of the three demands issued by Enforced entitled Enforced to claim the acceleration of all amounts owing in terms of the Loan Agreement and to call up the security given under the Loan Agreement.
The SCA ultimately held that in terms of the relevant provisions of the Loan Agreement, there was no actual duty on Enforced to notify Verifika that it intended to call up the security and that Enforced simply provided Verifika with a notification that there was an event of default and demanded payment of any and all outstanding amounts owing in respect of the Loan Agreement. The SCA held that by virtue of the fact that Verifka failed to make payment of the outstanding amounts within three business days after Enforced’s first written demand, an event of default in terms of the Loan Agreement had occurred and Enforced became entitled to accelerate payment of all amounts owing in terms of the Loan Agreement and to call up the security granted by Laferla to Enforced.
The SCA ordered, inter alia, that Verifika and Laferla pay to Enforced an amount of R1,361,704.74 together with interest thereon and that Verifika and Laferla pay the costs of the application and counter-application, including the costs of two counsel, jointly and severally on an attorney-client scale.
