Introduction
In many instances where a seller or a supplier sells goods to their customers on credit, the
contract between the parties or the terms of the credit application may stipulate that the
credit facilities are granted by the seller to the purchaser at the seller's discretion, and that
the seller may, without notice and at any time, vary or terminate the credit facilities.
This kind of provision may have severe consequences for the purchaser. The seller can
suddenly, without any notice, reduce a customer’s credit terms or terminate the credit
facilities altogether, leaving its customer stranded and severely disrupting or harming the
customer’s business. The seller, on the other hand, would argue that this provision is
essential in order to protect its position, in the event that a customer defaults or where a
customer’s creditworthiness is in doubt.
Customers or purchasers who find themselves on the receiving end of this kind of provision
would question whether in commercial law, the contractual right to unilaterally amend or
terminate credit terms is legally enforceable and whether there are any legal limitations to
such a contractual right.
This question, amongst other issues, was revisited in an appeal to a Full Bench of three
judges in the KwaZulu-Natal High Court in Pietermaritzburg (“the KZN Full Bench”) in the
matter of Spar Group Limited and Others v Twelve Gods Supermarket (Pty) Ltd and
Others (AR 31 of 2021, AR 32 of 2021) [2022] ZAKZPHC 29 (07 July 2022).
Background
The appeal to the KZN Full Bench related to three issues, one of which was the unilateral
amendment of credit terms. Here we focus only on the decision of the Appeal Court
regarding the unilateral variation of credit terms.
The first to thirteenth respondents in the KZN Full Bench appeal make up a group of
companies which are SPAR retailers. This group of companies owns and operate various
SPAR supermarkets and TOPS liquor stores situated in Gauteng, North West Province and
KwaZulu-Natal. The fourteenth to seventeenth respondents in the appeal are members of
the family which indirectly own and manage this group of SPAR and TOPS stores.
These family-owned companies (“the respondent companies”), as well as all other entities
which own and operate SPAR branded stores, are effectively SPAR franchisees. Spar,
however, prefers not to characterise them as “franchisees”. Instead, Spar has adopted a
“Guild” structure. This structure entails that, in order for a person or company to trade under the SPAR banner, that person or entity is required to become a “retailer member” of a non-profit company called the Spar Guild of Southern Africa NPC (“Spar Guild”). Each SPAR
store is required to have its own separate Spar Guild membership in relation to that store.
The Spar Group Limited (“Spar Group”) is a company listed on the Johannesburg Stock
Exchange. Its main business is to supply wholesale goods to SPAR retailers/franchisees
from six distribution centres which it operates in six different regions of South Africa. These
distribution centre goods are, generally, supplied to Spar retailers/franchisees on 19 days
credit.
In addition to supplying SPAR retailers/franchisees directly from its distribution centres, Spar
Group also facilitates the supply of goods to SPAR retailers/franchisees from third party
suppliers, known as “drop shipment” suppliers. These drop shipment suppliers supply
basic and high volume goods such as bread, milk, snacks, and various Coca-Cola
beverages. SPAR retailers purchase these drop shipment supplies through the Spar Group
Limited, usually on 30 days credit.
In order to be eligible to purchase wholesale goods and drop shipment goods on credit,
SPAR retailers must be members of the Spar Guild and are required to agree to Spar
Group’s standard written credit agreement for the purchase of distribution centre goods and
drop shipment goods.
Clause 5 of the credit agreement entered into by Spar Group and the respondent companies
provides as follows:
‘Credit facilities are granted by the seller to the applicant, at the seller's discretion,
and the seller may, without notice, at any time vary or terminate such facilities.’
(emphasis added)
On 15 October 2019 Spar Guild, at a secret hearing of its directors at which the respondent
companies were not represented, invalidly purported to terminate the retailer memberships
of the respondent companies. The following day, 16 October 2019, Spar Group,
implemented these invalid terminations by obtaining ex parte orders (orders obtained without
notice) in the Pretoria High Court and the Pietermaritzburg High Court for perfection of
notarial bonds over the respondents’ stores. These ex parte perfection orders were set aside
two days later by both Courts, after the respondent companies brought urgent applications to
set aside the perfection orders.
Later in October 2019, after the perfection orders were set aside, Spar Group unilaterally
amended the respondent companies’ credit terms by drastically reducing the time periods in
which the respondent companies were required to pay for goods sold by the Spar Group
distribution centres and goods purchased from drop shipment suppliers. The time period for
payment for distribution centre goods was reduced from 19 to 7 days, and the time period for
payment for drop shipment goods was reduced from 30 to 7 days.
The respondent companies, represented by Fluxmans Attorneys, then instituted two related
applications in the Pietermaritzburg High Court, under case numbers 8280/19P (‘the
termination application’) and 9215/19P (‘the drop-shipment application”).
In the termination application, the issue was whether the Spar Guild had validly terminated
the respondent companies’ Spar Guild memberships, and whether the Spar Group had
validly amended the respondent companies’ credit terms by reducing the time allowed for
repayment.
In the drop-shipment application, the issue was whether the imposition of limits on the
quantity of goods the respondent companies could purchase from the Spar Group and its
drop-shipment suppliers was valid and reasonable and in accordance with the approved
credit agreement.
The two applications were heard together by Mr Justice Barnard, an Acting Judge in the
Pietermaritzburg High Court. Judgments in both applications were delivered on 17 July
2020. Barnard AJ granted both applications.
Barnard AJ found that the terminations of the respondent companies’ retailer memberships
of Spar Guild were invalid.
In respect of the unilateral amendment to the terms of credit granted to the respondents,
Barnard AJ found that, despite the provisions of clause 5 of the credit agreement allowing
‘Spar to amend the credit terms if need be’, the amendment of the credit terms was invalid
as it was not done in good faith and was unfair due to the lack of consultation with the
affected respondent companies.
In his judgment in the drop-shipment application, Barnard AJ determined that the limitation
on the quantity of drop-shipment supplies which the respondent companies could order,
which were imposed by Spar Group, similarly lacked honesty and good faith. He held that
the respondent companies were entitled to purchase goods sufficient for their usual trade
requirements.
The appeal to the KZN Full Bench was against the orders made by Barnard AJ in the
termination application and the drop-shipment application.
SPAR’S unilateral variation of the respondent companies’ credit terms – the principle
of “arbitrio boni viri”
Barnard AJ recognised that clause 5 expressly permits SPAR Group to amend the credit
terms but found that Spar Group’s conduct in doing so was unreasonable.
In doing so, Barnard AJ applied the following established legal principle:
where a party has a unilateral discretion under a contract, unless that contractual
discretionary power is clearly intended to be completely unfettered, that discretion
should be exercised “arbitrio boni viri”, meaning that the unilateral discretion should
be exercised fairly, reasonably and in good faith.
In the application before Barnard AJ, SPAR argued that clause 5 of the credit agreement
provides that the credit and drop shipment terms are stipulated “at the seller's discretion, and
the seller may, without notice, at any time vary or terminate such facilities.” Therefore, in
amending the credit terms afforded to the respondent companies, Spar Group argued that it
had validly exercised its contractual discretion.
In addition, Spar Group argued that the objective and uncontested facts did not support the
finding that Spar Group acted outside the principle of arbitrio boni viri. Spar Group
contended that it came to a legitimate and reasonable decision, taken in a private
contractual setting, and after a substantial period of engagement with the respondent
companies, it could not continue to do business with the respondent companies on the
existing terms as the relationship of trust between the two entities had broken down
irretrievably.
It was argued that Spar Group’s decision to change the credit terms was based on the
financial statements provided by the respondent companies at court coupled with the fact
that Spar Guild had issued notices of termination, which meant that the credit terms had to
be restricted to the period of the termination. This affected the creditworthiness of the
respondent companies and aggravated the risk to Spar Group if it continued to do business
with them. Spar Group’s decision to reduce the credit terms was, it was argued, also
consistent with Spar Guild’s obligation to act in the best interests of all its members, and the
Spar Group’s accountability to its shareholders.
In the appeal before the KZN Full Bench, Spar Group expanded on its argument as follows:
a clause which permitted the Spar Group to determine the “prestation” (performance)of the counterparty to a contract, was not against the general principles of contract and was not invalid;
the arbitrio standard was only capable of a very restricted application as it did not apply to all exercises of contractual discretion;
for termination in matters of contract, there was no need to go beyond the giving of notice nor was any good reason required for the exercise of contractual discretion;
if the Court were to find that the arbitrio standard was required for the amendments of credit terms imposed by Spar Group, then the hostile standoff between the parties, the risk of having no or inadequate security for the credit advanced to the respondents because of the intended termination, and the liquidity shortages evident in the financial statements furnished by the respondent companies provided justification for Spar Group’s reduction of the credit terms;
Although Spar Group was entitled to cancel the credit facilities, it acted reasonably in only limiting the facilities.
The KZN Full Bench agreed with the following counter arguments offered by the respondent
companies:
- clause 5 should not be construed literally or narrowly, but considered within the
context of the reciprocal nature of the contractual relationship between the parties.
As retailer members of a trading group, the respondent companies are bound to
purchase their stock from Spar Group and are therefore obliged to accept Spar
Group’s credit terms in order to operate their businesses;
- the advancing of goods on credit is not a future contract that is subject to a decision
by Spar Group, on each occasion, whether to enter into such agreement or not. It is
an ongoing relationship and part of a larger whole, which was acknowledged in Spar
Group’s statement that the credit agreement is part of an ‘ongoing commercial
relationship’ between the parties;
- Spar Group’s discretion must therefore be exercised reasonably and honestly
because of the reciprocal nature of the trading model, and it is not a discretion to be
exercised unfettered.
In agreeing with the counter-arguments offered by the respondent companies, the Court
analysed and confirmed previous Court decisions relating to the principle of arbitrio boni viri.
The KZN Full Bench found the Spar Group’s discretion was not unfettered. It referred to
previous decisions and found that there was no reason for drawing a distinction between a
stipulation relating to credit terms for goods sold by Spar Group to Spar retailers on credit
and other similar stipulations conferring on a party to a contract a discretion to determine a
performance, such as the power to determine the price or rental.
There was no reason to limit the arbitrio boni viri rule to instances where the power vests in a
party which was entitled to receive credit. In fact, if one considers that all contracts are
subject to the principle of good faith, and that parties should as far as possible be held to
their contracts, there is good reason to apply the rule also to cases where the power is given
to the party that gives credit.
The KZN Full bench therefore agreed with Barnard AJ’s finding that the arbitrio standard was
applicable to Spar Group’s amendment to the terms of credit enjoyed by the respondent
companies.
The KZN Full Bench also agreed with Barnard AJ’s finding that the decision to amend the
respondent companies’ credit terms was not taken by Spar Group reasonably, honestly and
in good faith in the context of the ex parte perfection applications. The KZN Full Bench
agreed with Barnard AJ’s finding that the timing of the reduction in the credit terms available
to the respondent companies indicated that, Spar Group having failed in the perfection
applications and being unable to take control of the respondent companies business
operations, was attempting to achieve the same end as the termination notices through
alternative means.
Conclusion
The KZN Full Bench confirmed and applied the principle of arbitrio boni viri in relation to a
party’s application of a unilateral discretion under a contract.
The Court confirmed that it is permissible for a party to have a such a discretion, but applied
the qualification that such a discretion should be exercised arbitrio boni viri, fairly, reasonably
and in good faith.
The KZN Full Bench found that the arbitrio principle applies where a wholesaler, such as
Spar Group, has a discretion in regard to the credit terms on which it sells goods to Spar
retailers/franchisees on credit, both directly and via drop shipments. There was no reason to
distinguish this contractual discretion from other similar contractual discretions.
The question whether the amendment of credit terms was arbitrio boni viri depended on the
facts and the context of each case.
In this instance, in the context of the invalid termination of the respondent companies’ Spar
Guild memberships, the amendments of their credit terms were not reasonable or fair, as the
amendment of their credit terms was another means of attempting to achieve the invalid
terminations of their retailer memberships.
However, in other contexts, the application of this discretion may be valid, if the context
dictates that a supplier’s limitation or termination of a customer’s credit terms is justified and
reasonable.
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