IN THE COURT OF APPEAL

AT NAIROBI

(CORAM: OUKO, KIAGE & MURGOR, JJ.A)

CIVIL APPEAL NO. 61 OF 2013

BETWEEN

FIDELITY COMMERCIAL BANK LIMITED………....………APPELLANT

VERSUS

KENYA GRANGE VEHICLE INDUSTRIES LIMITED…..….RESPONDENT

(Appeal from a Judgement of the High Court of Kenya at Nairobi (Mutava J.), dated 26^th July, 2012

in

H.C.C.C. No. 27 of 2005)

**********

JUDGMENT OF THE COURT

By a Hire Purchase finance, the appellant, a limited liability company carrying on the business of banking advanced to Takrim Bus Services (Takrim) funds to purchase two luxury buses, which were to be purchased from the respondent, a limited liability company carrying on the business of importing, assembling and selling buses. As a matter of fact it was the respondent that had introduced Takrim, one of its customers, to the appellant. Indeed, by a letter dated 22^nd March, 1999 it was the respondent that had requested the appellant to extend the facility to Takrim. Subsequently, the respondent gave a certain undertaking as to the repayment of the facility. That first letter, as shall be apparent shortly, was relied on by the respondent and the learned Judge to supply some of the terms of the undertaking that are the subject of this controversy.

This appeal arises from the judgement of the High Court (Mutava J.) rendered on 26^th July 2012 in HCCC No. 27 of 2005 following an action brought by the appellant against the respondent to enforce the undertaking after Takrim failed to honour the repayment schedule. In the suit, the appellant had sought an award of Kshs. 4,059,304 with interest at the rate of 12% p.a from the date of filing until payment in full, being the amount outstanding from Takrim in the appellant’s books in respect of the two buses.

The case was built on these two letters. We reiterate that in the first one dated 22^nd March, 1999 the respondent introduced Takrim to the appellant while in the second letter, dated 29^th April, 1999, the respondent gave the appellant an undertaking in consideration of the latter’s financing the two buses for Takrim. In it, the respondent undertook to the appellant that, should Takrim fail to meet its obligation under the arrangement by not paying a maximum of two installments, it would purchase the buses from the appellant at the amount outstanding in the appellant’s books immediately the appellant repossessed them. Pursuant to this undertaking, the appellant entered into two hire purchase agreements with Takrim in respect of the two buses. Thereafter, Takrim took possession of the said two buses.

Takrim later defaulted in payment of the installments and several attempts to repossess the buses were made. For instance the appellant wrote three letters dated 5^th May 2000, 27^th May, 2000 and 24^th July, 2000, respectively, demanding the settlement of the loan. The appellant was able to repossess the buses in March 2002, but shortly after agreeing on the rescheduling of the facility released back to them to Takrim on certain conditions. It would seem those conditions were not met by Takrim leading to a second repossession. At the time of the second repossession, the amounts outstanding from Takrim, according to the appellant, was Kshs. 5,159,304 with interest accruing at the agreed rate of 35.91% p.a. By this time, one of the units had caught fire and was completely burnt while the other unit had also been involved in an accident. Contrary to the understanding between the parties, Takrim had not taken out an insurance cover for the buses.

By a letter dated 26^th August 2004, the appellant notified the respondent of the outstanding amount and demanded that the terms of the guarantee requiring it to purchase the luxury buses upon repossession be honoured. The respondent failed to purchase any of the buses. As a result, the appellant proceeded to sell one of the buses (Chassis No. 1832492) at Kshs. 1,100,000 and credited Takrim’s account with the amount. The appellant however failed to sell the second bus (Chassis No. 1833761) resulting in an outstanding balance of Kshs. 4,059,304 which, as we have stated, constituted the appellant’s claim against the respondent before the High Court.

The respondent, in its defence, denied the terms of the undertaking and alleged that if the same existed, the default on the part of Takrim fell outside the financial period set out in the undertaking. Further, that the undertaking was neither sealed with the company seal nor backed by the company’s board’s resolution so as to be binding on it. The respondent blamed the appellant for breach and variation of material terms of the guarantee by taking additional securities and for failing to comprehensively insure the buses.

Before Mutava, J. both sides presented oral evidence of what we have summarized here. The main contention before him was the tenure of the undertaking or guarantee. While the respondent argued that the letter of undertaking was valid only for the period of repayment of the facility, namely, 24 months from the date of disbursement, the appellant, for its part, maintained that the letter of guarantee was open-ended and did not specify any defined term of validity; and that the letter constituted a continuing undertaking that was actionable upon default and demand.

The learned Judge considered the evidence on both sides and submissions in support of either party’s case. On the tenure of the letter of guarantee by the respondent in favour of the appellant dated 29^th April 1999, the learned Judge noted that its terms did not specify any defined term of validity. Because, according to the Judge the wording of the letter was “blunt” as to its tenure, he resorted to the terms of the earlier letter dated 22^nd March, 1999 as the primary document from which the answer to the question of tenure lay. In his view, the undertaking, seen in the context of the two letters imposed the following conditions; that the undertaking was in relation to two buses to be financed by the appellant at a cost of Kshs. 4 Million each; that the repayment would be over a period of 24 months; that in addition to the normal guarantees, Takrim would provide two to four additional logbooks as security; that the respondent undertook that, in the event of default, it would repurchase the two buses in question for an amount not exceeding the balance of the loan (with arrears of maximum of 2 installments) less recoveries made from other securities and guarantees provided by the customer; that the undertaking was only enforceable once there was default on the facility; and that the respondent would only be liable once the appellant had enforced and made recoveries from other securities and guarantees provided by the borrower. The extent of liability was also limited to the ensuing balance of loan increased to maximum of two monthly installments.

In addition to the aforementioned prerequisites, the learned Judge noted that the letter of undertaking introduced a further condition that the repurchase of the buses by the respondent would be subject to the appellant repossessing them first.

Answering the question whether these conditions were fulfilled by the appellant, the learned Judge was of the view that as at 5^th May, 2000 the loan accounts were in arrears of more than two installments and continued to grow leading to the repossession of the buses; that in breach of the terms of the letter of undertaking, the appellant did not enforce the terms of the letter of undertaking. Instead, the appellant entered into a rescheduling agreement with Takrim and released the buses back to Takrim. The Judge was however satisfied that the respondent, through its representatives, was involved in some way in the rescheduling of the loan. On these facts, the learned Judge explained that the proper course of action for the appellant would have been upon the repossession of the buses to immediately enforce the letter of undertaking by inviting the respondent to repurchase them.

He also noted that the letters re-scheduling the facility did not mention the terms of the undertaking essentially because the rescheduling was a bank-customer arrangement between the appellant and Takrim; that upon the second repossession in January 2004, one of the buses had been involved in an accident and could therefore not be sold; that the appellant’s demand on the guarantee came after the guarantee had expired; and that the respondent could not be compelled to repurchase the buses after the 24 month repayment period contemplated in the letter of 22^nd March, 1999 which had already expired. He found no evidence that the appellant had taken action to enforce the other securities it held over the debt including guarantees executed in its favour by the directors of Takrim; and that there was no comprehensive insurance policy over the buses at the time of the accident. As a whole he held that:

“… Overall, it was not possible in the totality of events to tell the net balance of the debt that the Defendant could be called upon to shoulder fulfillment of its commitment under the letter of undertaking.

In the end, while the letter of undertaking was worded in very specific terms, I do not think that this court would be dispensing justice, if the letter was looked at purely on its face value and in isolation of (sic) the full circumstances and conditions under which it was issued…”

Ultimately, the learned Judge was not convinced that the appellant had made out the case to entitle it to enforce the terms of the letter of undertaking of 29^th April, 1999 and to recover the sum of Kshs. 4,059,304. He dismissed the suit with costs to the respondent.

This appeal challenges that decision on 6 grounds that the learned Judge erred in:

“1. Introducing, considering and evaluating pre-contract documents to the contract of suretyship contained in the undertaking dated 29^th April, 1999 when in fact the contract was explicit in its terms.

2. Finding that the letter dated 22^nd March, 1999 was the primary understanding of the parties and that the tenure of the contract of suretyship dated 29^th April, 1999 hinged on that letter.

3. Finding that the terms and conditions set out in the letter dated 22^nd March, 1999 were part and parcel of the contract of suretyship dated 29^th April, 1999 when in fact some of those terms were not included in that contract.

4. Evaluating the totality of the evidence placed before him and in arriving at a wrong decision.

5. Finding that the court would not be dispensing justice if the contract of suretyship was looked at purely on its face value in isolation of other circumstances and conditions which were not part of the contract.

6. Failing to find that the appellant’s claim was merited and ought to have been allowed”.

To our mind and in terms of these grounds, the appellant was aggrieved by the reliance by the Judge of the letter of 22^nd March, 1999 to construe the terms of the letter of guarantee.

Mr. Kanjama, learned counsel for the appellant urged us to find merit in this appeal and to hold that, on the basis of the letter dated 29^th April, 1999, it was intended that there would be no cap on the intervening period between repossession and notification of the respondent; that it was erroneous for the learned Judge to use previous correspondence to interpret the impact of the undertaking while the letter dated 29^th April, 1999 was self – explanatory; that the letter was the final conclusion of the negotiations before the actual agreement; that the earlier letters were extrinsic evidence and could only be made reference to in the event the intention of the parties could not be ascertained. On the extent of the respondent’s liability, counsel submitted that in law, the liability of the guarantor is coextensive to that of the debtor hence coterminous; that the creditor does not have to exhaust all the remedies available to him against the principal debtor in the event of a breach.

Regarding the appellant’s indulgence of the respondent and the rescheduling of the loan, counsel argued that the guarantee agreement dated 5^th May, 1999 allowed the creditor room to grant the respondent indulgence without notice and that would not prejudice the guarantee; that in any event, the respondent’s interests were catered for through the agency of one Mohammed, who attended the meeting and further that the correspondence in relation to the rescheduling of the facility were copied to the respondent, which was aware of and indeed approved the indulgence.

Ms. Sharon Lipwop, learned counsel for the respondent in opposing the appeal and supporting the impugned decision submitted that the learned Judge correctly concluded that the letter of guarantee could not be read in isolation from the letter dated 22^nd March, 1999 as well as the letter approving the facility. She contended that the letter of guarantee was based on the correspondence exchanged and not a deed so as to invoke the parole evidence rule.

Counsel urged us to consider that the letter of guarantee read together with the letter dated 22^nd March, 1999 and the one offering the facility dated 8^th April 1999 specified the conditions precedent before liability could accrue against the respondent; that the appellant breached the 3 conditions on liability, namely, the 2 years period of the guarantee; the failure by the respondent to purchase the buses as soon as they were repossessed and; lastly, the failure by the appellant to inform the respondent immediately there was default. For these reasons, counsel contended that the respondent was discharged.

The jurisdiction of this Court has been summarized in numerous decisions. In Susan Munyi V Keshar Shiani, Civil Appeal No. 38 of 2002, it was reiterated as follows:

“As a first appellate court, our duty of course, is to approach the whole of the evidence on record from a fresh perspective and with an open mind. We are to analyze, evaluate, assess, weigh, interrogate and scrutinize all of the evidence and arrive at our own independent conclusions. In undertaking this task, however, we always bear in mind that unlike the trial court which had the advantage of hearing and observing the witnesses, we make our conclusions from the evidence as captured in the cold letter of the record. We therefore operate under a decided handicap as there is much to be gleaned from the demeanor and nuanced communication of a live witness that is inevitably unavailable, indeed lost, on the record. For precisely this common sense reason, an appeal court must accord due respect to the factual findings of the trial court and will be circumspect and slow to disturb them.”

From our own review of the record, we believe there are only two issues for determination: the validity of the contract of guarantee and the extent of the respondent’s liability.

Because a contract of guarantee is essentially a contract the following basic principles of contract law will apply.

A contract of guarantee binds the person giving a guarantee to honour its terms irrespective of any dispute that may be existing between the parties to the transaction for which the guarantee was given. A guarantee is therefore an accessory contract by which the guarantor undertakes to be answerable to the promisee for the debt or default of another person whose primary liability to the promise must exist.

The duty of the guarantor is created by the guarantee document itself and not the terms of the underlying contract.

This Court explained in Kenindia Assurance Company Ltd V. First National Finance Bank Ltd Civil Appeal No. 328 of 2002 that guarantees are special contracts and are;

“…… in the nature of a covenant by the appellant to pay upon the happening of a particular event. It is a form of security of guaranteeing payment by a third party. In such cases, the most important factor to consider before liability can attach is whether there has been default. Once default is established and there has been a formal demand the other conditions are of a secondary nature and may not be used to defeat the security.” (Our emphasis).

In considering both the validity and tenure of the contract of guarantee, we find no better place to start than the Encyclopedia of Forms and Precedents, 4^th Edn, Vol 9 page 761 para 25 where the principles of construction of guarantees were set out as follows;

“The ordinary rules of construction applicable to all contracts also govern the contracts of guarantee. The whole agreement must, in the usual way, be considered, and the natural meaning given to the words used unless such meaning involves obvious absurdity. The surrounding circumstances must also be taken into consideration, where the guarantee requires explanation. The surety will not be charged beyond the precise terms of his engagement, he being regarded in the light of a ‘favoured debtor.’”

So that where the intention of parties has in fact been reduced to writing, under the so called parol evidence rule, it is generally not permissible to adduce extrinsic evidence, whether oral or written, either to show the intention, or to contradict, vary or add to the terms of the document, including implied terms. Courts adopt the objective theory of contract interpretation, and profess to have the overriding aim of giving effect to the expressed intentions of the parties when construing a contract. This is what sometimes is called the principle of four corners of an instrument, which insists that a document's meaning should be derived from the document itself, without reference to anything outside of the document (extrinsic evidence), such as the circumstances surrounding its writing or the history of the party or parties signing it.

In Prudential Assurance Company of Kenya Limited V Sukhwender Singh Jutney and Another, Civil Appeal No. 23 of 2005 the Court citing a passage in Odgers Construction of Deeds and Statutes (5^th edn.) at p.106 emphasized that in construing the terms of a written contract;

“It is a familiar rule of law that no parol evidence is admissible to contradict, vary or alter the terms of the deed or any written instrument. The rule applies as well to deeds as to contracts in writing. Although the rule is expressed to relate to parol evidence, it does in fact apply to all forms of extrinsic evidence.”

The supporting rationale for this rule is that, since the contracting parties have reduced their agreement to a single and final writing, extrinsic evidence of past agreements or terms should not be considered when interpreting that written contract agreement, as the parties had consciously decided to ultimately leave them out of the contract. In other words, one may not use evidence made prior to the written contract to contradict the ultimate contract that has been reduced into writing.

The two main documents in this controversy are the letter addressed by the respondent to the appellant on 22^nd March 1999 requesting the appellant to extend hire purchase facility to Takrim and the subsequent letter dated 29^th April 1999 by which the respondent, in consideration of the appellant financing the two buses for the benefit of Takrim, guaranteed to the respondent that in the event that Takrim failed to meet payment of a maximum of two installments and immediately after the buses were repossessed, it would purchase the buses at the amount outstanding in the appellant’s books.

Because of their relevance and importance we reproduce the two letters below. In the first one of 22^nd March 1999 the respondent wrote, in part as follows;

“RE: TAKRIM BUS SERVICES

We refer to the finance application for 2 Scania buses for the above. We request that you finance two buses for this customer (finance amount Kshs. 4 Million each, repayment over 24 months).

We would request the customer, in addition to the normal guarantees, to provide two to four additional logbooks (for buses or trucks) as security. Furthermore, K.G.V.I (the respondent) will also agree, in the event of default, to repurchase the two units under finance, for an amount not exceeding the balance of the loan (with arrears of maximum of 2 installments) less recoveries made from other securities and guarantees provided by the customer.

We look forward to an early response”. (Our emphasis).

In the second letter, coming one month after the first one, the respondent undertook that;

“In consideration of your having financed two Scania model F93 luxury bus bodies chassis for Takrim Bus Company of P.O. Box 99301 Mombasa, we undertake that in the event Takrim Bus Service fail to meet their monthly instalments to you on their hire purchase accounts in timely manner, we will purchase from you the said buses at the outstanding amount in your books, as soon as you have repossessed them.” (Our emphasis).

The learned trial judge allowed the first letter to be admitted in evidence on the circumstances surrounding the negotiation of the contract. In particular, the learned trial Judge found, as indicated earlier, that, because the terms of the letter of guarantee did not specify any defined term it was ambiguous in so far as the tenure of the guarantee was concerned. On the basis of that ambiguity the learned Judge believed he was justified to consider the letter of 22^nd March 1999 to supply some of the terms and to ascertain the intentions of the parties.

The question we pose is whether it was a deliberate act that the terms contained in the first letter of 22^nd March, 1999 were left out in the second letter of 29^th April, 1999. The main, indeed only, issue is the extent to which the pre-contractual negotiations can be relied upon in the interpretation of a substantive contract.

It must be remembered that a typical commercial contract is usually preceded by pre-contractual negotiations and representations which may either be written or oral. Negotiations being a consensual bargaining process to reach an agreement involve haggling and each party hassling to bargain so as to secure maximum benefit from the other party. Negotiation takes place at a pre-contract period and only facilitates conclusion of a contract. It is initiated with a proposal which may mature into an offer. In the process, the parties involved must enjoy unfettered freedom of making proposals after proposals and also of making counter-proposals after counter-proposals. Such proposals and counter-proposals are all made without prejudice as the parties’ rights and obligations at this stage remain unaffected as they do not intend to be bound by the offer made or by the counter-offer.

It is elementary learning that for there to be a contract, there has to be an acceptance of an offer on the same terms of the offer and such acceptance must be unconditional, unequivocal and absolute, accompanied by consideration.

The traditional view was expressed quite persuasively in the decision of Lord Craighead in the House of Lords’ case of Chartbrook Limited v Persimmon Homes Limited (2009) UKHL 38 as follows;

“...the very purpose of a formal contract is to put an end to the disputes which would invariably arise if the matter were left upon what the parties said or wrote to each other during the period of their negotiations. It is the formal contract that records the bargain, however different it may be from what they may have stipulated for previously”.

The principle undergirding this rule flows from the notion of freedom of contract that is central to the law of contract; that it would be perverse and directly inconsistent with the intention of the parties after reaching a bargain and choosing to record that bargain in writing, for any court to resort to the prior history of exchanges and negotiations in order to resolve a dispute arising from the interpretation of the terms of the written bargain; and that the parties by consensus have themselves chosen not to give their prior negotiations contractual force and instead they have reached an agreement, and documented it.

The rule of exclusion of negotiations prior to entry of a contract as well as the parole evidence rule are subject to a number of exceptions. For instance, evidence of surrounding circumstances will be admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible to more than one meaning, but not to contradict the language of the contract when it has a plain meaning. Extrinsic evidence of terms additional to those contained in the written document will be admitted if it is shown that the document was not intended to express the entire agreement between the parties. If the parties intend their contract to be partly oral and partly in writing, extrinsic evidence is admissible to prove the oral part of the agreement. In Gillepsie Bros. & Co. v Cheney, Eggar & Co. (1896) 2QB 59 Lord Russell C.J. expressed this as follows;

“…although when the parties arrive at a definite written contract the implication or presumption is very strong (sic) and such contract is intended to contain all the terms of their bargain, it is a presumption only, and it is open to either of the parties to allege that there was, in addition to what appears in the written agreement, an antecedent express stipulation not intended by the parties to be excluded, but intended to continue in force with the express written agreement.”

Today, it cannot therefore be argued that the mere production of a written agreement, however complete it may look, will as a matter of law render inadmissible evidence of other terms not included expressly or by reference in the document. In other words, it must first be determined that the terms of the parties’ agreement are wholly contained in the written document. Whether the parties did so agree or intend is a matter to be decided by the court upon consideration of all the relevant evidence. See Savings and Loan Kenya Limited V. Mayfair Holdings Limited Civil Appeal 152 of 2006 and Twiga Chemicals Industries Limited V. Allan Stephen Reynolds Civil Appeal No. 300 of 2006.

The letter of 22^nd March, 1999 was clearly an application for a hire purchase facility by the respondent on behalf of Takrim in which the former offered to repurchase the two financed buses in the event of default by Takrim. The respondent suggested that should the appellant accept its offer, its liability, could be limited to the balance of the loan. It requested that in addition to its undertaking, Takrim be made to provide two to four additional logbooks (for buses or trucks) as security; and that its guarantee would only be due upon the Takrim failing to pay arrears of maximum of 2 installments less recoveries that the appellant would have made from other securities and guarantees provided by Takrim.

As the learned Judge accurately observed, the letter of undertaking did not specify any defined terms of validity and that first letter was not responded to by the appellant. The Judge, however in error, proceeded to hold that the terms in the first letter were accepted in the two hire purchase agreements made in respect of the two buses, without specifying how the terms were incorporated. The two agreements specifically, in pertinent parts, made provision for the;

i. sum advanced at Kshs. 4,000,000 for each bus

ii. make of the buses

iii. deposit

iv. 23 monthly installment of Kshs. 216,667

v. insurance cover

vi. joint and several personal guarantees of partners of Takrim .

Nowhere in the two letters of approval is there mention that the guarantee would be limited to only 24 months, the period of the facility. The letter of undertaking which incidentally was written by the two directors of the respondent themselves was categorical that they did “… undertake that in the event Takrim Bus Service fails to meet their monthly installments …..in timely manner, we will purchase from you the said buses…..as soon as you have repossessed them”.

The respondent cannot be heard to argue that if there was a default in repayment of the facility, it would be absolved after the period of the facility. It was liable immediately Takrim defaulted in meeting its monthly installments “in a timely manner”. It was expected to purchase the buses upon their being repossessed by the appellant. It is in evidence that upon default, the buses were repossessed but later released upon renegotiated terms. While it is not in dispute that the account of Takrim was rescheduled and the buses released, the respondent contended that the rescheduling was irregular and did not bind it because it was not involved in it nor was it given a notice of it; that its staffer, Mr. Farhad was at the rescheduling meeting because he had dropped Mr. Mohammed of Takrim to the meeting since the latter could not drive in Nairobi; and that there was no evidence that the appellant had enforced the other securities. The respondent further submitted that at the time the rescheduling arrangement was reached, the period of its undertaking had expired.

We have already answered the last question and held that there was no time limit on the respondent’s liability on the undertaking. Regarding the first concern, we are unable to follow the conclusion of the learned Judge that there was no linkage between the rescheduling of the facility and the original undertaking. The learned Judge in the same breath had found that the respondent through its representative had been involved “in some way” in the rescheduling of the facility.

We are ourselves persuaded that the respondent was always aware of the default and indeed at some point set out to help the appellant in tracing the buses for the purposes of being repossessed and to assist in their reselling. All the letters to Takrim from the appellant regarding the status of the facility were copied to the respondent. The meeting at which it was agreed that the facility be rescheduled was attended by a representative of the respondent. Indeed, the letter formally conveying the rescheduling terms made reference to a “telephone discussion with Mr. Farhad and Bashir of Kenya Grange” and that having considered the request from Takrim and “as Kenya Grange have confirmed their willingness to it” the new terms were accepted by both sides.

In conclusion, by guaranteeing that it would buy the buses upon the default by Takrim, the respondent was bound and became liable as soon as that default was demonstrated. The guarantee of 29^th April 1999 was open–ended, continuing and became actionable upon default and demand. No notice was required to be given in writing as the respondent had received all the letters the appellant copied to it hence was aware of the default.

With regard to the other securities, it was not a requirement of the guarantee that those had to be enforced first before the respondent’s undertaking could itself be enforced.

The fact remained that the respondent did not purchase the vehicles as required by the undertaking. In any case, the hire purchase agreement provided that the duration and extent of the facility were in the appellant’s sole discretion which could withdraw, curtail or vary its terms at any time. It further stipulated that, without notice and at any time it could extend indulgence and grant extension of time without discharging or in any way affecting the liability.