Can a supplier unilaterally change its customer’s credit terms?

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 family members who indirectly own and manage this group of SPAR and TOPS stores.

These family-owned companies (the respondent companies) and 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 must agree to Spar Group’s standard written credit agreement for purchasing 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, vary or terminate such facilities at any time.’

(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”).

Termination 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.

Jonathan Shafir is a Director at Fluxmans Attorneys