Otto Friederich Graf v Hans Joachim Werner Buechel

Buechel (respondent) was the sole shareholder, director and loan account creditor of Western Seaboard Development (Pty) Ltd ('the company'). The company purchased immovable property with intention to develop a sectional title hotel. Graf (appellant) lent the purchase price to the company secured by a mortgage bond over the property. When conditions relating to development were not met by a fixed date, the parties entered into an extension agreement. In terms of this agreement, Buechel and the company deposited with attorneys share certificates, signed but blank transfer forms, cession of Buechel's loan account claim, and power of attorney authorizing Graf to pass transfer of the property. Clause 9 provided that upon default Graf could elect to acquire the company by transferring the shares to himself or take transfer of the immovable property (which would be valued). The company failed to repay and was wound up. On 7 May 1999, the shares were transferred from Buechel to Graf in terms of clause 9. Buechel sought to undo the transfer on the basis that clause 9 constituted an invalid pactum commissorium.

• Whether a pactum commissorium in a contract of pledge is unenforceable even if the pledgor is not the pledgee's debtor
• Whether clause 9 of the extension agreement constituted an invalid pactum commissorium
• Whether the contract should be regarded as a conditional sale rather than a pactum commissorium where the value of the pledge is less than the debt
• Whether a clear rule of common law should be applied based on policy considerations underlying the rule rather than the rule itself

The appeal was dismissed with costs, including costs of two counsel. The order of Selikowitz J in the court below was upheld, declaring that the portion of clause 9 allowing acquisition of the shares and loan claims was a pactum commissorium and invalid, and that the transfer of shares in May 1999 was invalid and of no force and effect.

A pactum commissorium (an agreement that if the pledgor defaults, the pledgee may keep the security as his own property) in a contract of pledge is unenforceable under South African common law even if the pledgor is not the pledgee's debtor. The prohibition established by Constantine applies generally to any pledgor ('si quis' - if anyone). Where a rule of common law is clear and unambiguous in general terms, it is unnecessary and wrong to enquire in each instance whether the policy considerations which motivated the rule are present before applying it. A creditor may keep the thing pledged if the pledgor has agreed (whether at the time of pledge or later) that he may do so, provided a fair price or valuation is to be given when the debt falls due - this constitutes a conditional sale (per D 20.1.16.9). An agreement that allows appropriation of pledged property without provision for fair valuation is an invalid pactum commissorium. Contracts against public policy are judged objectively by their tendency, not their actually proved result.

The court noted that the reasons for the pactum commissorium rule remain sound today as in Constantine's time (approving Mapenduka v Ashington). The court observed that the third party pledgor may be the corporate alter ego of the debtor, or subject to the same pressures (e.g., debtor's spouse or parent), or a person whom the debtor will be obliged to compensate in full. The court noted that if it can be established that things have so changed since a rule was instituted as to render it no longer appropriate, that may be reason to change or abolish the rule. The court suggested that the limitation on contractual freedom represented by the pactum commissorium prohibition is justifiable in light of constitutional protection of the values of dignity and equality. The court emphasized that to the extent valuation exceeds the amount owing to the creditor, the excess belongs to the pledgor.

This judgment is significant in South African law as it: (1) Definitively establishes that the prohibition against pactum commissorium applies regardless of whether the pledgor is the debtor or a third party. (2) Reaffirms the proper approach to interpreting clear common law rules - they must be applied according to their terms, not selectively based on whether underlying policy considerations are present in each case. (3) Demonstrates the reception and continuity of Roman and Roman-Dutch law principles in modern South African law. (4) Balances freedom of contract against protection from potentially unjust contractual terms, finding the limitation on contractual autonomy justifiable in light of constitutional values. (5) Provides guidance on when an agreement may be characterized as a conditional sale (which is valid) versus a pactum commissorium (which is void) - the key being whether provision is made for fair valuation at the time of enforcement. (6) Affirms that contracts against public policy are judged objectively by their tendency, not actual consequences. The judgment represents an important exposition of the law of security and pledge in South Africa.