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Property Law Update

Construction: Bond stands up under challenge

Performance bonds ought to be quite simple documents. There are a few important legal niceties to attend to, but otherwise the surety guarantees the contractor’s performance of the underlying building contract. If the contractor does not achieve guaranteed performance, the surety can be required to pay subject to the financial limit of the bond. It is perhaps surprising, then, that cases grappling with the meaning of bonds are such a regular feature in the courts. The latest of these cases was decided just before Christmas: Ziggurat (Claremont Place) LLP v HCC International Insurance Company PLC.

Ziggurat were the employer. Their contractor, engaged under the JCT 2011 Standard Building Contract, had fallen into insolvency. HCC were the surety who issued the bond. The questions that arose for the court were pretty fundamental: was payment under the bond triggered by the contactor’s insolvency; and how was liability under the bond to be established? The risk of insolvency is one of the principal reasons why bonds are taken up, so it is perhaps surprising that there was any doubt about whether the bond would pay out on insolvency. This is not the first case where that issue has come up.

The bond was in the ABI standard form with one important amendment. Clause one of the standard bond provided for payment by the surety of Ziggurat’s losses and damages sustained as a result of the contractor’s breach of the building contract. However, there is a problem with this: becoming insolvent is not a breach of the JCT contract. It will almost always lead to a breach further down the line, but the insolvency itself is not a breach. Insolvency under the JCT forms suspends payment and performance obligations, regardless of whether it leads to termination.

As a result of this, Ziggurat amended the wording of the standard form, adding a new clause two as follows: ‘The damages payable under the Guarantee Bond shall include (without limitation) any debt or other sum payable to the Employer under the Contract following insolvency (as defined in the Schedule) of the Contractor’.

This raised the question of whether this provision was just to make it clear that in the event of breach, sums becoming due after insolvency were recovered or whether a claim could be made on the grounds of insolvency alone, even if there was no breach of contract. The poor choice of language in the new clause opened the door to HCC to argue that a breach was still required. Damages are payable following breach of contract or duty. Arguably, therefore the reference to damages was a reference back to the damages to be claimed following breaches provided for under clause one. The language in clause two is, however, confused. It refers to debts as well. Debts are different to damages.

The court’s decision here is another example of the courts’ modern approach to interpreting ambiguous contracts. . In appropriate cases, the court will favour the interpretation that makes business sense. Here the court held that clauses one and two were intended to mirror the two principal termination routes under the contract – default and insolvency. Clause two gave rise to a right to claim in the event of insolvency. The lesson from this part of the case is that when amending standard forms care is needed with the wording and as always it is necessary to check how the other side might argue the chosen wording should be read.

As I have said above, there will usually be a breach at some point after insolvency. That will usually occur after the project is built out and the employer’s account for the additional cost of completion is delivered to the contractor. His failure to pay will be a breach. Two important points arise from this. First, that breach is likely to be some months or years after the insolvency. That needs to be borne in mind when deciding on the event or date when the bond will expire. Often the event chosen is practical completion. Second, the account under the JCT forms is required after completion of the works (by others) and making good of defects. Even if completion by others equates to practical completion of works, the bond would then expire before the statement is due to be issued.

In this case, as is common, the bond required there to be ‘established and ascertained pursuant to and in accordance with the provision of and by reference to the contract’. To the court, that meant the employer’s account, following completion and making good of defects, was a prerequisite to an entitlement to claim under the bond. Once that account was delivered, a liability arose under the bond. It is not necessary to establish entitlement in adjudication, litigation or arbitration. The account crystallises liability but is not conclusive as to the amount of the liability. It is still open to the surety to challenge the calculation of the account. All this goes to show, these apparently simple documents require careful thought, consideration and drafting.

Originally published in Architect’s Choice

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