Contractual security Bonds, warranties and guarantees Adrian Smith MEd MSc FRICS FHKIS College of Estate Management
Why contractual security? To provide some reassurance that contractual obligations will be honoured. Provided, often as options, by some forms of contract (e.g. FIDIC and NEC3). May apply to the main contract, to sub-contracts or to service contracts e.g. consultancy appointments.
Problems Understanding what protection is available. What should be used when? Issues with drafting of the documents. Common pitfalls.
Guarantee: Definitions An undertaking of: if he does not do X, then I will Warranty: Bond: An assurance that specific facts or conditions are true or will happen. The other party may rely on that assurance and seek a remedy if it is not true. An arrangement where the performance of a contractual duty by one party (the principal) to another (the beneficiary) is backed up by a third party (the bondsman, surety or guarantor). A bond is therefore a form of indemnity ( Alfred McAlpine v Unex Corporation (1994))
Purpose of bonds So what might we want a bond for? Usually either: to provide security for the contractor s performance; to secure payment eg retention or advance payment bonds; to cover specific obligations eg bid bonds.
How do bonds work? The principal (usually a contractor, subcontractor, or consultant) pays the surety (the bondsman) a fee in order to guarantee his obligation to the beneficiary (usually the client). If the obligation is not performed, then the surety compensates the beneficiary for the loss. The surety will then attempt to recover his losses from the principal under a counter-indemnity.
Contractual requirements What if the contractor fails to provide a bond required by a contract? Where contracts specifically require contractors to obtain bonds, failure is a breach sufficient to allow termination of the contract. Swartz and Son (Pty) Ltd v Wolmaranstadt Town Council (1960). It was the view of the court in Sweett v Michael Wight Homes (2012) that the employer would be justified in withholding the value of the bond from payments due to the contractor.
Contractual requirements What if a contract administrator fails to secure a bond from the contractor? May amount to professional negligence. Convent Hospital v Eberlin & Partners (1990) But see also Sweett v Michael Wight Homes (2012)
Sweett (UK) Ltd v Michael Wight Homes Ltd (2012) Sweett were Employers Agent under a JCT 2005 Design and Build Contract and agreed to prepare contract documentation and arrange for its execution. There was a contractual requirement for a bond. Contractor went into liquidation. No bond. Case began as Sweett suing for their fees after the employer failed to pay. Employer counterclaimed that Sweett were guilty of negligence in failing to ensure a bond was in place. Sweett found to have no liability because they had merely agreed to arrange execution not to ensure. Therefore no absolute obligation. (cont d)
Court s reasoning: Sweett (UK) Ltd v Michael Wight Homes Ltd (2012) Sweett had made it an obligation under the contract for Contractor to provide a bond; Sweett kept the Employer informed that the contractor had not provided one; Sweett had continually chased the Contractor for the bond, and contractor had given assurances that it was in progress ; Employer had not pressed Sweett to take any further action; Work was progressing well on site and no-one seemed unduly concerned.
Bonds - basic legal principles Principle 1 - Primary obligation A true on-demand bond An undertaking to pay a sum of money to the employer without any reference to the liability of the contractor. Only constraint is that the call must not be fraudulent. Therefore unless there is clear evidence of fraud, payment must be made. Balfour Beatty Civil Engineering v Technical and Guarantee Co Ltd (2000). There is a presumption that a bond is not on-demand unless it is issued by a bank. Not strictly true, but most are.
Headline 'On-demand' bonds make unwelcome comeback Construction Manager March 2011
Bonds - basic legal principles Principle 2 Secondary obligation Usually called a Default Bond. Liability is contingent upon proof of a breach by the contractor.
Bonds and Guarantees Much confusion over the terminology: On-demand bonds. Simple bonds. Performance bonds. Conditional ondemand bonds. Surety bonds. Surety guarantees. Parent company guarantees. If there is a dispute what matters is what they are, not what they are called. The court will decide on the basis of the wording of the document.
Marubeni HK and South China v Government of Mongolia (2005) Government of Mongolia Ministry of Finance guaranteed the obligations of a Mongolian company. Issued a letter stating that it unconditionally pledges to pay to you upon demand all amounts payable if not paid when they become due [and] pledges the full and timely performance by the buyer of all terms and conditions of the agreement Court decided this was not an on-demand bond because the reference to monies not paid when they become due would require proof that payment had not been made. The document was therefore a default bond.
VAG v Alpha Trains (UK) (2010) VAG were the parent company of Vossloh Locomotives, and guaranteed its obligations to supply trains to Alpha. Guarantee said that VAG undertakes that if [Vossloh] fails to pay any secured obligations when [they] are expressed to be due then [VAG] shall forthwith on demand pay Is this an on-demand bond? No! It requires proof of failure to pay. It is therefore a default bond
Clough Engineering Ltd v Oil and Natural Gas Corporation (2008) Contract concerned development of an oil and gas field off the Indian coast. Contract required Clough to provide an unconditional and irrevocable bond for 10% of the contract sum in the event of the contractor failing to honour any of the commitments entered into under this contract. Disputes arose, which caused ONGC to terminate the contract and call on the bond.
Clough Engineering Ltd v Oil and Natural Gas Corporation (2008) Bond stated that the bank would pay on first demand.on breach of contract by the contractor without any demur, reservation, contest or protest or reference to the Contractor. Clough argued that the wording prevented a claim on the bond because breach had to first be proved. Rejected at first instance and also on appeal.
Lesson.. On-demand bonds, particularly if not issued by a bank, require absolutely clear wording which leaves no room for doubt. If proof of default is not required then the bond must clearly say so.
On-demand bonds I promise to pay you x on receipt of your written request without prior proof of any conditions. Automatically payable once a request has been made. Can be risky - no proof of default required. Edward Owen Engineering v Barclays Bank (1978) English supplier provided an on-demand bond to a Libyan customer to cover default on a contract Customer himself defaulted, and called in the bond Court found that the bond must be honoured.
Conditional on-demand bonds Pure on-demand bonds are comparatively rare. Most will have some conditions attached: a statement from the architect or engineer that the contractor hasn t performed; a warning notice served on the contractor; and so on. Therefore they are called conditional ondemand bonds.
AES-3C Maritza East 1 Food v Credit Agicole Bank (2011) An on-demand bond stated that it was payable against an appropriately worded demand accompanied by any notice to the contractor relating to breaches of obligations to which the demand referred. Maritza claimed 97m enclosing notices amounting to 27m. Bank refused. Maritza then resubmitted claiming 96.6m and enclosing notices for the same amount. Bank paid 96.6m. The bond was on-demand, and required no proof that the amounts were due, but it was conditional upon the notices being served in the correct form.
Trafalgar House Construction (Regions) Ltd v General Surety & Guarantee Co Ltd (1995) Document described as a bond, and treated as a default bond at first instance. Court of Appeal decided it was actually an on-demand bond. Finally the House of Lords decided that it was really a guarantee.
Guarantees Under English law, a contract of guarantee must as a minimum be evidenced in writing (s4 Statute of Frauds 1677). The memorandum must: identify the parties; include the material terms; be signed by the party to be charged (defendant). It must also be made as a deed, otherwise it will not be enforceable..
Guarantees Actionstrength Ltd. v International Glass Engineering (2003) Actionstrength were a sub-contractor main contractor became insolvent. Employer promised to pay Actionstrength direct if they would complete their work. Employer subsequently refused to pay - Actionstrength sued on the basis of the employer s promise
Guarantees Court said no! Employer s offer was not recorded in writing, and could therefore not constitute a legal guarantee. Do not be persuaded by oral assurances from third parties.
Guarantees Kleinwort Benson Ltd v Malaysia Mining Corporation Bhd (1989) it is our policy to ensure that the business of [the subsidiary] is at all times in a position to meet its liabilities to you [under the loan agreement]. Subsidiary became insolvent. Kleinwort Benson went to the defendant for payment.
Guarantees Kleinwort Benson Ltd v Malaysia Mining Corporation Bhd (1989) Court of Appeal held that there was no obligation created by the letter. It expressed an intention at the time the letter was written and not a promise that the policy would continue. Lesson: If you want a guarantee, make sure that you get one!
Calls on the bond The bondsman will only pay out if: any conditions have been met; if the bond actually covers the circumstances of the case; in the case of a default bond, if it can be proven that the default has in fact occurred.
Examples Perar BV v General Surety and Guarantee (1994) A general performance bond to guarantee the obligations of a design and build contractor. Bond conditional upon the contractor s default. Contractor went into administrative receivership so contractor s employment automatically terminated, but contract not terminated. Held by the Court of Appeal that default meant breach of contract, and the contractor s insolvency did not constitute default. Bond did not therefore cover the circumstances of the case.
Examples Following Perar, bond wording altered to include contractor s insolvency as well as default. Such a bond used in a similar form of contract in Paddington Churches Housing Association v Technical and General Guarantee (1999). Bond promised to reimburse the employer s net established and ascertained damages. Held however that these could not be calculated until the works had been completed by another contractor, and a full statement of account drawn up.
Resisting calls on the bond Why would you want to? Because once a successful call is made the bondsman will immediately claim his money back under the counter-indemnity. Counter indemnities are almost always written in strictly on-demand terms So what can be done? Very difficult with pure on-demand bonds. Easier with conditional or default bonds
Resisting calls on the bond The Guarantor guarantees to the Employer that, in the event of a breach by the Contractor, the Guarantor shall satisfy and discharge the damages sustained by the Employer as established and ascertained in accordance with the provisions of the Contract and taking into account all sums due or to become due to the Contractor. Can it be proved that there has been a breach? Can you put enough doubt into the bondsman s mind? Are the damages claimed established and ascertained? Does this require a decision of a Court or an arbitrator? Are there any sums due to the Contractor? Have they been ascertained and agreed?
Variations In general, it is a basic rule of most forms of guarantee that any variation to the risk covered will invalidate the guarantee. Not applicable in the case of pure on-demand bonds because no proof of default is required. Is an issue in the case of conditional ondemand and default bonds.
Variations So what about variations in construction contracts? For example where a contractor is initially engaged to complete a project on a shell and core basis, and is subsequently instructed to carry out fitting-out work as well?
Variations Historic position set out in Holme v Brunskill (1878) If there is any alteration to the terms of the guaranteed contract, the surety ought to be consulted and his consent sought. If the surety does not consent then the surety is discharged.except in cases where it is selfevident that the alteration is unsubstantial or must be beneficial to the surety
Variations The Wardens and Commonality of the Mystery of Mercers of the City of London v New Hampshire Insurance (1991) Contractor entered into an advance payment bond for 4.5m. Contractor subsequently went into liquidation and employer claimed on the bond. However, employer had failed to give possession of the site until 10 weeks after the contractual date, and so was claimed by the bondsman to be in breach of contract. Bondsman refused to pay. High Court agreed. Court of Appeal disagreed. Default was insufficient to constitute a repudiatory breach. Bond therefore remained in force.
Variations What if there had been a fixed end-date on the bond in New Hampshire Insurance and the completion date (and the need to call on the bond) occurred after this date? Would the bond have still been available? Highly unlikely! Watch out for the knock-on effect of any variation.
Solution Either draft a bond which provides for variations to the construction contract (such as the standard FIDIC form). OR Keep the bondsman informed of all significant variations and seek his advice and consent.
Drafting and interpretation Historically, the courts took the view that in cases of ambiguity a guarantee should be strictly construed in favour of the guarantor. the court [will] in case of doubt lean in [the surety s] favour. Neither equity nor law will put a construction on the document which results in imposing on the surety any more than.he must be said expressly to have undertaken. Hilbery J. in Eastern Counties Building Society v Russell (1947). Later qualified as a fair but strict reading of the language of the guarantee First National Finance Corp. v Goodman (1983).
But beware ambiguity.. Drafting Rainy Sky S.A. v Kookmin Bank (2011) Rainy Sky and others entered into ship-building contracts with Jinse Shipbuilding in Korea. Jinse procured an advance payment bond from Kookmin Bank in return for advance payments from the buyers. Jinse became insolvent and Rainy Sky attempted to reclaim their advance payments under the bond. Kookmin refused to pay on the grounds that the bond did not cover the specific circumstances of the insolvency.
Drafting Dispute was about how the words used in the bond contract should be interpreted. In his judgment (p.8), Lord Clarke states: The issue between the parties.is the role to be played by considerations of business common sense in determining what the parties meant..
The purposive approach Courts have moved to a purposive approach to the interpretation of contracts. They will look beyond the bare words used. In order for the agreement.to be understood, it must be placed in context. The time has long passed when agreements.were isolated from the matrix of facts in which they were set and interpreted purely on internal linguistic considerations.we must inquire beyond the language and see what the circumstances were with reference to which the words were being used, and the object.which the person using them had in view. Lord Wilberforce in Prenn v Simmonds (1971).
The purposive approach If detailed and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense it must yield to business common sense. Lord Diplock in The Antaios (1976) Kookmin Bank therefore lost their argument, and the bond was enforced.
When does liability under the bond expire? Typically on a given date, or upon the occurrence of a particular event, eg completion of the contract, end of the defects liability period etc. There will typically be provisions to cover claims made prior to expiry.
Examples De Vere Hotels v Aegon Insurance (1998) Bond stated that it would end upon the issue of a certificate of practical completion. Contractor bankrupt and his employment therefore terminated. A second contractor appointed to complete the work, and a certificate of practical completion issued. Employer claimed against the bond for losses arising from the first contractor s bankruptcy bondsman refused to pay on the grounds that their liability ended once the practical completion certificate was issued. Court said no.
Simon Carves Ltd v Ensus UK Ltd (2011) Construction of a bioethanol plant in the UK. Contract was IChemE Red Book. Simon Carves (contractor) provided an ondemand bond expiring on the 31 st August 2010. Contract provided that, on the issue of the acceptance certificate, the bond would be null and void save in respect of any pending or previously notified claims. Following handover, but before the issue of the acceptance certificate, a dispute arose concerning odour emissions.
Simon Carves Ltd v Ensus UK Ltd [2011] Ensus issued a number of defect notices. Acceptance certificate issued on the 17 th August 2010, and odour emissions were listed as a defect. Contractor agreed to extend the bond, but reserved its position that the bond was null and void since the acceptance certificate had been issued and no claim had been made. Contractor then sought an injunction to prevent calls on the bond. Ensus argued that their defect notices and defects list constituted a claim, and that they were therefore entitled to rely on the bond.
Simon Carves Ltd v Ensus UK Ltd [2011] Court made a distinction between the operation of the contract and the bond. Operation of the contract did not constitute a claim on the bond, and a separate claim was required. Contractor s injunction was therefore granted.
An interesting footnote. What if a claim is made, and paid, by an employer on an on-demand bond, but the contractor believes the amount paid is excessive compared to the actual employer s loss?
Spiersbridge Property Dev t v Muir Construction (2008) A construction contract in Scotland. Muir arranged for an on-demand bond with Bank of Scotland for 10% of the contract sum ( 590,000) in the event that they failed to perform all of the conditions of the contract. Spiersbridge claimed under the bond, and were paid in full. The Bank then reclaimed the 590,000 from Muir, under their counter-indemnity, and Muir paid in full.
Spiersbridge Property Dev t v Muir Construction (2008) Muir however argued that the amount paid out under the bond was significantly greater than the loss Spiersbridge could have suffered as a result of their breach, and that as a result Spiersbridge had made an unjustified gain at their expense. They therefore argued that a term should be implied into the construction contract requiring Spiersbridge to account for that gain, and that they should only be entitled to keep an amount equal to their actual losses. The remainder to be returned to Muir.
Spiersbridge Property Dev t v Muir Construction (2008) Muir s argument relied on two questions:- i) In contract, is there a common-law duty to account for such payments? ii) If the payment made under the bond is greater than the loss sustained, is the payee entitled to keep it?
Spiersbridge Property Dev t v Muir Construction (2008) Is there a common-law duty to account?.it seems to me implicit in the nature of a bond.that, in the absence of some clear words to a different effect, when the bond is called, there will, at some stage in the future, be an accounting between the parties in the sense that their rights and obligations will be finally determined at some future date. Morrison J. in Cargill International v Bangladesh Sugar & Food Industries (1996) later confirmed by the Court of Appeal in Comdel Commodities Ltd v Siporex Trade (1997) So yes.
Spiersbridge Property Dev t v Muir Construction (2008) If the payment made under the bond is greater than the loss sustained, is the payee entitled to keep it? I take the view that if there has been a call on a bond which turns out to exceed the true loss sustained, then the party who provided the bond is entitled to recover the overpayment. Lord Denning in State Trading Corporation of India Ltd v E.D. & F Man (Sugar) Ltd (1981) So no.
Spiersbridge Property Dev t v Muir Construction (2008).absent clear words to the contrary, I would expect that in the normal case the calling of a bond will be followed in due course by an accounting under which the party receiving payment. will retain only the amount of his proved losses. Lord Glennie in Spiersbridge v Muir (2008) He therefore decided that a term should be implied into the main contract requiring the payment to be accounted for.
Warranties An assurance from one party to another that specific facts or conditions are true or will happen. The other party may rely on that assurance and seek a remedy if it is not true. Typically used on projects where property developers immediately sell on completed schemes to third party purchasers.
Why collateral warranties? Because a contractual arrangement provides opportunities to recover economic losses which would not normally be recoverable in tort.
Who needs them? Funders to provide a direct right of action against design teams in the event of defects in design. Employers to provide a direct right of action against sub-contractors. Third party purchasers to provide a right of action against contractors in the event of defects.
Safeway Stores v Interserve Project Services (2005) Chelverton Properties were property developers. Interserve were their contractors. Safeway were the third party purchasers. Interserve entered into a warranty with both Safeway and Chelverton. The contractor shall owe no duties or have any liability under this deed which are greater or of longer duration than that which it owes to the developer under the building contract. Intention is clearly that the contractor takes no more risk under the warranty than under the building contract.
Safeway Stores v Interserve Project Services (2005) There was a dispute between Chelverton and Interserve over defects to the two storey car park, which was resolved by a deduction from the final account. Chelverton became insolvent before paying the balance of the final account ( 1.2m). Safeway then paid 400k to rectify the defects and sought to recover under the warranty. Interserve successfully claimed that since they would not have been liable to Chelverton for the costs, they should have no liability to Safeway under the terms of their warranty.
Questions?