When a bond is only as good as its words

Performance bonds continue to cause considerable difficulty in the construction industry. The 1994 case of Perar BV -v- General Surety and Guarantee Company highlighted the difficulty that an employer could face in seeking to obtain payment under a performance bond, following the insolvency of its contractor.

It was held in this case that once the contractor's employment had been automatically determined under the provisions of the JCT contract as a consequence of the contractor entering into administrative receivership, thereafter the contractor had no obligation to continue with the works and therefore was not in breach for failing to do so. Since the contractor was not in breach, the surety did not become liable under the bond.

The practical effect of this decision was that in a circumstance in which the employer most needed the bond, that is the insolvency of the contractor, the bond proved to be unavailable.

Many commentators at the time blamed the archaic wording of the performance bond and urged practitioners to use modern language to explain and define more clearly the nature of the undertakings contained in the bond.

It was also accepted that the JCT contract was at fault and accordingly amendment 7 was published to JCT 81, the With Contractor's Design form. This amendment revised the determination provisions of the contract and added a new clause 27.8, whereby the relevant provisions were now "without prejudice to any other rights or remedies which the employer may possess".

Curiously, this particular clause had been in place in the JCT 80 standard form since amendment 11 published in 1992.

Armed with relatively clear language in the performance bond and appropriate revisions to the JCT contract, it was assumed employers might feel more confident in the security provided by such bonds.

The case of Tower Housing -v- Technical and General Guarantee Company proved otherwise. Tower entered into a contract with a building contractor called Deltamar Construction in April 1995 in the JCT 81 form. A performance bond was provided which stated that "...in the event of a proven breach of the contract by the contractor and/or in the event of the determination of the contractor's employment under the contract for reasons of insolvency, whether such determination is automatic or otherwise... (the surety shall) ...satisfy and discharge the net damages sustained by the employer as established and ascertained pursuant to and in accordance with the provisions of the contract..."

The bond also went on to state that "nothing therein contained shall oblige the employer to await completion of the works prior to making any proper demand hereunder".

Administrative receivers were appointed to Deltamar prior to completion of the works and new contractors were engaged under the direction of the employer's agent to complete the works. It was immediately apparent that the cost to complete the works in these circumstances would be at least £80,000 in excess of the outstanding balance of the contract sum, and that the surety would therefore be likely to be asked to pay the full amount of the bond of some £44,000.

In due course a claim was made for payment under the bond, and faced with the refusal to pay, a writ was issued followed by a summons for summary judgment under Orders 14 and 29 of the Rules of the Supreme Court.

In affidavits in support of the summary judgment, the employer presented an anticipated final account showing projected losses of the employer in excess of the amount of the bond.

All of this appeared perfectly clear cut and yet His Honour Judge Humphry Lloyd QC refused to grant summary judgment in respect of the amount claimed. The difficulty lay in the fact that the performance bond was drafted in such a way that the damages to be recovered by the employer would have to be "established and ascertained" properly in accordance with the building contract. Since the final account for the completion works had not been concluded this was not possible. The anticipated final account prepared by the employer's representatives was insufficient for the application of summary judgment.

Even the proviso that the employer could make a claim prior to completion of the works could not help the employer since it too required a "proper" demand to be made under the bond. No proper demand could be made until the final account for the completion contract had been prepared with all sums properly calculated in accordance with the contract.

What then of the new clause 27.8 of the JCT contract? Unfortunately this was not tested since it was not suggested by the employer that there had been a breach of contract by the contractor which would be the subject of this clause. It is doubted whether this provision could in any event have the desired effect. Given that the contract provides for the automatic determination of the employment of the contractor upon the insolvency event, it would seem there can be no opportunity for the employer to "accept" the repudiatory breach of the contractor.

In consequence, despite the changes which followed Perar, it appears that the employer may still be denied the intended use of such a bond in the event of the most significant risk occurrence, namely the insolvency of the contractor.