February 22, 2012

Dont break the bond!

In the current economic climate the existence of a performance bond is especially important to property developers employing building contractors. It is equally important that employers do not do anything during the course of the project which could invalidate their security. A bondsman will inevitably look to avoid paying out under a bond where it can.

In Hackney Empire Limited v Aviva Insurance UK Limited, Hackney employed a contractor to carry out certain works. Hackney received a bond from the contractor. During the project the works ran into difficulty and delay. Hackney and its contractor agreed a commercial deal to keep the works going. In return for a revised completion date, Hackney agreed to pay instalments totalling £1million on account of the contractor’s loss and expense claims which had not yet been substantiated. This agreement was later recorded in a side agreement. The agreement confirmed the £1milion payment, and imposed a cap on the LADs recoverable under the original contract.

The contractor became insolvent before the works were completed. By that time Hackney had paid instalments under the side agreement totalling £750,000. Hackney made a claim under the bond against Aviva, the surety. Hackney claimed the original amount of LADs and the return of the £750,000 paid under the side agreement.

Aviva sought to avoid any liability on the basis that Hackney had agreed changes to the original contract without obtaining Aviva’s consent as surety.

The court decided that the side agreement did vary the LADs provision under the original contract. However, because the reduced LADs under the side agreement benefitted rather than prejudiced Aviva, this did not invalidate the bond. Hackney was able to recover LADs against Aviva. However, if the variation had been one which prejudiced the surety then it is clear that the bond would have been invalidated.

Hackney was unable to recover the £750,000 back from the surety. This was because this sum had been agreed and paid under a separate agreement from the building contract and did not itself vary the terms of the building contract. Aviva’s bond was only in respect of liabilities under that building contract – not the separate side agreement.

This case provides a cautionary tale for Employers. The terms of a commercial deal are not guaranteed to be caught by an existing bond; further that deal may also invalidate the bond if the original contract has been varied and/or the new terms are prejudicial to the surety. If in doubt, consult with the surety before proceeding, and include wording in the bond which allows variations to the building contract. These steps may prove key to preserving your security in the longer term.

If you would like to discuss any of the issues raised in this e-brief please contact a member of our construction team on 0113 227 0100 or email construction@gordonsllp.com.