Commercial Law – Alleged Breach of Contract – Construction Contract – Performance Bonds

May 28, 2023 0 Comments

The case of Spiersbridge Property Developments Ltd v Muir Construction Ltd [2008] involved a determination related to an action alleging breach of a construction contract. A bank had paid an amount demanded by the persecutor under a performance bond and it had to be decided, if the demand for the bond exceeded the sum finally due, whether the persecutor was obliged to account for the excess to the bank or to the defense.

The persecutor in this case was a developer company and the defender a construction company. The parties entered into a construction contract in June 2005, according to this contract, the defender was to design and build a development consisting of warehouses and office space.

This case focused on the fact that the persecutor was claiming for alleged delays in the completion of the works, while the defender counterclaimed requesting an extension of the period in which he could comply with his obligations.

In accordance with clause 2.10.2 of Schedule 1 of the construction contract, the defender, as the contractor, undertook to execute and deliver to the pursuer, as the employer, no later than 14 days after a written request from the pursuer to make then :

“…A performance bond in an amount not less than 10% of the Contract Sum in the same terms as the draft performance bond set out in Part Five of this Schedule.”

A performance bond was subsequently issued by the Bank of Scotland. The performance bond was in the form of a letter addressed to the persecutors and included substantially the same terms as the preliminary bond referred to in clause 2.10.2.

Then, in November 2006, the persecutor filed a lawsuit demanding that the bank pay £503,193.75 under the bond, which the bank duly paid to the persecutor. The defense attorney stated that he was obliged, by virtue of a counter-compensation that he had granted to the bank, to pay the same amount to the bank and that he had done so.

In addition, the defender stated in his counterclaim that the reasons for which the persecutor demanded the bail were wrong. The defender argued that the cause was wrong due to the fact that he had not breached the contract as claimed by the persecutor. He claimed that the persecutor was required to account for the sums received under the bail. The basis for that statement is that the following term should have been implicit in the construction contract:

“…In the event that…the persecutor made a call on the bail, he would account to the defender for the proceeds of the bail, withholding only the amount equivalent to any loss suffered by the persecutor as a result of the breach of contract of the defender, if any”.

It was argued that such a term needed to be implied as a matter of commercial efficiency. This meant that the dispute over whether the defender had breached the construction contract, as claimed by the persecutor, had not yet been resolved.

Despite the fact that a ‘test before response’ had been designated, the parties also disagreed on whether the persecutor was required to account to the defender for that excess, in the event that it was determined that he was entitled to an amount less than the one paid by virtue of jumping.

Consequently, the persecutor argued that his duty to render an account was owed to the bank and not to the defender. The persecutor’s main concern was that if he paid that excess to the defender, he risked being sued by the bank for an equal amount.

The parties came to a mutual decision to decide the matter in a discussion before the trial. The decision question during the debate was:

“Where a performance bond claim had been made for an amount that was finally found to exceed the amount owed to the party making the claim, was that party required to account for that excess:

(a) To the bank; gold

(b) to its opposing contracting party?”

The attorney for the persecutor said there were three contracts that needed to be considered:

§ The surety contract, that is, the performance guarantee contract between the persecutor and the bank;

§ The work contract, which was the contract between the persecutor and the defender; and

§ The bank contract between the defender and the bank under which the bank agreed to issue the performance bond.

It was necessary to decide to whom the persecutor of the excess should account and the way to achieve it. It was argued that the most sensible route was by implication of a term in the bond contract. The term would state that the pursuer would return the excess to the bank. This would correspond to a corresponding term that would be implicit in the bank contract according to which, if the defender had already paid it, the bank would refund said amount to the defender.

However, this posed some potential difficulties. If the term was implicit in the construction contract where the defendant became insolvent, and the pursuer was obligated to account for the excess to the defendant, the payment by the pursuer would go into the pot for the general pool of creditors of the defendant. This would mean that unless the defender has already paid it, the bank would lose out.

The defendant’s attorney asserted that the term should be implicit in the construction contract. If it were the case that it was the bank that could sue the bail for the excess, the bank would be assuming the burden of trying to prove in litigation with the persecutor that the defender did not breach the contract. Alternatively, that the damage suffered by the persecutor is less than the amount required by virtue of the bond.

It was argued that this was not a task that a reasonable banker would be particularly willing to undertake, not only because of the difficulty of handling such a case, but also because it would be expensive.

It would be much better for the bank to be able to rely on its counter-indemnification of the defender at the time the bond is required. If the bank had the right of action to recover the excess, counsel for the prosecution argued that these difficulties could be overcome by an assignment of the right of action by the bank to the defender. However, this would not work as the terms of the bond prohibited the bank from assigning its rights without the consent of the pursuer. Furthermore, if the bank had been paid by the defender in accordance with its counter-compensation, it would not have suffered any loss and would not have the right to cede.

After much deliberation, the court held that where a demand for a performance bond was made for an amount that was ultimately determined to be in excess of the sum owed to the demanding party, that party was required to account for that excess to the opposing contracting party. In the circumstances of this case, the parties had agreed that the persecutor’s obligation to account for any excess must be based on an implicit term in one of the contracts to which he was a party.

This meant that the question then became which share best gave the transaction the expected commercial effectiveness.

The court was of the opinion that the natural implication was an implication of the type argued by the defender, that is, an implication of a term in the construction contract as follows:

‘…In the event that… the persecutor made a call on the bail, he would account to the defender for the proceeds of the bail, retaining only the amount equivalent to any loss suffered by the persecutor as a result of the breach of contract of the defender, if any”.

An implicit term in the construction contract was held to have none of the disadvantages of involving the bank in the merits of the case. In addition, it also made it possible to establish what loss, if any, the persecutor had suffered as a result of the defendant’s alleged breach of the construction contract. This could be determined in litigation or arbitration between the parties to that contract.

The court further held that it was unrealistic to think that the bank would not have agreed with the defender a counter-compensation in terms of which the defender would in turn compensate the bank for a similar amount when claiming the bond.

In the event that the demand for the bail is excessive, the defender would be left without money, not the bank. According to the court, it seemed quite natural that it was the defender to whom the persecutor would have to account for this excess. However, this left a potential problem. The problem is that if the defender becomes insolvent after the bank has posted the bond, but before the bank can claim against the defender for the counter-compensation, then the bank could lose if it had not taken the guarantee.

This potential issue was considered to be simply a business risk that the bank would decide whether or not to take based on its assessment of the defender’s creditworthiness. As such, the bank could overcome this problem by refusing to issue the bond, or by requiring some collateral before agreeing to issue it.

© RT COOPERS, 2008. This Information Note does not provide a comprehensive or complete statement of the law relating to the subjects discussed nor does it constitute legal advice. Its sole purpose is to highlight general issues. Specialist legal advice should always be sought in relation to particular circumstances.

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