In a recent case*, the Scottish Court of Session reiterated the importance of acting consistently with agreed procedures for making a demand under a performance bond. The ruling emphasised that it is irrelevant whether or not the procedures appear to have significant practical effect.
The Scottish Coal Company Limited (the Contractor) was granted planning permission for a surface mine at Dalfad in Aberdeen, but it was subject to various restoration obligations that were secured by an on demand bond provided by Zurich Insurance.
The Contractor went into liquidation in 2013 and the liquidators refused to perform the restoration obligations under the agreement. Therefore Scottish Coal was in breach of its agreement with East Ayrshire Council (the Beneficiary).
In June 2013, the Beneficiary issued the Guarantor with a demand to begin the process of recovering the monies payable under the bond which totalled £3.344million. Zurich declined to make payment.
Zurich’s position was that the demand was invalid as it was not consistent with the relevant requirements which were outlined in the bond. It was accepted that the demand needed only to be in ‘substantially the form’ of the demand referred to in the bond, but nevertheless, the Beneficiary had failed to do this.
The demand did not include the necessary statements regarding the Beneficiary’s correspondence with the Contractor. The missed information included confirmation that:
- The Beneficiary had provided Scottish Coal with written notice of its failure to perform the restoration obligations not less than 60 business days prior to the date of the certificate
- Scottish Coal had subsequently failed to remedy the breach.
Zurich argued that the Beneficiary side-stepped the procedures to capitalise on a commercial advantage which was due to expire. Had the Beneficiary postponed the issue of the demand for 60 days whilst they complied with the requirements, they would have been entitled to less than half of what they were claiming.
The Beneficiary justified their actions by stating that the procedures were of no practical necessity, nor were they an absolute condition precedent to liability under the bond. The basis for this argument was that the steps were designed for temporary breaches, as opposed to major events (particularly those that are common knowledge), and in any event, it was clear that Scottish Coal’s liquidators were not prepared to comply with the written notice and remedy the breach.
It was ruled that the demand should have been structured in line with what was stipulated in the bond. The document that the Beneficiary had relied upon was invalid and, therefore, the claim failed.
The agreed format for the demand was particularly relevant to the decision. It will never be acceptable for a party to decide that sections of an agreement are not necessary, because of circumstances present at the time. The requirements were deliberately included in the bond and agreed upon by both parties at the time of contracting.
Zurich would justifiably wish to ensure that the demand was made in accordance with the bond requirements as otherwise; they may have difficulty in enforcing any indemnities.
What does this mean going forward?
Where administrative steps are required under a contract that has been created and consented to by those involved; there must be strict adherence to the procedure. Allowing the Beneficiary’s actions would have set a precedent that allowed scope for uncertainty, which would be at odds with the function of an agreement, particularly a bond.
Under on demand bonds, beneficiaries are in a favourable position as they are not required to prove any loss before demanding payment. However, this case highlights that, should a beneficiary stray from the agreed procedures for making a demand, the court is likely to be unforgiving.
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*East Ayrshire Council v Zurich Insurance Public Limited Company (2014)