Insolvency and performance bonds

Since the case of Perar BV v. General Surety and Guarantee in 1994, there has been some confusion and misunderstanding as to the implications of this case and whether insolvency amounts to a breach of contract, or more importantly, if it needs to be, when claiming on a performance bond.

This was recently discussed in the case of Ziggurat (Claremont Place) LLP v HCC International Company Plc just before Christmas.

Background

The surety issued a performance bond in favour of Ziggurat, to secure the performance of a contractor’s obligations under a contract for new student accommodation at Newcastle University. The contract was in the form of the JCT Standard Building Contract 2011. This enables the employer to terminate the contractor’s employment under the contract upon insolvency, and provides for an accounting exercise to take place upon completion of the works by a third party. This produces a debt due by either the employer or contractor, but would usually be a debt due from the contractor to the employer. However, under this form of contract, insolvency itself is not a breach of contract.

The contractor became insolvent and Ziggurat made a claim under the bond. The bond contained the following key provisions (key wording in bold for emphasis).

“(1) The Guarantor guarantees to the Employer that in the event of a breach of Contract by the Contractor the Guarantor shall subject to the provisions of this Guarantee Bond satisfy and discharge the losses and damages sustained by the Employer as established and ascertained pursuant to and in accordance with the provision of or by reference to the Contract and taking into account all sums due or to become due to the Contractor.

 (2) The damages payable under this Guarantee Bond shall include (without limitation) any debt or other sum payable to the Employer under the Contract following the insolvency (as defined in the Schedule) of the Contractor.”

The surety sought clarification on the interpretation of the bond, as it claimed that Ziggurat had to first establish that its losses resulted from a breach of contract by the contractor. Usually, to claim under a conditional performance bond, a beneficiary needs to establish both breach of contract, and damages.

Decision

On the facts, the court decided that a breach of contract was not required to trigger the surety’s liability under the bond, as a debt payable under clause 2 of the bond, following the contractor’s insolvency, was sufficient. Clause 2 was deemed to be separate, and a stand-alone obligation, to clause 1, otherwise clause 2 would be rendered redundant.

In any event, the court decided that, even if its initial view was wrong that a breach was not required, there had in fact been a breach as it was clear that the contractor’s failure to pay the debt due under the final accounting provisions in the contract did amount to a breach of contract. Damages payable under the bond were the amount of that debt, up to the maximum bond amount. Even though insolvency itself was not a breach of contract, it would almost always have the same effect; namely the contractor failing to complete its obligations under the contract and/or not being in a position to pay the debt due to the employer upon completion of the works- both would be a breach.

Implications

This case is a useful reminder of the correct understanding of the Perar case. It doesn’t matter whether or not insolvency is expressed to be a trigger under a bond. A performance bond will still respond if the contractor becomes insolvent, even in the absence of an express reference to insolvency (which many employers and beneficiaries request). This is because, even if a breach of contract is required in the wording of the bond, the contractor’s failure to pay the debt due on completion of the works by a third party amounts to a breach. Accordingly, the additional language that some beneficiaries request, to refer to insolvency, is unnecessary.

A final point to note is that, on the facts in this case, the court decided that the contractor’s dispute over the validity of the employer’s termination of the contractor’s employment under the contract did not affect the court’s finding that there had been a breach of contract resulting from the subsequent insolvency of the contractor. As from the date of the insolvency, regardless of any arguments that the employer was in breach of contract for incorrectly terminating prior to the contractor’s insolvency, the final accounting exercise (resulting in a debt due to the employer) still applied.

The other point is that the Court said that the amount of the debt was challengeable by the contractor and, therefore, by the surety.