Commercial Law – Alleged Breach of Contract – Construction Contract – Guarantees of Faithful Performance

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 pursuer under a performance bond and it had to be decided, if the demand for the bond exceeded the sum ultimately due, whether the pursuer was obliged to account for the excess to the bank or to the defending party.

The persecutor in this case was a development 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 claimed for alleged delays in the completion of the works while the defender counterclaimed requesting an extension of the period in which he could fulfill his obligations.

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

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

Subsequently, the Bank of Scotland issued a performance bond. The performance bond was in the form of a letter addressed to the pursuers and contained substantially the same terms as the preliminary bond referred to in clause 2.10.2.

Then, in November 2006, the pursuer filed a lawsuit demanding that the bank pay £503,193.75 under bail, which the bank duly paid to the pursuer. 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 why the persecutor demanded bail were wrong. The defense attorney argued that the cause was erroneous due to the fact that he had not breached the contract as alleged by the persecutor. He stated that the persecutor was required to account for the sums received by virtue of the bail. The basis for that assertion is that the following term should have been implied in the construction contract:

“…In the event that… the pursuer made a call on bail, he would account to the defendant for the proceeds of the bail, retaining only the amount equivalent to any loss suffered by the pursuer 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 effectiveness. This meant that the dispute over whether the defender had breached the construction contract, as the persecutor alleged, had not yet been resolved.

Although a ‘pre-response test’ had been appointed, the parties also disagreed as to whether the pursuer was required to account to the defender for such excess, in the event that he was found to be entitled to less than the one paid by virtue of the jump.

Consequently, the persecutor argued that his duty to render accounts was owed to the bank and not to the defender. The pursuer’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 reached a mutual decision to settle the matter in a pre-trial discussion. The decision issue during the debate was:

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

(a) To the bank; gold

(b) to your opposing contracting party?”

The pursuer’s attorney said there were three contracts that needed to be considered:

§ The bond 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 should account for the excess 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 chaser would return the excess to the bank. This would correspond to a corresponding term that would be implicit in the banking contract according to which, if the defender had already paid it, the bank would reimburse said amount to the defender.

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

The defendant’s attorney stated 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 pursuer 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 costly.

It would be much better for the bank to be able to rely on its counter-indemnity from the defender at the time bail was required. If the bank had a right of action to recover the excess, counsel for the pursuer argued that those difficulties could be overcome by an assignment of the right of action by the bank to the defendant. However, this would not work as the terms of the bond prohibited the bank from giving up its rights without the consent of the pursuer. Furthermore, if the bank had been paid by the defender in accordance with his counter-indemnity, he would not have suffered any loss and would not have the right to assign.

After much deliberation, the court held that when a demand was made on a performance bond for an amount ultimately found to exceed the sum due to the party making the demand, 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 pursuer’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 one of which share best gave the transaction its intended commercial efficiency.

The court took the view that the natural implication was an implication of the kind advocated, that is, an implication of a term in the construction contract as follows:

‘…In the event that…the pursuer made a call on bail, he would account to the defendant for the proceeds of the bail, withholding only an amount equal to any loss suffered by the pursuer as a result of the breach of contract of the defender, if any.

It was held that an implicit term in the construction contract had none of the disadvantages of involving the bank on the merits of the case. In addition, it also allowed to establish what loss, if any, the persecutor had suffered as a result of the alleged breach of the construction contract by the defender. 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 on a counter-compensation in terms of which the defender would in turn indemnify the bank for a similar amount when claiming bail.

In the event that the bail demand was excessive, the defendant 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 had to account for this excess. However, this left a potential problem. The problem is that if the defender goes bankrupt after the bank has posted the bond, but before the bank can claim against the defender for counter-indemnity, then the bank could lose if it had not taken the collateral.

This potential problem was seen as 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 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 issues discussed nor does it constitute legal advice. Its sole purpose is to highlight general issues. Specialized legal advice should always be sought in relation to particular circumstances.