UK: I've Been Expecting You, Mr Bond...

Last Updated: 30 August 2012
Article by Scott McKinnell and Tom Holroyd

A certain secret agent regularly makes his appearance on the small and large screen.

Bonds of the legal kind are also becoming more regular all year round, particularly with the current economic climate and concerns that many employers have as to the ability of contractors to perform contracts and their financial stability. If the contractor fails to perform as he is required to or becomes insolvent, then in principle the employer can recover a sum of money from the contractor.

With the economic downturn, on-demand bonds rather than performance bonds are becoming more popular. 

In theory at least, all an employer has to do if he has an on demand bond is make a call on the bond to release the funds usually by providing a written statement that the contractor is in default in someway.

Performance bonds however usually require the employer to show that the contractor's performance has fallen below a particular standard, which will in practice probably take longer and may require a court judgment, or an arbitrator's or adjudicator's award.

Until recently, the courts have enforced this strict nature of on-demand bonds. Generally only in cases of a clear fraud on the part of the employer could a contractor successfully challenge and prevent a call on an on-demand bond.

But the recent case of Simon Carves v Ensus shows that a more pragmatic approach may now taken by the judiciary. Not only did the court grant an injunction preventing the employer from calling on the on-demand bond but it dispelled the notion that a court would only prevent a call on such a bond in the case of fraud.

The situation seemed simple enough. Simon Carves Limited (SCL) was employed as a contractor by Ensus UK Limited (Ensus) to carry out works at a process plant in Teesside designed to produce bioethanol. Under the terms of the contract SCL was to provide a bond a security for its obligations. The bond was an on-demand bond to which certain conditions were attached. One of these conditions being that once Ensus had issued the Acceptance Certificate the bond was to become null and void regardless of how long there was left to run on it.  The Acceptance Certificate was issued and therefore as far as SCL was concerned the bond had become null and void.

But there was an added complication. The bond would only become null and void on the issue of the Acceptance Certificate if there were no pending or previously notified claims made by Ensus.

Ensus had issued a Take-Over certificate of the plant on 17 February 2010. In March 2010 there began to be complaints received from individuals in the area of foul smelling emissions which later became the subject of Enforcement Notices from the Environment Agency. Ensus notified SCL of these problems initially by a defect notice followed by a variation order before re-issuing the original defect notice again in June 2010. SCL undertook some work in relation to these notices but it seems that the work carried out was unsatisfactory. In spite of this, however, Ensus issued the Acceptance Certificate just fewer than two weeks before the on-demand bond originally was due to expire. There was disagreement between the parties as to who was to blame for the odour problems but in any case an agreement was reached that the bond would be extended (as provided for under its terms) until a final solution was reached. SCL reserved its position as to liability, Ensus carried out some remedial works and the bond was extended into 2011.

When the bond was due to expire again, by now well into February 2011, SCL brought an application for an interim injunction preventing Ensus from calling on the bond given that there were no pending or previously notified claims and therefore that the bond was null and void. Unbeknownst to SCL, however, two days before the hearing at which the injunction was granted, Ensus had made a call on the bond. SCL were then forced to make another application to seek a variation to the original injunction requiring Ensus to withdraw its demand on the bond. This was granted but only until the matter could be heard before the court in a full hearing.

At the full hearing the court had to decide whether Ensus were entitled to call the bond or whether the conditions within the bond itself meant that it was indeed null and void. The judge, Mr Justice Akenhead, had also to consider whether injunctive relief was available to cases such as this where there were no allegations of fraud. Also, if calls on on-demand bonds could be resisted in cases other than fraud was the court required to apply a stricter test that the usual principles for deciding whether or not to grant such relief?

Up until this point almost all cases that had been decided related to allegations of fraud. The very nature of on-demand bonds had made this the case since the employer does not have to prove default of the contractor, merely state that it has occurred. However the court in this case denied that injunctive relief was only available in cases of fraud. It was held that the defect notices submitted by Ensus did not amount to a pending or previously notified claim for the purposes of the conditions attached to the bond. As such, and because SCL had reserved its position from the start, the bond was null and void from the date the Acceptance Certificate was issued. It was true that the bond had been extended pending the investigations into the odour problems but SCL had been unequivocal on reserving its position regarding the bond from the start. SCL had shown it had a serious issue to be tried and that it had a very strong case.

The court denied that a stricter test than the general principles governing injunctive relief need be applied and as such the injunction was to remain in place. In applying the general principles the court decided that SCL could not be compensated by damages. The damage to its commercial reputation, standing and creditworthiness if the bond was called upon would be difficult to quantify. But the preservation of the status-quo meant that the bond needed to be continued pending the outcome of odour investigations. Although Ensus had to withdraw its call on the bond and were prevented from calling for so long as the injunction continued, SCL also had to ensure that the bond did not expire until a final resolution of the odour problems had been reached.

So what does this mean for the future of on-demand bonds? Will we see more successful resistance to calls made on such bonds being upheld by the courts or will they shy away from this decision?

Given the current climate and the fact that every penny counts together with a potentially more pragmatic attitude on behalf of the judiciary we may well now see more resistance to calls on on-demand bonds. Whilst this will be good news to contractors, employers who accept on-demand bonds with conditions attached should be aware that if those conditions are not met and they do not comply with the proper procedures for calling on a bond, they may well find that the bonds are shaken but not stirred.  This promises to make 2012 an interesting year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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