Performance bonds are widely used in the construction industry as a means of protecting employers against non-performance or financial default by the contractor.
If such circumstances arise, it is important that an employer can make an enforceable claim for payment under the bond to secure release of funds which may be required to complete works on the project. In a recent Irish case, the court took a new approach to the interpretation of a form of wording widely used in performance bonds and dismissed the employer's application to enforce the bond, noting that the employer had first to exhaust the dispute resolution procedures under the building contract to crystallise the amount to which the employer was entitled.
In Clarington Developments Ltd v HCC International Insurance Company Plc1, Clarington (the employer), entered into a building contract with Sammon Contracting Ltd (the contractor) for the construction of a primary care centre and sports hall at Newbridge.
The parties entered into a performance bond in which HCC International Insurance Company plc was the surety. By clause 1 of the bond, in the event of default by the contractor under the building contract, the surety undertook to satisfy and discharge any damages sustained by the employer by reason of that default "as established and ascertained pursuant to and in accordance with the provisions of the [building contract". Similar language is found in most performance bonds available in the sector.
The employer considered that the works were defective and the contractor went into liquidation. The employer sued the surety to enforce payment under the performance bond and have the High Court quantify damages. The surety was successful in having the proceedings struck out.
This was not the first time that the language in clause 1 has come before the courts. In the 2017 case of Ziggurat (Claremont Place) LLP v HCC International Insurance Co Plc2, the England & Wales High Court heard a case in which the same surety sought to resist making payment under a bond containing the same wording as in Clarington. In this case, the Court reviewed the leading authorities and confirmed the position in England & Wales to be as follows.
- Establishing a debt due under the building contract is an accounting exercise based on the substantive contract provisions relating to quantifying loss. It is the amount "on a statement made by the employer in accordance with the terms of the contract ... damages are calculated by reference to the code of the contract".
- The employer does not need to obtain a judgment against the contractor (or the contractor's agreement to the quantum of debt due). Once the accounting process under the building contract occurs, it is unnecessary for the employer to pursue the contractor in order to make a claim against the surety. "Any other result would destroy the commercial value and purpose of the bond."
A serious issue in Ireland
Back to Clarington, in which the Irish courts, in accepting arguments made by the surety, departed from the position previously understood to apply in the industry, as confirmed in Ziggurat. The Irish High Court considered that the language in clause 1 of the bond meant that damages had to be determined in a manner conforming with the building contract, which included not just substantive provisions on quantifying damages, but also procedural provisions such as dispute resolution. The court stated that "clause 1 of the bond makes it a condition precedent to any claim against the surety that the quantum of damages sustained have first been established and ascertained pursuant to the dispute resolution mechanisms provided for under the building contract". In Clarington, this would mean that the employer would, potentially, have to go through an arbitration with the contractor before it made a claim for payment from the surety.
The judgment in Ziggurat is not binding on Irish courts but it reflects commercial common sense. The interpretation of the court in Ziggurat looked at what a reasonable person would have understood the words to mean "using the language in its commercial and factual context". The Ziggurat decision was not referred to by either party in Clarington and the Irish High Court did not have the benefit of considering this recent decision involving the same surety and bond wording. Unfortunately, the judgment in Clarington risks undermining the value of many performance bonds in Ireland and Irish practitioners will need to come up with innovative solutions to protect the value of these instruments on construction projects.
1  EWHC 3286
2  IEHC 630.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.