Managing bonds and securities in the time of Covid-19

By Katherine Butler, Associate, Fenwick Elliott

The construction industry is no stranger to the impacts of cyclical market shifts. However, the economic climate in the post-Covid era may feel more like a cliff edge than a downturn. Contractors (and Employers) the world over are feeling the pinch and, as a result, project security is becoming a much more prominent issue. 

This article will look at recent developments in the UK concerning bonds, how Singapore has sought to manage the impact of Covid-19 on construction securities, and finally some points to note when following the UK Government’s advice on responsible contract behaviour.

Bonds in the UK

In summary, bonds are forms of security which are separate from the underlying contract (say, the construction contract) to which they relate. Surety contracts are agreed between three parties – the Contractor (aka the Principal), the Employer (aka the Beneficiary) and the Bondsman (aka the Surety). Under these contracts, the Bondsman promises to pay a specified sum to the Employer upon the happening of a specified event related to the Contractor’s performance of the underlying contract. 

Bonds, in the UK market, generally fall into two main categories – performance (or conditional) (“PBs”) and on demand (“ODBs”), with the former being much more common on domestic projects. These instruments are materially different from each other and when/how an Employer can get this money will depend on what type of bond it has:

• ODBs have been described as equivalent to a discount on the overall contract price.1 This is because Employers can simply ‘demand’ the sum so long as it complies with the terms of the bond itself. 
• By contrast, PBs operate as guarantees of the underlying contract and will generally only be triggered where the Contractor is in breach of its obligations thereunder. This means that an Employer must demonstrate its losses arising from a breach of the main contract before the bond will answer. The wording of PBs is often based on the Association of British Insurers (“ABI”) model form of guarantee bond which requires losses to be “established and ascertained pursuant to and in accordance with the provisions of or by reference to the Contract and taking into account all sums due or to become due to the Contractor”.  

A successful call on a bond can have serious consequences for the Contractor in terms of both cash flow and its creditworthiness for getting bonds in the future. Notwithstanding, recent trends in the English courts indicate that resisting payment under a bond is becoming more difficult. 

In respect of ODBs, the 2015 decision in MW High Tech Projects UK Ltd v Biffa Waste Services Ltd2 details that payment will only (generally speaking) be resisted where the bank or bondsman has notice of clear fraud.3 This is a high threshold test and therefore occasions when payment under an ODB is restrained will be limited - see Issue 14.

Until recently, the position as to when PBs should pay out was a lot less clear cut. Specifically, there was very little guidance offered by the courts as to how an Employer should “establish and ascertain” its losses in respect of bonds using the ABI wording. This changed in February 2020 with the decision in Yuanda (UK) Company Limited v Multiplex Construction Europe Limited and ANZ Bank.4 Here, Mr Justice Fraser focused on the requirement for sums to be “established and ascertained pursuant to and in accordance with the provisions of or by reference to the Contract” (emphasis added). His Lordship went on to determine that sums properly due under the contract would satisfy the requirements of being ‘established and ascertained’. This specifically included sums determined as due by adjudication awards and/or independent certification.

In relation to the specific facts in the case, if Multiplex obtained an adjudicator’s award in its favour, then the bond should respond. This judgment ends the speculation as to whether a party calling the bond had to wait until the overall balancing of the final account had taken place to ‘establish and ascertain’ the sums payable. Likewise, having the matter finally determined by the courts before the bondsman should pay out was also deemed to be unnecessary. 

The decision in Yuanda offers clarity, but not necessarily comfort, as to when a PB can properly be called. Adjudication is recognised as a necessarily ‘rough and ready’ process, which is why awards are binding but not final. Given this, and particularly considering the consequences that calling a bond has for the Contractor, the decision has the potential to cause unfairness. However, the judgment is evidently influenced by the commercial realities of project security and the need for PBs to actually offer benefit to their holders. In this case, the fact that the PB in question was very close to expiring may have swayed his Lordship’s decision towards immediacy. On this basis, we anticipate future arguments that this decision rests on its facts and is not of general application. Overall, to be continued…     

Temporary Measures in Singapore

In Singapore, the Government enacted the COVID-19 (Temporary Measures) Act 2020 (the “Act”) in April last year. This legislation, and numerous subsidiary regulations, provides ‘relief’ in respect of performance obligations and/or other measures (e.g. restrictions on domestic court proceedings and/or issuing bankruptcy petitions) for identified types of contract (the “Scheduled Contracts”)5.  Scheduled Contracts include construction contracts and any PBs granted under them. Under section 6 of the Act, the beneficiary of a construction contract PB is prevented from making a call unless the bond is within 7 days of expiring. This provision also offers automatic extensions to a bond’s expiry date, until 7 days after the end of the ‘Prescribed Period’6 provided the PB in question expires more than 7 days from the date of application. 

As is indicated in the Act’s full title, these measures are temporary and the original Prescribed Period was due to last six months from commencement. This period has since been extended twice and, at the time of writing, is due to expire on 31 March 2021. It will then remain to be seen whether bondsmen are inundated with calls on PBs thereafter. However, on the basis that the Act also provides relief from performance, including a statutory entitlement to significant extensions of time, it may be more difficult for Employers to establish damages.

‘Responsible Contractual Behaviour’ in the UK 

The Act offers a significant relief package which aims to stave off the worst effects of the pandemic for both Contractors and Employers. In giving such relief a statutory footing, Singapore has arguably taken one of the most robust approaches globally. Meanwhile in the UK, no similar measures have been enacted. Instead, on 7 May 2020, the Cabinet Office issued a note entitled Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the Covid-19 emergency.7 In this note, the UK Government urges parties to act “responsibly and fairly in the national interest” in their contractual dealings during the pandemic. The guidance asks parties to be “reasonable and proportionate in responding to performance issues and enforcing contracts (including dealing with any disputes), acting in a spirit of co-operation and aiming to achieve practical, just and equitable contractual outcomes having regard to the impact on the other party”.8 Further, such reasonableness applies to “exercising remedies in respect of impaired performance, including enforcement of security, forfeiture or repossession of property, calling of bonds or guarantees…”9

Whilst the messaging is that everyone should ‘play nicely’ in these challenging times, there is no moratorium or other formal restriction imposed on parties enforcing performance or commencing disputes. Nevertheless, many in the construction industry are taking a sensible approach and are mindful that relying on their strict legal rights could lead to everyone losing out. One such approach is to vary construction contracts to establish new rules, which reflect the new normal, that will be most beneficial/least devastating to all involved. Taking such a reasonable step can, however, have significant consequences when it comes to project security. 

As detailed above, PBs involve three parties – the Principal, the Beneficiary and the Surety. In the event that the Principal and the Beneficiary agree to alter the terms of the underlying contract without involving the Surety, its obligation to pay out on the bond may be discharged. This is known as the rule in Holme v Brunskill10 and it has been the law for nearly 150 years. Here, the Court of Appeal established that if the parties to the underlying contract wish to amend that contract, they need to consult with and obtain the consent of the Surety. This is unless it is “evident that the alteration is unsubstantial, or that it cannot be otherwise than beneficial to the surety”.11 Insofar as there is no consent and the alterations cannot be shown to be patently ‘unsubstantial’, the Surety is discharged and the security falls away.

Parties with the benefit of a PB should therefore be very careful to ensure that the right consents are obtained before any amendments, even ones considered to be trivial, are agreed. Saving which, the security may survive provided that the bond includes sufficiently broad ‘indulgence’ provisions which allow for variations/amendments of the underlying contract, without needing to refer to the Surety. Either way, this could be an easy trap for the unwary, particularly in the current circumstances where parties are eager to try and make the best of potentially very bad situations.

Conclusion

Whilst legally enforceable relief may be available in other jurisdictions, no such protection is offered in respect of bonds that are subject to English law. Those with the benefit of such security should be alert to the potential ways in which they may, albeit inadvertently, lose it. Likewise, Contractors should note that attempts to resist payment under the securities they have provided may prove fruitless. 

Overall, and not just as a result of Covid, there has been a tightening of the bonds market more generally in recent years. With fewer reinsurers operating and parties needing to satisfy much more stringent requirements, options to obtain bonds are narrowing and protecting creditworthiness has become a key concern. It does, however, remain to be seen whether the trend seen in the Yuanda and MW High Tech cases survives into the post-Covid era. Alternatively, the courts may take a softer approach in line with the Government’s advice to play nicely.  

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• 1. Per Lord Denning in Edward Owen Engineering Limited v Barclays Bank International Limited [1978] Q.B. 159.
• 2. [2015] EWHC 949 (TCC).
• 3. Following the judgment in Edward Owen.
• 4. [2020] EWHC 468 (TCC).
• 5. As detailed in the First Schedule to the Act.
• 6. Being the period within which the relief measures are available.
• 7. Published 7 May 2020. Available at https://www.gov.uk/government/publications
• 8. Ibid. paragraph 14.
• 9. Ibid. paragraph 15(g).
• 10. (1878) 3 QBD 495.
• 11. Ibid., per Cotton LJ at page 505.