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This is the sad tale of the £11 million refurbishment project at Hackney Empire Theatre. Following the insolvency of its main contractor, Sunley Turiff Construction, it was left facing a £3.2 million hole in its finances. The new theatre’s first season of productions and the Christmas pantomime had to be cancelled and tickets refunded.
You would have thought the theatre could take some comfort from the fact that a £1.1 million performance bond had been taken out with Aviva to cover any damages caused by breaches of the building contract. But, instead, Hackney Empire was left fighting a claim by Aviva that the performance bond had been discharged as a result of actions Hackney had taken to assist the contractor in completing the building contract.
The building contract provided for a completion date of 2 September 2002. The contractor began working on the refurbishment but from an early stage it suffered from cash flow problems. After numerous discussions, Hackney agreed to pay the contractor £1 million on account, in a series of instalments, in order to ensure that the works were completed by a deadline of 31 May 2003. The parties entered into a side agreement in February 2003 in which the contractor agreed to repay the monies advanced if the completion date was not met. However, despite this, in July 2003 the contractor went into administration and the works were abandoned.
Hackney claimed repayment of £750,000 (which was the total monies advanced to the contractor by the time of abandonment) and for the loss of over £3 million it had suffered as a result of the delay. Hackney therefore claimed the full amount of the performance bond from Aviva.
Aviva relied on the rule that if there is any agreement between the parties with reference to the original contract, then a surety, such as Aviva, should give its consent to such agreement. The court will only look at the merits of the variation and consider discharging the bond if consent has not been given and it is evident that the variation is substantial and prejudicial to the surety.
Aviva claimed that the side agreement had invalidated the bond irrespective of whether it varied the contract. Hackney had made payments to the contractor under a side agreement without Aviva’s knowledge or consent.
Aviva argued that they did not consent to the agreement and it was evident that its terms were substantial and could be prejudicial to Aviva. The payments made by Hackney had changed the calculation of the risk of the bond being called, and materially prejudiced Aviva because the contractor had increased its indebtedness. Hackney claimed that the rule only applied to the extent that the agreement varied the building contract, and then only if the variation increased the risk of default by the contractor and, therefore, the likelihood that the bond would be called.
The court rejected Aviva’s argument and held that while the side agreement did vary the building contract, it fell within the exceptions to the rule. It determined that the variations were “insubstantial”, in that the side agreement limited the amount of liquidated damages Hackney could claim if the target completion date was met (which was beneficial to Aviva) and provided that neither party would refer disputes to adjudication (which the court held was of no consequence to Aviva). The court held that even if there was a rule (the existence of which was uncertain) that the surety would be released in the event of conduct which, whilst not amounting to a variation of the contract, prejudiced the surety, the payments made by Hackney under the side agreement fell short of being prejudicial to Aviva.
Aviva also argued that the bond only covered the contractor’s obligations under the original contract. Hackney’s response was that the side agreement was a variation to the terms of the building contract. As the bond stated that no alteration of the terms of the building contract would release the surety, it would cover this type of variation. However, the court accepted Aviva’s argument that the obligation to pay £750,000 did not fall within the original bond. That was a new obligation created by the side agreement, for which Aviva was not liable.
The judgment highlights the problem of granting concessions when the continued solvency of a contractor is in doubt. It should not be assumed that the bond will still be valid if the building contract is varied.
Bonds are interpreted very strictly and sureties will not be slow to raise technical arguments to challenge a claim. Material amendments to the underlying contract could invalidate them. When obtaining a bond, it is crucial to include wording so that the bond will not become void if the contract is varied or an indulgence is granted to the contractor. Side agreements do not automatically come under the ambit of the bond and consent should always be obtained from the bondsman before they are entered into.