REUTERS | Mathieu Belanger

Bonds and warranties: specific performance v substituted performance?

We are often contacted by clients when a main contractor has failed to provide documents that they are contractually obliged to procure, such as sub-contractor warranties, performance bonds or parent company guarantees. The terms of these documents are usually agreed and appended to the building contract, but the contractor is only required to provide these once the works have commenced. If the contractor fails to do so, what can the employer do?

Market practice

Often an employer will add financial sanctions into a building contract for non-provision of documents. For example, the right to withhold a lump sum or an agreed proportion of the next interim payment until the documents have been provided. The amount that can be withheld is heavily negotiated, and will be nowhere near the amount that would be covered by a performance bond or recoverable under a warranty.

If financial sanctions have been levied and the documents are still not forthcoming, the next step would be a claim for breach of contract and the resultant damages. However, on a practical level, it can be very difficult to show actual loss for failing to provide a warranty or performance bond during the course of the works. The loss will not usually become apparent until a breach occurs or a defect appears.

The only other possible claim is for specific performance of the obligation to provide the documents but, historically, the courts have not favoured this in construction disputes and it is seldom granted (particularly where it would require the court to supervise performance).

Until recently this would have been the end of the story but Liberty Mercian Ltd v Cuddy Civil Engineering Ltd may have changed this.

Liberty Mercian v Cuddy Civil Engineering Ltd

Liberty Mercian and CCEL have been before the TCC on three separate occasions in the last 18 months, most recently in October last year.

Ramsey J dealt with several issues in the first two judgments, including establishing which company was the correct contracting entity (it was CCEL) and whether obligations to provide a performance bond and warranties survived termination of the contract (they did).

Once this had been established, Ramsey J’s main focus was on whether to grant specific performance of these obligations. In his second judgment, he stated that he would have been inclined to grant specific performance but was reluctant to do so where the obligations to provide the performance bond and warranties may prove impossible to perform.

Ramsey J gave CCEL further time to use its best endeavours to obtain both the performance bond and the warranties, so the position on alleged impossibility could be properly considered at a later date. In the third hearing, he considered the issue of impossibility.

Performance bond

CCEL argued that, despite its best endeavours, it had been impossible to obtain a performance bond. The financial institutions it approached had refused to provide one in the form required by the contract, given the advanced stage of the works and the very real prospect that the bond would be called. It had also been suggested that they would only have considered issuing a bond if CCEL made a cash deposit equal to the value of the proposed bond, plus a premium for issuing the bond, which doesn’t make much commercial sense.

Counsel for Liberty Mercian asked for equivalent performance by way of a payment into court of the sum of £420,000 and dug up some very old authorities (including two eighteenth century decisions) to justify this. On the basis of these authorities, Ramsey J held that, if a form of performance would provide Liberty Mercian with equivalent rights to those under a bond, then there may (in principle) be an order for specific performance by way of substituted performance. As such he ordered a payment into court of the sum of £420,000 to stand as equivalent to the bond, and on the same terms and conditions.

Sub-contractor warranties

CCEL also said that despite its best endeavours, it had been unable to obtain warranties from the sub-contractor (Quantum), who was insolvent and had been dissolved. However, there was evidence that Quantum had held professional indemnity insurance that may respond to a claim under the warranties and for that reason Ramsey J ordered CCEL to obtain them.

Ramsey J held that the enforcement of an obligation to obtain a warranty from a party that was insolvent and had been dissolved would not, in general, be a matter for which the court would order specific performance (on the basis that it would serve no useful purpose). However, in this case, given there was evidence that the warranty may be backed by insurance cover, it was appropriate to grant specific performance against CCEL.

Implications of Liberty Mercian v CCEL

This is a very interesting decision. Specific performance is an equitable remedy that is only granted at the court’s discretion, and usually only where performance would be possible. In Liberty Mercian v CCEL, the court considered significant obstacles that the contractor highlighted, but still found a way to order specific performance.

In relation to the performance bond, specific performance by way of “substituted performance” by payment into court was granted despite the fact that the court would have to supervise that payment. This is most unusual, and I don’t think that it can be relied upon as a generic precedent given how much turned on the specific facts of this case.

In relation to the subcontractor warranty, the court relied upon evidence that there had been professional indemnity insurance in place in 2012, even though it was not currently maintained (as Quantum were insolvent and dissolved). There was no guarantee that the insurers would respond to any claim, since professional indemnity cover is typically provided as an annual policy and operates on a claims made basis. However, the court felt that the employer ought not to be deprived of a potential claim when the position was not entirely clear. Whether it will ultimately be successful in a claim remains to be seen.

In the absence of financial sanctions in a contract (as set out above), contractors have often assumed that, if they can show that it is impossible to obtain a warranty, bond or guarantee for whatever reason, they are then off the hook. Employers may also have felt at that stage that they have run out of options and stopped pushing the contractor to provide the documents. This decision suggests that these assumptions may no longer hold true in all cases.

Only time will tell whether Liberty Mercian v CCEL will be treated as of general application or confined to its somewhat unusual facts.

Berwin Leighton Paisner LLP Geraldine Laing

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