PERFORMANCE BONDS (REVISITED)

1. Introduction The issue of bonds, whether performance bonds or advance payment bonds still remains a major cause of litigation in the insurance industry today. The terms and conditions of bonds are dictated by the insurer with little input from the contractor or principal, yet the current wordings of many bonds in the market today do not adequately protect the insurer. 2. Presumption against on-demand bonds A bond may either be “on-demand” or “conditional”. However, in the interpretation of the type of bond, there is judicial authority that there is a presumption against a finding of an on-demand bond. In Marubeni Hong Kong v Govt of Mongolia (2005), the Court of Appeal in England held that, in the case of non-bank bonds, there is a very strong presumption against the existence of an on-demand bond and it would require clear words to the contrary to rebut the presumption. 3. Applicable laws Bonds are recognised as a category of general insurance business. See section 2(3)(g) of the Insurance Act 2003. Therefore, the provisions of the Insurance Act together with the common law principles of insurance are applicable to and govern the operation and interpretation of bonds. Bonds are also contracts and therefore principles of contract law such as privity of contract, frustration and misrepresentation also apply to bonds. 4. Insurer cannot invoke principal contract The insurer is not a party to the main contract between the principal and the contractor and cannot invoke the terms and conditions of that contract. In African Insurance Dev. Corp. v Nig. Liquified Natural Gas Ltd (2000), the contractor failed to execute the contract within the stipulated time and the principal sued the insurer to enforce the performance bond. The insurer invoked the arbitration clause in the main contract and filed a motion for stay of proceedings. The Supreme Court held that on the principle of privity of contract the insurer was not a party to the main contract and therefore it could not invoke the arbitration clause. 5. Defences of insurers 5.1 Now, what are the defences available to an insurer when a bond is called and what conditions can be inserted to protect an insurer? In performance bond claims the main defence is of course that there was in fact no breach of contract by the contractor. Other defences which could be raised are; (i) that the litigation against the insurer was time barred as the performance bond required any legal action under the bond to be brought within three months after the expiration of the bond; (ii) that the insurer was not notified in writing by the contractor or principal about the contract variation within fourteen days from the date of the variation; (iii) that the default or breach of the contractor was not proved and liability under the bond was contingent upon the liability of the contractor; (iv) that proof of the breach was not supported by an engineer’s or architect’s certificate or other relevant technical documentation; (v) that the value of the performance bond was gradually reduced by the amount of work done by the contractor which work must be ascertained before taking any legal action. Failure to notify variation of contract 5.2 The failure of the principal or contractor to notify the insurer of any major variation of the contract is a valid ground for repudiation. Any such contract variation amounts to a change in the risk assumed by the insurer which requires full disclosure by the insured. See section 55 of the Insurance Act 2003. Avoid liability for damages 5.3 One other matter is that some insurers undertake liability for damages rather than the value of the bond. This is dangerous as damages are wide enough to include sums awarded by the court over and above the value of the bond. Supporting documents 5.4 Now even where the principal insists on an on-demand bond, it can still be worded to require that the demand should be accompanied by supporting documents, such as warning letters or letters of complaints from the principal, architect or engineer, rather than a bare letter of demand. Reduction of liability 5.5 It is beyond dispute that the value of the performance bond is gradually reduced by the amount of work done by the contractor and such work must be ascertained before taking any legal action against the insurer. Nevertheless, many bonds do not expressly state this position. Counter indemnity 5.6 Again, it is standard practice to insist on a counter indemnity to cover the exposure of the insurer but most bonds do not contain any express wording regarding this indemnity. Procedural matters 5.7 Any claim against an insurer following the call on a performance bond must be commenced by way of writ of summons and statement of claim supported by front loaded documents. In a recent case handled by our firm we moved to successfully strike out a bond claim commenced by originating summons on the grounds that the claim was contentious. 6. Conclusion We are still surprised to find bonds that do not adequately protect insurers and leave little room to raise viable defences. Therefore the underwriting and legal departments of insurance companies must co-operate and tighten policy wordings in this area. Jide Bodede 08035130694 Jide@lawfieldslawyers.com