Construction contract – Surety – JCT standard form construction contract (1998 ed) – Appellant giving bond to secure performance of contractor’s obligations to respondent employer – Respondent agreeing to make payment to contractor on account of claims for loss and expense to be repaid if contractor failing to substantiate such claims – Contractor’s employment later terminated for non-completion – Appellant held liable under bond – Whether liability discharged as a result of earlier payment by respondent to contractor – Whether such payment constituting advance payment of contract price without consent of surety – Appeal dismissed
The respondent employed a contractor, on a construction contract in the JCT standard form (1998 ed), to carry out works on a major renovation of the Hackney Empire theatre. The performance of the contractor’s contractual obligations was secured by a bond for nearly £1.107m executed in favour of the respondent by the contractor and the appellant as its surety. The bond contained an “indulgence clause”, which provided that the appellant would not be released from liability by any alteration in the terms of the contract or in the extent or nature of the works, or any allowance of time by the employer or the architect under the contract or any forbearance or forgiveness in respect of any matter concerning the contract.
The works fell significantly into delay, with the parties disagreeing about the cause. The contractor denied that it was at fault and claimed that the delays were the result of the volume and content of the instructions issued by the architect, such as to entitle it to extensions of time and substantial sums for loss and expense; it threatened an adjudication. In those circumstances, the respondent and the contractor concluded a side agreement under which the respondent paid £750,000 to the contractor on account, pending the provision of proper particulars of the contractor’s claims; that sum was to be repaid if and to the extent that those claims were not established.
The architect subsequently issued a certificate of non-completion, recording that the contractor had failed to complete the works by the contractual completion date. The respondent then terminated the contractor’s employment pursuant to clause 27.3.4 of the construction contract.
The respondent brought a claim against the appellant for the full sum secured by the bond. The respondent contended that: (i) it had been discharged from all liability under the bond by reason of the respondent’s conduct in making extra-contractual payments of £750,000 to the contractor; and (ii) in any event, the respondent was limited to claiming £205,000 in liquidated and ascertained damages for delay, which had fallen due under the contract prior to its termination, since the respondent had not operated the contractual machinery under clause 27 for the recovery of further sums.
The respondent’s claim was allowed in the court below. The judge held that the appellant was not discharged from liability under the bond since the side agreement was a separate free-standing agreement that did not vary the construction contract. He further found that the respondent had a good claim for damages against the contractor, which the appellant was liable to meet up to the limit of the bond. The appellant appealed.
Held: T§he appeal was dismissed.
(1) A surety might be discharged from liability where, without the consent of the surety: (i) there had been a material variation of the original contract to which the surety had not consented; (ii) the time for performance of the original contract had been extended; or (iii) the employer had made advance payments of the contract price. Those were all examples of the principle that the creditor must not transact the surety’s affairs without consulting him. In such cases, the surety would be discharged unless it was evident that the alteration was insubstantial or that it could not be other than beneficial to the surety: Holme v Brunskill (1878) 3 QBD 495 applied. Advance payment of a contract price could prejudice the contractor’s surety in two ways. First, the incentive for the contractor to complete was reduced, since less of the contract price remained to be earned. Further, the employer held less retention money, with the result that, if the contractor defaulted, less of the fund earmarked for the project was available to be paid to other contractors who stepped in and completed the work. Both of those matters increased the risk that the employer would suffer a loss and seek reimbursement from the surety: Calvert v London Dock Co (1838) 2 Keen 638 and General Steam-Navigation Co v Rolt (1858) 6 CB (NS) 550 considered.
The practice of including “indulgence clauses” in guarantees and bonds had grown up against that background; such clauses set out what could be done without needing to consult the surety. There was no standard wording for such clauses and each fell to be construed according to its terms and by reference to its context.
Accordingly, where an employer paid instalments of the agreed contract price before those instalments fell due under the terms of the original contract, then the surety’s liability might be discharged unless the surety had consented or there was an appropriate indulgence clause. However, the position was different where the employer paid sums to the contractor under a separate agreement from the one that the surety was guaranteeing. In those circumstances, the surety remained liable in respect of the original contract, but not in respect of the other payments or loans made under the separate agreement: Trade Indemnity Co Ltd v Workington Harbour and Dock Board [1937] AC 1 applied.
In the instant case, the parties had not altered the original construction contract but had entered into a separate side agreement under which the respondent effectively loaned £750,000 to the contractor. The contractor was to retain that money in the event that it subsequently established a loss and expense claim for £750,000 or more, but was to repay either the full amount or part of it if, respectively, it either failed to establish such a claim or established a claim in a lesser sum. The £750,000 was not part of the original contract sum, or a sum certified as due by the architect or otherwise falling due under the contractual provisions. It could only be seen as a sum paid outside the contract and for extraneous reasons. Consequently, it did not have the effect of discharging the appellant from liability under the bond.
(2) The appellant’s liability was not limited to the £205,000 liquidated and ascertained damages that had fallen due as at the date when the contractor’s employment ended. The right to claim damages survived notwithstanding the respondent’s termination of the contract under clause 27.3.4. Where an employer terminated the contractor’s employment under clause 27 of the standard form construction contract, its financial remedy was not thereafter limited to operating the procedure set out in that clause and then recovering whatever debt was thereby found to be due. The employer could exercise all of its rights under clause 27 and also pursue its general remedies, such as claiming damages for breach of contract. The employer was not put to an election between the two remedies. However, clause 27 did not permit double recovery and, in so far as losses were recovered under clause 27, they could not be recovered under the guise of damages.
Sally Dobson, barrister
