Hackney Empire Ltd v Aviva Insurance UK Ltd [2011] EWHC 2378 (TCC) (21 September 2011)
Teacher will you show to me
The bond between the land and sea
For I am new to mystery
I want everything laid out for me
Introduction
Such magical words of inspiration and wonder as ever from a band that continues to inspire so many. Many listen to their words of wisdom in awe of a teacher so worldly . A just cause indeed.
I continue a journey of sorts headlong through the current gloom.This case may be off great interest to Banking and finance lawyers as it re states some fundamental principles in particular the rule in Holme v Brunskill (1878) 3 QBD 495
Background facts
In essence this was a claim under a bond. Hackney Empire Ltd (“HEL”), owned a theatre in east London. In 2001 and decided to carry out extensive works of refurbishment.
The contractor was Sunley Turriff Construction Ltd (“STC”) who fell into considerable delay and was unable to complete the work. On 2 July 2003 STC went into administration.
STC made numerous claims, all but one or two of which were never properly substantiated. In December 2002, in an attempt to ensure that the works were completed as soon as possible, HEL agreed to advance STC £1 million in three instalments as a payment on account in respect of STC’s claims. The first instalment of £500,000 was paid in December 2002, the second instalment of £250,000 was paid in February 2003 and the final instalment was never paid
As is quite common the defendant, Aviva Insurance UK Ltd (“Aviva”), together with STC, executed a bond in favour of HEL in the sum of £1,106,852.
The bond secured the due performance of STC’s obligations under a building contract for the refurbishment works. The building contract was not entered into until some seven months later, 5 March 2002, but it was common ground that STC’s obligations under that contract that form the subject matter of the bond.
The Issues
The issue was whether Aviva was liable under the bond and, if so, whether that liability extends to STC’s failure to repay the £750,000 that was advanced on account of its claims that were never, in the end, substantiated.
Aviva alleged the payment of the £750,000 and/or the payments in respect of off-site materials were the result of agreements between HEL and STC made with reference to the building contract but without the knowledge of Aviva in circumstances that were prejudicial to Aviva. Thus it alleged its liability under the bond was discharged.
Alternatively that it cannot be liable for the default in respect of the £750,000 because that was not an obligation that came within the scope of its guarantee: in fact, it submits that its only liability would be in respect of HEL’s accrued right to liquidated damages in the sum of £205,000.
HEL contends that Aviva is liable under the bond because the arrangements by which HEL agreed to pay the £750,000 and for the off-site materials were variations to the building contract or acts of forbearance that were permitted under the terms of what is often called an “indulgence clause” in the bond.
The indulgence clause
The key clause in the Bond provided
“this obligation shall be null and void but otherwise shall remain in full force and effect but no alteration in the terms of the said Contract made by agreement between the Employer and the Contractor or in the extent or nature of the Works to be constructed and completed thereunder and no allowance of time by the Employer or the Architect under the said Contract nor any forbearance or forgiveness in or in respect of any matter or thing concerning the said Contract on the part of the Employer or the said Architect shall in any way release the Surety from any liability under the above-written Bond.”
This is a standard variation clauses and similar variation clauses are found in most well drawn guarantees and will be familiar to lawyers.
Aviva alleged they were released from liability by reason of a payment of £500,000 made by HEL to STC on 31 December 2002 and crucially a Side Agreement between STC and HEL of 26 February 2003.
HEL case was that
- the general rule is that a surety will be discharged if there is a variation to the principal contract. That is only the case if the variation of the principal contract is such that it increases the risk of default by the principal and consequently the likelihood that there will be a call under the bond.
- This is to be contrasted with a variation which merely affects the amount of the surety’s ultimate liability but leaves the risk of default unchanged: see a statement to this effect in Andrews and Millett, Law of Guarantees, 5th edition, pages 362-3.
- It cannot be said that the original obligations of the contract were swept away and that a new obligation was put in its place that did not fall within the bond. In support of this submission they relied on Wittman v Willdav [2007] EWCA Civ 824.
- Alternatively, the Side Agreement was an alteration of the terms of the building contract within the meaning of the indulgence clause in the Bond.
- The payment of a sum on account of claims was a forbearance or forgiveness in respect of the requirement to comply with the provisions of the contract before any payment in respect of loss and expense could be made under the terms of the building contract.
Aviva allege that the case falls squarely within the rule in Holme v Brunskill (1878) 3 QBD 495.as set out in the judgment of Cotton LJ, at 505:
“The true rule in my opinion is, that if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and that if he has not consented to the alteration, although in cases where it is without enquiry evident that the alteration is unsubstantial, or that it cannot be otherwise than beneficial to the surety, the surety may not be discharged; yet, that if it is not self-evident that the alteration is unsubstantial, or one which cannot be prejudicial to the surety, the court, will not, in an action against the surety, go into an enquiry as to the subject of the alteration, or allow the question, whether the surety is discharged or not, to be determined by the finding of a jury as to the materiality of the alteration or on the question whether it is to the prejudice of the surety, but will hold that in such a case, the surety himself must be the sole judge whether or not he will consent to remain liable notwithstanding the alteration, and that if he has not so consented he will be discharged.”
Applying this Aviva allege first, there was an agreement – that of 16 December 2002 and/or the Side Agreement – between the principals (HEL and STC) with reference to the contract guaranteed (the building contract). Second, Aviva did not consent to this agreement. Third, it is not self-evident that the alteration is “unsubstantial” or one which cannot be prejudicial to the surety.
Accordingly, the court will not go into the merits of the alteration or the question as to whether or not it is prejudicial to the surety, but will allow the surety to treat himself as discharged if he so elects.
Counsel for Aviva submitted that If he is wrong about this the actions of HEL in advancing money to STC on account of claims, if not amounting to a variation of the building contract, was conduct that was prima facie prejudicial to the interests of Aviva, as bondsman, with the result that Aviva is entitled to treat itself as discharged. In support of this submission he relied on the case of General Steam Navigation Company v Rolt (1858) 6 CB (NS) 556.
MR JUSTICE EDWARDS-STUARTconsidered the rule in Holme v Brunskill (1878) 3 QBD 495 and noted that Aviva relied on the Side Agreement in its entirety. In particular they sought to rely on Cotton LJ’s phrase “if there is any agreement between the principals with reference to the contract guaranteed“ in the passage quoted.
On that basis it was submitted that the rule applied if any agreement was made between the principals to the contract guaranteed that was related to the principal contract. Accordingly, Aviva alleged it was entitled to rely on the Side Agreement irrespective of whether or not the extent to which it varied the terms of the building contract. The response from HEL counsel was that “the alteration” to which Cotton LJ referred several times must be an alteration to the principal contract.
MR JUSTICE EDWARDS-STUARTrejected Aviva’s submissions and held that what Cotton LJ meant when he said “any agreement . . . with reference to the contract guaranteed” was any agreement to alter the contract guaranteed.
As a matter of syntax, the repeated references to “the alteration” in the passage quoted must refer to an alteration to the principal contract. In the context of this passage a separate agreement that was made in relation to the principal contract would only be relevant if it varied the terms of the contract guaranteed.
Indeed, the facts in Holme v Brunskill. was a clear example of a variation to the contract guaranteed and so it was most unlikely that Cotton LJ was intending to lay down a rule of much wider application than was necessary to decide the issue before him.
Aviva also sought to rely upon General Steam Navigation Company v Rolt (1858) 6 CB (NS) 556.In that case the company contracted with a Mr Mare to build an iron paddle-wheel steamship to certain specifications. The price was £14,120, to be paid in four equal instalments.. The third instalment was to be paid when the vessel was launched and the final instalment when the vessel had been completely finished and delivered. Mr Mare’s obligations under the contract were guaranteed by the defendant.
The third instalment was paid on 5 July 1855 when the vessel was ready to be launched, although it had not in fact been launched, and thereafter the company paid £1,000 on 11 August 1855 and £2,000 on 13 September 1855, by which time the vessel was still not completed. On 25 September 1855 Mr Mare was declared bankrupt.
The headnote to the case states that the case is authority for the following proposition: “A material variation of the terms of the contract with the principal discharges the surety“.
The court noted it was difficult to discern from the report how the variation came to be effected .The payments were made “by arrangement” between the company and Mr Mare.
Triodos Bank NV v Dobbs [2005] 2 Lloyd’s Rep 588, was relied on by both parties. Counsel for Aviva relied upon the Judgment of Longmore LJ,
“It is, of course, the law that a material variation in the contract between the creditor and the principal debtor will discharge the guarantor, unless the variation is one to which he assented or which is provided for in the contract of guarantee. In his book (1898) on the Law of Principal and Surety, Mr Sidney Rowlatt (as he then was) said this:-
“. . . it is apprehended that assent, whether previous or subsequent to a variation, only renders the surety liable for the contract as varied, where it remains a contract within the general purview of the original guarantee . . . . If a new contract is to be secured there must be a new guarantee.”
MR JUSTICE EDWARDS-STUART noted that this was authority for the proposition that, where the bond provides that it will not be invalidated by any alteration or variation to the principal contract or the surety agrees to the variation, the surety will only be liable if the contract as varied remains a contract within the general purview of the original guarantee.
Thus , in the words of Longmore LJ, the question for the court is whether the (new) agreement, for the breach of which the claimant is suing on the bond, is properly to be regarded as an amendment or variation of the principal agreement which is within the purview of that original agreement.
Aviva could not rely on the rule in Holme v Brunskill in relation to the first payment of £500,000.The rule in Holme v Brunskill applies only where the principal contract has been varied.
There are further issues raised in this case which the reader is urged to consider and have been left out for brevity, somewhat stated ironically.
There ends a further lesson for lawyers and students alike.
The last words as ever go to the Late Mr Adamson .
For I am new to mystery
I want everything laid out for me.
Kind regards
oldlawyer1
Oldlawyer 1 