Bonds: style over substance?
The ongoing saga of the Scottish Coal Company liquidation provides the background to East Ayrshire Council v Zurich Insurance  CSOH 102.
East Ayrshire Council (EAC) granted planning permission for a surface mine at Dalfad subject to restoration obligations on Scottish Coal. These obligations were secured by a restoration bond granted by Zurich Insurance. Following Scottish Coal’s liquidation, it and its liquidators, were unable to carry out the restoration work.
EAC served a demand on Zurich to make payment of £3.344m in terms of the bond.
Relevant Bond Provisions
Clause 2.2: “… following the service upon the cautioner of a certificate of default the cautioner shall … pay the sum demanded…”
Clause 2.4: “Any demand served by the Council in accordance with sub-clause 2.2 shall be conclusive evidence of the liability of the cautioner to pay …”
“certificate of default” was defined as a certificate “in substantially the form” set out in an Appendix to the Bond. It required EAC to certify three things:
(a) the company had failed to perform and discharge the restoration obligations;
(b) written notice of such failure had been given to the company not less than 60 days prior to the date of the certificate and the company had failed to rectify the failure; and
(c) the sum in the certificate was accordingly due and payable to EAC under the terms of the bond.
Zurich refused to pay, arguing that the certificate of default was invalid. It did not certify that EAC had served a 60 day notice of failure (since no such notice had in fact been served) and therefore was not “in substantially the form” of the Appendix. The certificate was conclusive evidence of liability so it had to be compliant.
EAC argued that service of the 60 day notice would achieve no practical purpose since it was clear that there would have been no compliance whether it was served or not. EAC also argued that the reference to “in substantially the form” of the style meant strict compliance was not required.
Lord Malcolm summarised the principles applicable to performance bonds based on the case law as:
- Normal principles of construction of contract apply;
- A performance bond creates an absolute and unqualified obligation on its issuer to pay if presented with a compliant demand;
- The issuer of the bond should simply compare the demand with what the Bond requires. It need not make any other inquiry;
- The issuer is not obliged to pay if a demand is not in the agreed form, even if differences are not material. If the issuer paid on a non-compliant demand, it could face difficulties enforcing the counter-indemnity against the defaulting party; and
- Whether strict compliance is required depends on the terms of the Bond.
The conclusive nature of the certificate was an important factor. The certificate had “direct, immediate and significant contractual effect”. The parties had agreed that three matters had to be certified and each was necessary for a valid demand. Whether a requirement was reasonable or not did not matter. A “reasonable reader” of the bond would understand that all three elements of the style certificate had to be included. The deficiency in the certificate rendered it invalid. EAC could not expect on demand payment unless the demand was in the agreed form.
Beneficiaries of on demand bonds are in the enviable position of being able to secure payment simply on the issue of a demand. This case makes clear, though, that a hard line will be taken if a beneficiary tries to take a short cut and issue a demand in other than the agreed form.