Performance bonds: Scottish court affirms broad interpretation

In March this year we reported on a Scottish decision which suggested that greater leniency may apply to the interpretation of performance bonds in Scotland than in England. The court has now provided further guidance following the case going to proof.

Fife Council v Royal & Sun Alliance Insurance plc : a re-cap

As explained in more detail in our earlier Law-Now (click here) a bond was provided by Royal & Sun Alliance (“RSA”) in favour of Fife Council (the “Council”) to secure remediation obligations accepted by the Scottish Coal Company. After Scottish Coal’s demise in 2013, the Council made a demand under the bond by a letter dated 2 December 2015 in which it notified RSA of a default and called on it to make payment of £3.1m for the costs of remediation work.

RSA rejected the Council’s demand, arguing among other things that the Council had not provided reasonable evidence of its intention and ability to proceed with the work in accordance with clause 3.1 of the bond which required: “notice in writing of any Default and a full breakdown of any proper and reasonable cost … together with reasonable evidence of the intention and ability of [the Council] to proceed forthwith with any such operation.” The Council’s demand had included an explanation of the proposed works, together with a plan and a full cost breakdown prepared by an environmental consultant, but the only express statement as to the Council’s “intention and ability” was a statement that the Council would “comply with its obligations under the Bond”. The Council argued that RSA was fully aware of its intention to undertake the work and pointed to prior correspondence and evidence that it had carried out work on other sites.

In its earlier decision, the court had ruled that the bond did not require strict performance and that it was open to the Council to show by background evidence that the wording used in its demand had satisfied the requirements of clause 3.1. The case was therefore put to an evidential hearing on this point.

The Court’s decision following proof

The court ultimately accepted that the wording of the Council’s demand was sufficient to comply with the “intention and ability” requirements of clause 3.1 of the bond.

A key part of RSA’s case was that the Council did not have any obligations under the bond and the statement in the demand that the Council would “comply with its obligations under the Bond” was therefore meaningless. The court rejected the premise of this argument, finding that general wording in the bond stating that RSA would pay to the Council the cost of remedial works carried out imposed an obligation on the Council to expend bond monies for that purpose. Accordingly, the court found that the reasonable recipient of the Council’s demand would interpret the statement that the Council would comply with its obligations as confirmation that the Council intended to carry out the remedial works described in the demand.

As to the Council’s ability to carry out those works, the court considered that the cost breakdown, plans and explanation provided with the demand as to the proposed works was sufficient to constitute evidence of the Council’s ability to carry out those works.

These findings made it strictly unnecessary for the court to consider the background evidence leading up to the demand, but those facts were also found to support the court’s conclusion in any event.

Conclusion and implications

The court’s decision provides confirmation of the broad approach to the interpretation of performance bonds noted in our earlier Law-Now. The decision continues the theme of the Scottish courts interpreting performance bonds in the same way as commercial contracts, with reference to their underlying commercial purpose, and that the court is prepared in certain circumstances for background evidence to be relied upon to clarify the terms of a demand.

Particularly in relation to on-demand bonds, this appears to be a broader approach than might be expected in England. Bondsmen should be aware that the Scottish courts may be less likely to take a strict approach to the interpretation of such instruments and include express drafting to address this if necessary.

References: Fife Council v The Royal and Sun Alliance Insurance PLC [2017] CSOH 115