Warranties, bonds and novation

Chapter 5

Warranties, bonds and novation

33 Can a warranty be effective before it is signed?

There are relatively few cases on warranties, and Northern & Shell plc v John Laing Construction Ltd¹ settles an important point.

Laing entered into a contract for the construction of an office block. Under the main contract, Laing was obliged to give a warranty in stipulated terms to the company leasing the building from the developer. The successor to this company was Northern. Defects were discovered some years after completion of the building, and Northern relied on the warranty to recover damages from Laing because the warranty provided that Laing had complied with the terms of the main contract. The warranty stated: ‘5. This deed shall come into effect on the day following the date of practical completion of the building contract.’

The limitation period for a deed is 12 years, and Northern had not started legal proceedings until not long after that period had expired. However, there was a complication in that the warranty had not been signed until five months after practical completion, and Northern argued that the normal rules applied and the cause of action arose when it was signed. If that was the case, the issue of proceedings would be inside the 12-year period.

The Court of Appeal decided in favour of Laing. It ruled that clause 5 meant what it said. It had been open to the parties to amend the clause when the warranty was signed so as to take account of the fact that the warranty was being signed retrospectively. The fact that the parties did not amend clause 5 indicated that they intended the warranty to come into effect on the day after practical completion.

The lesson to be learned is that the wording of a contract of any kind executed by the parties after the project has begun should be carefully reviewed, just in case any part should be amended. This is frequently the case in regard to dates for possession in building contracts that might be signed months after possession is given late. In the case described here, the effect was that the warranty started at a date before it was signed. If clause 5 had not been included, the warranty would not have been effective until it was signed. Obviously, if it had never been signed it would never have been effective at all, with or without clause 5.

34 What are ‘step in rights’?

Where warranties are provided, particularly to funders of projects, there is often a clause included which gives a particular party the right to ‘step in’ and replace one of the parties to an agreement between the other two parties. For example, an employer may enter into a standard form building contract with a contractor for the construction of a building. A bank may be providing funds to the employer to enable the project to be built. The bank will often require the contractor to execute a warranty in favour of the bank. The essential clause in the warranty will be the step in clause, which enables the bank to take the place of the employer in the building contract in certain circumstances. The circumstances, set out in the clause, are usually when particular occurrences entitle the contractor to terminate the building contract or treat it as repudiated. The contractor is required to notify the bank if it intends to terminate, and it must take no further action until the bank has decided whether to step in. The bank has only a specified number of days within which to make its decision.

If the bank does decide to step in, the contractor must accept the bank’s instructions as if it was the employer. The employer is one of the parties to the warranty principally to acknowledge agreement to the step in procedure and to agree that the contractor can treat the bank as the employer. This is to avoid any danger that the contractor will be in breach of the building contract. It is likely that there will be specific provisions to safeguard the contractor in the event that the employer has not discharged all payments due. Sometimes, the step in procedure is included in warranties given by the architect to a funder, or in warranties given by the architect to the employer where the architect is employed by the contractor in a design and build scenario. In the latter instance, the step in rights may be required by the employer in the event that the contractor goes into liquidation and the employer wishes to complete the building using the contractor’s architect.

35 JCT contracts do not seem to mention performance bonds. What are they?

Although JCT contracts refer to certain bonds, such as advance payment and off-site materials bonds, they make no mention of performance bonds. The purpose of any bond is to guarantee payment of some compensation, usually in the event that the party on whose behalf the bond is provided fails to carry out some contractual obligation. In the instances noted above, the bonds would relate to failures to repay the advance payment in the instalments required or failure to provide the materials or goods for which payment has been certified by the architect and paid by the employer. They are sometimes referred to as guarantee bonds or guarantees. As a guarantee, a bond must be in writing.²

A performance bond is a specific kind of bond whose purpose is to provide compensation if the contractor fails to carry out the building contract. Because JCT standard contracts do not include performance bonds or provision for them, an employer requiring such a bond must ensure that the necessary additional clauses are inserted in the contract at tender stage and that a suitable bond is attached to the documents and, in due course, to the contract. A bond is normally executed as a deed by a person referred to as the surety. The surety is usually either a bank or an insurance company. If the contractor fails to perform, the surety agrees that it will compensate the employer up to an agreed maximum. The maximum amount is usually 10 per cent of the contract sum, but it may be more on small contracts. This ensures that the employer will have some money available, for example if it becomes necessary to engage another contractor to complete the Works, probably at additional cost.

There are two basic types of bond: default bonds, where the employer has to demonstrate that the contractor was in default of its obligations before the surety can be required to pay out, and on demand bonds, where payment can be required from the surety without the employer having to demonstrate any default on the part of the contractor. Sureties tend to favour on demand bonds because they do not have to carry out any expensive investigations or make any judgment about the contractor’s performance.³