Can you amend a contract without losing your rights to claim under your bond? You can if its a loan and not a variation.
This was the decision of the Court of Appeal in Hackney Empire v Aviva which has received more coverage than most bond cases.
Is it because the case decided a legal nuance which needed clarity? Err…I fear the real reason had more to do with the involvement of Lord Sugar!
As set out in this news piece in Building, the facts were relatively simple. STC was the contractor for a £11m refurbishment on the Victorian Hackney Empire theatre, “backed by £1.1m from Lord Sugar as well as funding from the Heritage Lottery Foundation and the Arts Council.” The issue was whether payments made by the employer to the contractor totalling £750,000 to help with cashflow problems had invalidated the bond.
As with most projects, the temptation when the contractor is looking shaky is to speed up payments. The alternative is too awful to contemplate! But you need to beware the impact those changes have on any bonds or guarantees.
The payments were made under a separate side agreement. Did the side agreement vary the contract? If not, did it prejudice the surety and permit the surety to avoid having to pay under the bond?
There were two tricky legal aspects which teh court considered, but you can just skip to the conclusion…
What is the ‘Rule in Holmes v Brunskill’?
In an article in Building, lawyer David Bebb refers to the rule in Holmes v Brunskill.
His original explanation of the rule (from his article on the High Court decision) was:
“This rule provides that if there is any agreement between… HEL and STC… to alter the …building contract… then [Aviva] should be consulted and if [Aviva] has not consented to the alteration, or if it is not self-evident that the alteration is unsubstantial or which cannot be prejudicial to [Aviva], then the court will not go into the merits of the alteration or the question of whether it is prejudicial but will instead allow [Aviva] to be discharged from its obligations.”
In the plain language of David Thomas QC (in Keating Chambers’ newsletter) ‘a bondsman is discharged if the contract he guarantees is varied without his consent.’
The case also considered whether the rule extended beyond variations OF the bonded contract, to other agreements which varied the performance of obligations UNDER the bonded contract including the side agreement.
What is an Indulgence Clause?
An ‘indulgence clause’ is a term of the bond which allows the parties to vary the underlying agreement without the surety’s consent.
It has no standard form but includes wording to the effect that “no alteration variation or modification of the terms of the underlying agreement or the works and no allowance of time, forbearance etc releases the surety from liability under the bond“.
The purpose of an indulgence clause is to allow the parties to vary the bond without the need for the consent of the surety, and so avoid the consequences of the rule in Holmes v Brunskill.
What Should You Do?
Any recipient of a bond needs to be vary careful to ensure that (1) the bond includes an indulgence clause and (2) no actions or decisions which might prejudice the surety are taken without the surety’s consent, including side agreements and novation.
Case: Aviva Insurance Ltd v Hackney Empire Ltd  EWCA Civ 1716 (19 December 2012)
Image: Matt Biddulph via Flickr used under a creative commons licence.