The insolvency of Scottish Coal Company Ltd ("SCC") has given rise to two recent Scottish Court of Session cases regarding performance bonds – East Ayrshire Council ("EAC") v Zurich Plc (24 June 2014) and South Lanarkshire Council ("SLC") v Coface SA (27 January 2015). 

In each case a bond was granted in favour of the relevant local authority in support of the open cast coal mine restoration obligations of SCC.  Following its insolvency SCC defaulted on its restoration obligations and in each case the local authority made a claim on the relevant bond.  The claim in each case was resisted by the relevant bond provider; successfully in the EAC decision and unsuccessfully in the SLC decision.  The terms of the bond in each case were different and the claims resisted for different reasons.

The cases include a summary of applicable legal principles and provide some useful practical insight.

Legal principles

The following principles were described by Lord Malcolm in the EAC decision as being applicable to the type of bond in that case (in the SLC decision Lord Woolman, referring to Lord Malcolm's decision, considered that some of the same principles were applicable):

The normal principles of interpretation of contracts applied to the bond.

The bond was an autonomous contract creating an absolute and unqualified obligation on the bond provider to pay if and when presented with a compliant demand.

The bond provider was expected to do no more than compare the demand with the agreed requirements to see they match up.

In considering the bond claim nothing depended on the circumstances of the dispute between the bond beneficiary and the account party nor the bond provider's knowledge of those circumstances.

The bond was an immediately enforceable obligation of the bond provider to pay against stipulated documents.

The bond provider was not obliged to pay if a demand did not follow the agreed terms – otherwise the bond provider would face difficulties in enforcing its counter indemnity obligation against the defaulting party (this was described as an important factor).

Whether strict compliance with a style of demand contained within a bond is required depends on the terms of the contract – in the EAC case the demand needed to cover certain substantive matters described in the bond.

Practical insight

  • Construction context: while these cases were about open cast coal mine restoration bonds they provide some insight as to the principles that might apply to a similar type of bond in a construction context such as a construction performance bond.
  • Follow the claims procedure: the cases demonstrate the importance of carefully following the claims procedure described in a bond – it is important to look at how the notice is to be transmitted, what the address for notices is and what the form and substance of the notice should be having regard to the terms of the bond as a whole.
  • Strict compliance: Bond providers are prepared to resist and defend bond claims and enforce strict compliance with the bond requirements – they may be required to do so in order to successfully call on a counter indemnity.
  • Clear and consistent language: the cases reinforce the message that where possible bonds should use clear and consistent language to describe the communications needed to make a valid claim.