It is common for English Law contracts to expressly limit a party's exposure if it is in breach. The recent decision in Sabic UK Petrochemicals Limited v Punj Lloyd Limited and Others held that the innocent party was entitled to call securities (in this case, performance bonds) and then to claim the whole amount of the liability cap. The amount recovered from the bonds was in addition to the cap, not part of it.

The use of performance bonds is commonplace and the parties could be forgiven for thinking that their treatment in a claim will not be controversial and that they are simply a form of security for claims which can be enforced on demand without the need for court proceedings. The SABIC v PLL decision highlights that the implications of providing a bond are more fundamental.

Background

SABIC entered into a £135 million contract with Simon Carves Ltd ("SCL"). SCL secured its performance by providing a parent company guarantee from PLL, and an on demand performance bond in the sum of £13.5 million.

After many problems and a renegotiation which need not concern us, SABIC terminated SCL's contract and retained someone else to finish SCL's work at considerable cost. SABIC called the performance bond.

Proposed treatments of the performance bonds

The contract specified that SCL's liability "under or in connection with the Contract (whether or not as a result of the Contractor's negligence and whether in contract tort, or otherwise at law) … shall not exceed 20% (twenty per cent) of the sum of the Contract Price ….". It also provided that if the total cost SABIC reasonably incurred exceeded the total that SABIC would have paid to SCL, the Contract not having been terminated, "the difference shall be recoverable by the Purchaser from the Contractor either by way of set off or as a debt." So, SABIC was entitled to recover its excess costs, but may have been limited to recovery of 20% of the price.

SCL argued that the liability cap should be applied to the total losses, ignoring the fact that the performance bond had been called, to give a figure that was the maximum loss recoverable by SABIC. The amounts already

recovered by SABIC under the bond should then be applied to that loss, and the remainder, if any, represented the further sum due to SABIC.

SABIC argued that the right approach was to establish the loss that remained after the sums recovered under the performance bond had been offset against the total loss. The liability cap should then be applied to that remaining loss.

The court's findings

The Court looked at why a bond had been provided, and noted that "proof of loss was not a prerequisite to a call on the bonds". Rather the "commercial purpose was that, if a dispute arose, SABIC should have immediate access to the funds without having to await the outcome of proceedings determining the contractual rights and wrongs of the dispute." Although there would ultimately be an accounting for SABIC's true loss, a bond did not give  compensation but was simply a financial instrument. In light of this, the Court agreed with SABIC and held that the liability cap should be applied to the loss that remained after applying the sums recovered under the performance bond.

What does this mean?

The decision does not impact on all forms of security. Performance bonds are financial instruments, and special rules apply to them. However, if a bond is called the courts are likely to consider that this was a way for the innocent party to reduce his loss on a dollar for dollar basis by the amount he collected. Effectively, this was part of the innocent party's mitigation. If the innocent party still had a loss after calling the bond, he would be free to  pursue his claims up to the full amount of any cap. Therefore, if the parties intend that sums recovered under a performance bond or other financial instrument (e.g. a cheque) will be part of the capped recovery this needs to be clearly spelt out in the contract. Most contracts currently used in the Middle East are silent on the point.