Hackney Empire Ltd v Aviva Insurance UK Ltd [21.09.11]

Surety’s liability under bond not discharged by employer making advanced payments to contractor under side agreement. Hackney hired Sunley Turriff Construction (STC) to carry out works as part of a multi-million pound redevelopment. After commencement, STC and Aviva executed a £1.1 million performance bond in Hackney’s favour to secure STC’s obligations under the building contract. The bond contained an indulgence clause, which provided that no alteration in the terms of the contract, extent and nature of the works or allowance of time for completion, would in any way release Aviva from its liability.

STC fell into considerable delay. By way of a side agreement, Hackney agreed to advance sums totalling £1 million to STC in an attempt to ensure the works were completed on time and in response to their claims for additional expenses. £750,000 was advanced before STC entered administration and its engagement terminated. Hackney suffered losses in excess of £3 million and made a formal claim for the full amount of the bond.

Aviva rejected the claim on three grounds, arguing that:

  1. The underlying contract had been varied by the side agreement. It relied on Holme v Brunskill [1878], which provides that a guarantor will be discharged from liability unless it has consented or it is self-evident that the variation is unsubstantial and cannot prejudice the guarantor. 
  2. It had been prima facie prejudiced by the payments made, as they increased the risk of default under the bond. It relied on General Steam Navigation Company v Rolt [1858], in which it was held that, if an employer acts in a manner which, whilst not varying the terms of the principle contract, is prima facie prejudicial to the guarantor, it will be discharged. 
  3. Alternatively, if it was found liable under the bond, it should not be liable for the £750,000 advance, as this was not an obligation within the scope of the bond.

Decision

The High Court rejected Aviva’s principle arguments, holding that:

  1. The variations to the underlying contract were ‘unsubstantial’, so fell within the exception to the rule in Holme v Brunskill. In any event, they were within the scope of the indulgence clause.
  2. The payments made to progress the works and satisfy STC’s claims, fell short of being prima facie prejudicial to Aviva.

However, Aviva succeeded on the point that the £750,000 did not fall within the original guarantee. The side agreement created entirely new obligations to repay those amounts, for which Aviva could not be liable.

Comment

The court drew an important distinction between alterations to a contract which will discharge a guarantor unless the alteration is self-evidently insignificant or non-prejudicial and conduct that, whilst not varying the contract, must be prima facie prejudicial to the guarantor in order to discharge liability. Crucially, the latter is a higher threshold. The rule in Holme v Brunskill only applies where there has been a variation to the contract.

This case highlights the dangers of executing a performance bond including an indulgence clause, as it offers protection to employers where contractual alterations are made without the consent of the guarantor.

Whilst Hackney obtained a favourable result in this case, employers should not assume that advancing sums to contractors (despite their best intentions that it will improve the chances of completion) will be recoverable under the bond. Despite the court’s findings, advancing payments for works yet to be completed or to contractors on the verge of insolvency, may, in other circumstances, be enough to cross the threshold of being prima facie prejudicial, offering guarantors a total absolution from liability.