Last year we reported on a decision of the Scottish Court of Session which suggested that greater leniency may apply to the interpretation of performance bonds in Scotland than in England (see our earlier Law-Now here). A further decision from the Court of Session issued last month would appear to support this trend.

Fife Council v Royal & Sun Alliance Insurance plc

The insolvency of the Scottish Coal Company in 2013 has resulted in a series of cases in the Scottish courts concerning performance bonds which had been issued to guarantee the performance of the company’s remediation obligations related to its opencast coal mining sites.

The bond in the present case was provided by Royal & Sun Alliance (“RSA”) in favour of Fife Council. The Council made a demand under the bond by letter dated 2 December 2015 in which it notified RSA of a default and called on it to make payment of £3.1m for the costs of remediation work.

The relevant provisions of the Bond stated:

“2.2 In the event of Default … [RSA] shall, if called upon by [the Council], pay to [the Council] the proper and reasonable cost … of any operation carried out … to restore and reinstate the said site…"

“3.1 Prior to the obligation upon [RSA] to pay any sums due hereunder becoming enforceable by [the Council], notice in writing of any Default and a full breakdown of any proper and reasonable cost … must be provided to [RSA] … together with reasonable evidence of the intention and ability of [the Council] to proceed forthwith with any such operation.”

RSA rejected the Council’s demand, arguing that the Council had to first carry out the remedial works before making any call on the bond (by reference to the phrase “carried out” within clause 2.2).

RSA also argued that the Council had not provided reasonable evidence of its intention and ability to proceed with the work as required by clause 3.1. The Council had merely stated in its demand that it would “comply with its obligations under the Bond” and no additional supporting evidence had been provided.

Was completion of the work a precondition of a bond call?

In addressing this issue, the court considered firstly the commercial context of the bond and its purpose, which was to cover the restoration of the site and some aftercare obligations. The court also noted the Expiry Date of the bond of 30 March 2017 and the fact that the period of time estimated as required for remediation and aftercare work meant that there was “virtually no prospect” of the remedial works being carried out before the Expiry Date. Requiring work to be completed in advance of any call was therefore considered to be an “uncommercial interpretation, as it frustrates the very purpose of the bond."

The court also found that clause 2.2 needed to be considered according to its own terms but also in the context of other provisions and consistent with its commercial purpose. A literal interpretation of “carried out” in clause 2.2 would be inconsistent with the natural meaning of 3.1 which required only a breakdown of cost rather than details of actual cost and referred to the Council’s “intention and ability” to proceed with the works. On a proper interpretation of the bond, therefore, the Council was not required to carry out the remediation work before RSA’s liability was triggered.

Reasonable evidence of the Council’s intention and ability?

Following the court’s previous decision in Coface SA v South Lanarkshire Council (reported in our earlier Law-Now here), the court concluded that the doctrine of strict performance which applies to Letters of Credit was not applicable to the present bond. This was highlighted by the fact that the strict compliance rule is usually justified by the fact that a bank is required to pay on the presentation of documents alone, whereas the requirement for “reasonable evidence” of the Council’s intention and ability to complete the remedial works required a factual assessment which was inconsistent with a strict compliance approach.

The Council had argued that the RSA was fully aware of its intention to undertake work and pointed to prior correspondence and evidence that it had carried out work on other sites. It argued that the statement in the demand that it would “comply with its obligations under the Bond” was to be read in this context. The court agreed with this approach and sent this part of the case to a hearing on the evidence in order to ascertain whether this background evidence was sufficient to comply with the reasonable evidence requirement of the bond.

Conclusions and implications

This case continues the theme of the Scottish courts interpreting performance bonds in the same way as commercial contracts, with reference to their underlying commercial purpose and not necessarily requiring strict compliance with their terms when making calls.

The court’s conclusions particularly in relation to the reasonable evidence requirement appears to provide support for the contention that a broader approach is being taken to performance bonds in Scotland than may be the case in England. Even assuming strong background evidence, the bare statement in the demand that the Council would “comply with its obligations under the Bond” would not itself appear to be evidence of ability to carry out the works. Similarly, the requirement for “reasonable” evidence of intention might be thought to require something more than a bare statement of intention.

These issues will no doubt be worked through in the court’s subsequent decision after an evidential hearing, however it appears from the present judgment that the court may have been prepared, subject to proof, for the background evidence relied upon by the Council to be incorporated within the demand by virtue of the Council’s bare statement of intention.