• Construction Bonds: The Bedevilment of Loose Language
  • May 15, 2012
  • Law Firm: Norton Rose Canada LLP - Montreal Office
  • Construction bonds
    A 2011 Supreme Court of Appeal (SCA) judgment indicates that courts will find that an on demand bond exists only where it is clear (on a proper interpretation of the document as a whole) that the parties intended the liability of the guarantor to exist separately from the liability of the contractor. The loose use of the words “on demand” or by giving the document that title does not necessarily mean that a bond is in fact one which can be called upon, in its entirety, literally “on demand”.

    Construction bonds are usually issued by a bank or insurance company. Under these bonds there exists an obligation to pay a specified amount. How much of the guaranteed amount is the beneficiary entitled to claim from the guarantor? This is the issue that arises when there is ambiguity as to the type of bond the beneficiary is holding and this is where the language of the bond proves to be decisive.

    The recent SCA judgement in Minister of Transport and Public Works, Western Cape v Zanbuild Construction [2011] ZASCA 10 (11 March 2011) has clarified the position with regard to two types of construction bonds that are frequently found in our construction contracts.

    The case involved the interpretation of two bonds (guarantees) issued by ABSA Bank in favour of the Western Cape Department of Transport. The issue was whether the department was entitled to demand the full amount of the bond or whether ABSA’s liability was limited to the amount of the contractor’s (Zanbuild) liability under the principle contract.

    At the time of the calling up of the bonds the department failed, fatally so, to contend that it had an identifiable monetary claim under the construction contracts against Zanbuild for the amount of the bond. This highlighted the pivotal issue in the case: the distinction between a “conditional” and an “on demand” bond. The court stated that the question whether a bond is a conditional bond or an on demand bond is dependent on the interpretation of the terms of that particular guarantee.

    The court quoted numerous decided cases on the very issue of this distinction and went to great lengths to uplift the actual terms of the bonds or guarantees in earlier cases. This enabled the court to compare the terms of the guarantee before it with those of the decided cases and draw the following “substantial differences”.

     


    Conditional bonds
    Conditional bonds often contain the language of a suretyship and “provide security for the compliance of the contractor’s performance of obligations in accordance with the contract”. They require the beneficiary to, at least, allege and possibly even establish liability on the part of the contractor for the amount claimed. Recovery of the amounts due is inevitably a long and drawn out process compared to that of an on-demand bond.



    On demand bonds
    On demand bonds, on the other hand, entitle the beneficiary to the full amount of the bond literally on demand. They require no allegation of liability. A simple demand, made on the specified terms of the bond is all that is needed to secure payment. The most commonly specified condition is that the beneficiary will be entitled to call on the guarantor should the beneficiary state that the contractor is in default of his obligations under the construction contract.



    Terms of bonds
    The guiding force for the SCA was the wording in the bonds that they existed to “provide security for the compliance of the contractor’s performance of obligations in accordance with the contract” and the “due and faithful performance by the contractor”1.

     

    The bond provided for a scenario where the beneficiary would be entitled to make multiple claims. The SCA reasoned that there is no rational basis why a party would claim less than the total amount they were entitled to on the occurrence of the specified event. The court concluded that the wording gave rise to a liability akin to a suretyship. The court held that the bonds did not constitute “on demand bonds” as submitted by the department, but rather that and were conditional on the liability of the contractor.

    The beneficiary should scrutinise the wording of the bond to ensure it is what it says it is, and does what they intend it to do. Failing to do this may result in falling prey to “loose language” and being precluded from enforcing the bond in a court of law.

    Parties to construction bonds should be very careful to ensure that the wording of their bond correctly encompasses what they intended that the bond protect.

     

    1 See also Vossloh Aktiengesellschaft v Alpha Trains (UK) Ltd [2010] EWHC 2443 (Ch)