Bonds: Style Over Substance?

Background

The ongoing saga of the Scottish Coal Company liquidation provides the background to East Ayrshire Council v Zurich Insurance [2014] CSOH 102.

East Ayrshire Council (EAC) granted planning permission for a surface mine at Dalfad subject to restoration obligations on Scottish Coal. These obligations were secured by a restoration bond granted by Zurich Insurance. Following Scottish Coal's liquidation, it and its liquidators, were unable to carry out the restoration work.

EAC served a demand on Zurich to make payment of £3.344m in terms of the bond.

Relevant Bond Provisions

Clause 2.2: "... following the service upon the cautioner of a certificate of default the cautioner shall ... pay the sum demanded..."

Clause 2.4: "Any demand served by the Council in accordance with sub-clause 2.2 shall be conclusive evidence of the liability of the cautioner to pay ..."

"certificate of default" was defined as a certificate "in substantially the form" set out in an Appendix to the Bond. It required EAC to certify three things:

(a) the company had failed to perform and discharge the restoration obligations;

(b written notice of such failure had been given to the company not less than 60 days prior to the date of the certificate and the company had failed to rectify the failure; and

(c) the sum in the certificate was accordingly due and payable to EAC under the terms of the bond.

Arguments

Zurich refused to pay, arguing that the certificate of default was invalid. It did not certify that EAC had served a 60 day notice of failure (since no such notice had in fact been served) and therefore was not "in substantially the form" of the Appendix. The certificate was conclusive evidence of liability so it had to be compliant.

EAC argued that service of the 60 day notice would achieve no practical purpose since it was clear that there would have been no compliance whether it was served or not. EAC also argued that the reference to "in substantially the form" of the style meant strict compliance was not required.

Decision

Lord Malcolm summarised the principles applicable to performance bonds based on the case law as:

Normal principles of construction of contract apply; A performance bond creates an absolute and unqualified obligation on its issuer to pay if...