Yuanda & Establishing and Ascertaining under the ABI model form of UK Performance Bond: Conceptual & Practical Challenges (Part Two)

Articles, News James Bradford 30th October 2020

In this second part of a two part series, Alexandra Bodnar and James Bradford look at some of the practical implications of the recent decision in Yuanda (UK) Company Limited v Multiplex Construction Europe Limited [2020] EWHC 468 and in particular what Fraser J’s conclusion that an adjudicator’s decision would be sufficient to ‘establish and ascertain’ the sums due under the bond means for the UK construction performance bonds market. They explore the difficulties and challenges which practitioners and market players may face in light of this decision.

Practical Implications of Yuanda on establishing and ascertaining

Even if it is accepted that the court in Yuanda was giving effect to the underlying building contract where adjudication was provided for, there are a number of potential practical difficulties which arise from adjudication being the mechanism to ‘establish and ascertain’ the sum due.

A recap: the relevant part of the ABI model form of bond provides that:

“The Guarantor guarantees to the Employer that in the event of a breach of the Contract by the Contractor the Guarantor shall subject to the provisions of this Guarantee Bond satisfy and discharge the damages sustained by the Employer as established and ascertained pursuant to and in accordance with the provisions of or by reference to the Contract and taking into account all sums due or to become due to the Contractor.” It is the underlined section with which we are concerned.

A. To pursue the Contractor or the Bondsman?

First, it is worth restating that a performance bond is most likely not a construction contract. On that basis, the employer[1] will be unable to adjudicate against the bondsman (absent a contractual provision) because a performance bond is not a “construction contract” as defined in the Construction Act  (see section 104 and 105 of the Housing Grants, Construction and Regeneration Act 1996 as amended[2]). Consequently, the employer cannot adjudicate against the bondsman as of right. Similarly, it is worth noting that if the underlying building contract itself is one of the excepted contracts under the Act (eg: oil/gas) and there is no contractual provision for adjudication, there exists no right for the employer to adjudicate against either the contractor or the bondsman.

Second, unless the bondsman agrees by the use of clear words (or unless a waiver or estoppel operates), the bondsman is not bound by the result of proceedings between the employer and the contractor. This includes adjudication proceedings. As explained in Andrews and Millett’s Law of Guarantees, 7^th Ed, 7-035:

‘In Re Kitchen Ex p. Young, (1881) L.R. 17 Ch. D. 668, it was held that a judgment or award in an arbitration to which the creditor and principal were parties, but the surety was not, is not even evidence that may be used to establish the liability of the surety. The reason for the rule was explained by James L.J. in these terms at 672:

“The principal debtor might entirely neglect to defend the surety properly in the arbitration; he might make admissions of various things which would be binding as against him, but which would not, in the absence of agreement, be binding as against the surety”.

….. The principle also applies to adjudications and any other form of dispute resolution which involves a decision on what sum is due or what damages are payable: Beck Interiors Ltd v Russo [2010] B.L.R. 37, per Ramsey J. at [50].’

It might be thought that the words ‘established and ascertained’ & ‘by reference to the [building contract]’ in the ABI model form are words which convey that the bondsman has agreed to be bound by a tribunal’s decision in dispute resolution proceedings as between the employer and the contractor. However, that may be a stretch of the language – as Lush LJ made clear in Re Kitchin, ‘explicit’ words would be needed to achieve this result. It also begs the question: where is the clear wording which conveys that the bondsman has agreed to be bound by an adjudicator’s decision but not (for example) an employer’s own assessment or an agreement between company chief executives or an indication/decision from a Dispute Avoidance Board? Such wording is not obviously apparent in the ABI model form.[3]  So, the idea that the bondsman has expressly agreed under the ABI bond wording to be bound by the result of an adjudication between employer and contractor may be problematic.

Third, the decision in Yuanda does not grapple with the fact that, in a contractor-insolvency situation, an employer may be forced to consider pursuing an insolvent contractor. An employer in that situation would likely first have to obtain permission from the court before it could even commence adjudication proceedings.[4] Permission is not easy to obtain. Yuanda itself was a non-insolvency breach case and so this issue did not arise, but in most situations where a beneficiary wishes to claim on a performance bond, the contractor will be insolvent. Faced with the prospect of adjudicating (or litigating) against an insolvent contractor in order to claim on the bond, and the inevitable irrecoverable costs, many employers would simply give up that fight.

The employer may have little practical choice but to pursue the solvent bondsman in order to establish the necessary requirements to claim on the bond and, because there will usually be no right to adjudicate against the bondsman, that will usually mean litigation (or perhaps arbitration). This is unlikely to be the commercial risk balance that most bondsmen foresaw when agreeing to supply a performance bond.

An additional consideration that must be thrown into the mix is that, post the Supreme Court decision in Bresco v Lonsdale[5], the insolvent contractor could commence an adjudication against the employer – indeed, an insolvent contractor seeking to establish that no sums are due to the employer (and thereby eradicate any risk of the bondsman trying to recover sums from the contractor upon the contractor’s indemnity) may think it has nothing to lose and everything to gain. An employer would need to weigh in the balance the risk that, if it were to commence litigation against the bondsman, the litigation may be stayed or rendered redundant by a potentially expensive adjudication thrust upon it by the insolvent contractor.

What this tells us is that it is in all the parties’ interests to ensure that the bond and the building contract are explicit as to the mechanism or mechanisms that will ‘establish and ascertain’ the sum due for the purpose of a call on the bond.

B. The Problems with Adjudication More Generally

Aside from the specific issues highlighted above, there are other problems with adjudication as the answer.

One issue is what happens when the adjudicator’s decision is unenforceable? It is implicit in Fraser J’s decision that the process must result in a valid adjudicator’s decision, i.e. one not reached in breach of the rules of natural justice or in excess of jurisdiction. If the employer is unfortunate enough to find itself on the receiving end of an unenforceable adjudicator’s decision, that decision is a nullity and the process was a waste.[6] That may not happen often but, as the law reports reveal, it happens more than it perhaps should. The implication in Fraser J’s decision must be right – a bondsman cannot be expected to pay upon an invalid adjudicator’s decision. But this gives rise to a difficult question of timing: The adjudicator’s decision is binding as between the parties to it unless and until successfully challenged. Even where Court enforcement action or Part 8 declaratory proceedings are started swiftly, it may still take a few weeks for a Court to hear the matter. Could a bondsman safely refuse to pay out on the basis that in a few weeks or months, the adjudicator’s decision may be rendered a nullity? Those few weeks or months may make all the difference to the solvency of the employer.

Another issue is that, unlike in litigation, an adjudicator’s decision is binding even if wrong in fact or law. Whilst an adjudication process may result in a fairly swift decision (in theory, in as little time as 28 days), inherent in that process is a risk of the adjudicator getting the answer wrong in fact or in law, and unfortunately that is something that happens fairly frequently. The parties sometimes have no control over who is appointed as adjudicator and, unlike a Contract Administrator making an assessment of what is due under a building contract, an adjudicator may have limited relevant expertise and insufficient time/scope for understanding the project and the issues. Repeatedly the Courts emphasise that adjudication is a ‘rough and ready process’ which is a different beast to litigation or arbitration. For these reasons, it might be said that adjudication is too risky a process, particularly if a bond expiry date is looming.

A further issue is what happens if one or other party decides they do not like the adjudicator’s decision and starts court or arbitration proceedings to finally determine the same dispute? This gives rise to a number of potential problems, including:

• For a start, adjudication, by its nature, is a process involving and binding only the parties to the adjudication. Can a bondsman (who is not a party to the adjudication) re-run the dispute if neither the employer nor the contractor seeks to do so, and what is the effect on the adjudicator’s decision? The case of Hurley Palmer v Barclays Bank[7] shows that the Contracts (Rights of Third Parties) Act is unlikely to assist the bondsman, at least absent clear provision in the bond and building contract. There is nothing to stop the bondsman litigating the same subject matter as the adjudication but, applying the established principle that adjudication binds only the parties to it, a Court action between employer and bondsman may have no effect on an adjudicator’s decision rendered in an adjudication between contractor and employer. If that is correct, there is a risk of conflicting decisions: the adjudicator’s decision (which remains technically unchallenged by either party to it) might remain binding as between employer and contractor in respect of the building contract, yet there may be a conflicting Court decision to which the bondsman is a party and which regulates the position under the bond. That would be highly unsatisfactory, yet for the Court to declare the adjudicator’s decision no longer binding as between contractor and employer would risk undermining the established understanding of how adjudication operates.
• Furthermore, how ought the parties deal with the fact that the bondsman has made a payment pursuant to an adjudicator’s decision which is later superseded by a Court decision? As between employer and contractor, the Supreme Court decision in Aspect v Higgins[8] establishes that (at least under a Scheme adjudication) there will usually be an implied term which governs repayment as between employer and contractor if a Court later reaches a different decision to an adjudicator. But that may not assist the bondsman, who is not usually a party to the adjudication or the building contract. Instead, the bondsman may seek to rely on an argument that it is entitled to repayment on the basis of restitution, perhaps because of a mistake arising out of the adjudicator’s decision. But restitution is not a guaranteed route of recovery, depending as it does on matters such as whether it would be inequitable to order recovery in circumstances where the employer has changed its position upon receipt of the funds. Another route might be based on the implication of a different term to the Aspect v Higgins term, as suggested in Tradigrain v State Trading Corporation of India[9], that under the building contract the employer must account to the contractor for any amount which has been paid under the bond to the extent that it exceeds the employer’s true loss, based on the notion that there is an accounting process which determines the parties’ true rights. But that would result in a payment to the contractor, not the bondsman (and Tradigrain expressly does not determine whether the contractor may hold it on trust for the bondsman).

These problems demonstrate how adjudication as a process does not fit neatly with established principles concerning performance bonds – at least, not without clear provisions in the bond.

Concluding thoughts and the Future

When performance bonds work, they can offer huge advantages to employers and contractors alike. However, these potential advantages have been thrown into doubt as a result of the recent case law and practitioners across the UK surety and construction market will need to consider and come to terms with the implications of Yuanda.

This is not to say that we believe that the decision is wrong per se and indeed it must be remembered that Yuanda dealt with a non-insolvency breach situation and facts including the imminent expiry of the performance bond and that an adjudication was already on-foot.

In light of Yuanda, we might see parties amending bonds to identify precisely what is meant by ‘establish and ascertain’. There are a number of possible options which parties may consider (but whose effectiveness remains to be seen), including: expressly agreeing that adjudication will ‘establish and ascertain’ a sum due under a bond, with inclusion of express rights for the bondsman to recover any overpayment if the adjudicator’s decision is found to be invalid or if a Court subsequently reaches a different decision, and for the bondsman to challenge the adjudicator’s decision; expressly providing that an adjudicator’s decision will not be sufficient to ‘establish and ascertain’; setting out a menu of options for ‘establishing and ascertaining’, potentially including an order of priorities; providing that an adjudicator’s decision becomes final and binding so as to ‘establish and ascertain’ only at that point, if not challenged within a certain period of time before then (e.g.: which would mirror the NEC4 form).

We might also see parties amending the underlying building contract to ensure that it always contains a mechanism for there to be an independent third-party assessment by a professional familiar with the project of what is due to the employer in the event of a breach and/or following an insolvency event. This may be a particular concern for JCT D&B contracts.

Naturally, each case must be judged on its facts and the wording of each bond will need to be carefully considered, however we speculate that it is perfectly possible that some parties may react to the case law in this way notwithstanding the fact that there is no guarantee that these options can themselves overcome the difficulties and challenges posed by the recent case law.

Important note: This article is in two parts. It is not a substitute for appropriate legal advice based on the facts of each individual case. Legal advice should be sought before acting or refraining from taking any action based on the contents of any of this article.

[1] We use the terms ‘employer’, ‘contractor’ and ‘bondsman’, but the precise identity of the relevant parties will depend on the facts.

[2] Section 104 of Housing Grants, Construction and Regeneration Act 1996: ‘a “construction contract” means an agreement with a person for any of the following – (a) the carrying out of construction operations; (b) arranging for the carrying out of construction operations by others, whether under sub-contract to him or otherwise; (c) providing his own labour, or the labour of others, for the carrying out of construction operations’; section 105 sets out various examples and illustrations of construction operations and what does not classify as a construction operation for the purposes of the legislation.

[3] Note that so-called ‘adjudication bonds’ exist, which are in different terms to the ABI model form and which expressly provide for a demand to be made as a result of an adjudicator’s decision.

[4] A Straume (UK) v Bradlor Developments Ltd [1999] 4 WLUK 18. See also the new wide ‘moratorium’ under the Corporate Insolvency and Governance Act 2020.

[5] [2020] UKSC 25

[6] This may be contrasted with a Court appeal process, where the first instance Court’s decision is not a nullity even where successfully appealed.

[7] [2014] EWHC 3042 (TCC)

[8] [2015] UKSC 38

[9] Tradigrain v State Trading Corporation of India [2005] EWHC 2206 (Comm); see also Cargill International SA v Bangladesh Sugar & Food Industries Corp [1996] 4 All E.R. 563

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James Bradford