Aviva Insurance Ltd v Hackney Empire Ltd

[2012] EWCA Civ 16716

HEL engaged Sunley Turriff Construction Ltd (“STC”) to carry out extensive refurbishment work to the theatre. In May 2001, STC started work under a letter of intent authorising it to carry out up to £500,000 of work. On 6 August 2001, Aviva issued a bond in favour of HEL for £1,106,852 to secure the performance of STC under the building contract. That building contract provided for a completion date of 2 September 2002 with liquidated damages at £5,000 per week. By October 2002, disputes had arisen and STC was claiming £4million.

In December 2002, the parties entered into a verbal agreement by which HEL paid £500,000 on account of STC’s claims for loss and expense with two further payments of £250,000 to follow. In return STC agreed to provide a programme demonstrating how it could complete the works by 31 May 2003 and agreed to complete them by that date.

In February 2003, the parties entered into a side agreement which limited the amount of liquidated damages payable by STC if the target completion date was met, and prevented the parties from referring disputes to adjudication for a period of time. The side agreement also referred to the £500,000 paid in December 2002 and the two further payments of £250,000. The first of these two further payments was made. The agreement provided that if STC did not meet the target date for completion of the works (which was 31 May 2003 but which by correspondence between the parties had been extended to 31 July 2003), it agreed to repay all of the sums paid under the side agreement.

On 2 July 2003, STC went into administration and five days later, HEL demanded repayment of the £750,000 paid under the side agreement. On 5 February 2004, HEL wrote to STC’s administrator confirming it had suffered losses of £3,154,142 as a result of STC’s failure to complete the work. Then on 8 March 2004, HEL made a claim under the bond for the full amount.

Aviva argued that the rule in the Victorian case of Holme v Brunskill meant that the payments to STC under the side agreement had discharged its liability under the bond. This rule provides that if there is any agreement between the principals (in this case HEL and STC) to alter the principal contract (i.e. the building contract) then the surety (Aviva) should be consulted and if the surety has not consented to the alteration, or if it is not self-evident that the alteration is unsubstantial or cannot be prejudicial to the surety, then the court will not go into the merits of the alteration or the question of whether it is prejudicial but will instead allow the surety to be discharged from its obligations. At first instance Mr Justice Edwards-Stuart held that the side agreement was a separate free-standing agreement, which did not vary the construction contract save in two immaterial respects. This was not challenged on appeal. Nevertheless, on appeal, LJ Jackson summarised the key principles as follows:

(i) The rule in Holme v Brunskill only applies where parties to the contract guaranteed have varied the terms of that contract without the consent of the surety.

(ii) Advance payments of the agreed contract price made by an employer to a contractor may have the effect of discharging the liability of the surety. However, additional payments (for example by means of a gift or loan) made by the employer to the contractor outside the terms of the original contract do not have that effect.

(iii) A surety will not be released from liability if (a) he has specifically consented to what was done or (b) there is an indulgence clause which covers what was done.
This left the question of HEL’s conduct, in particular whether the making the two payments totalling £750,000 to STC, was such as to discharge Aviva’s liability under the bond. Mr Justice Edwards-Stuart had held that the test which he had to apply in relation to conduct was as follows:

“if an employer acts in a manner in relation to the principal contract which, whilst not amounting to an alteration of its terms, is prima facie prejudicial to the surety who has guaranteed the contractor’s obligations under the principal contract, the surety will be discharged (absent any relevant indulgence clause in the guarantee).”

Applying the test, the Judge concluded that HEL had not acted in relation to the construction contract in a manner which was prejudicial to Aviva. Accordingly, Aviva was not discharged from liability under the bond. LJ Jackson noted that the dilemma for HEL was whether it should stand on its contractual rights and leave the contractor struggling with its financial problems or whether it should make additional payments to the contractor in the hope that this would result in improved progress on site. HEL chose the latter course.

The effect of the side agreement was that HEL loaned £750,000 to STC. If STC subsequently substantiated a loss and expense claim for £750,000 or more, then the money paid by HEL would be retained by STC as payment or part payment of that loss and expense. If STC failed to establish any loss and expense claim, then it would repay the £750,000 to HEL. If STC established a loss and expense claim for a sum less than £750,000, then STC would repay the excess to HEL.

The £750,000 which HEL paid to STC in December 2002 and February 2003 was not part of the original contract sum. It was not a sum certified as due by the architect or otherwise falling due under the provisions of the contract. In the view of the Judge, the two payments made totalling £750,000 could only be seen as sums paid outside the contract and for extraneous reasons. Therefore the two payments made by HEL to STC did not have the effect of discharging Aviva from liability under the bond.

However, Aviva’s liability as surety only related to the original construction contract and so it had no liability in respect of STC’s failure to repay the sum of £750,000 which it owed to HEL under the side agreement.

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