Scottish Court of Session Decisions

Pursuer:  Howie QC;  Ledingham Chalmers LLP

Defender:  Keen QC, Richardson;  Brodies LLP

24 June 2014

[1]        East Ayrshire Council (the pursuer) is a planning authority.  It granted Scottish Coal Company Limited (the company) planning permission for a surface mine at Dalfad which imposed certain restoration obligations.  Those obligations were secured by a restoration bond granted by Zurich Insurance Public Limited Company (the defender).  In April 2013 the company was wound up.  Since then it has failed in its restoration obligations in respect of, amongst other sites, the Dalfad mine.  The liquidators have said that they do not intend to perform any of the company's obligations in this regard.  The company is in breach of its obligations under the agreement relative to the planning permission.  Accordingly on 7 June 2013 the pursuer served a demand on the defender, in the form of a certificate of default, to make payment of £3.344m in terms of the bond. 

[2]        The defender has refused to make payment.  This is on the basis that the certificate of default omitted to state, as required by the bond agreement, that the pursuer had given the company written notice of its failure in the restoration obligations not less than 60 business days prior to the date of the certificate, and that the company had failed to remedy the breach.  In fact no such notice of failure had been served upon the company. 

[3]        The issue arising in the present action is whether this omission invalidates the certificate of default.  This depends upon a proper interpretation of the agreement between the parties.  If the certificate of default is valid, it is accepted that the pursuer is entitled to payment of the said sum, and vice versa.  The pursuer contends that, in the circumstances, the service of a 60 day notice upon the company would have achieved no practical purpose, since it was certain that there would be no compliance by the company with its restoration commitments.  The liquidators had made it clear that the company was disclaiming such obligations.  The pursuer points out that the parties' agreement allowed the certificate of default to be in "substantially the form" of the style set out in the bond.  In the whole circumstances the absence of any reference in the certificate of default to such a notice was immaterial.  It follows that the certificate of default was in "substantially the form" required by the bond.

[4]        The defender contends that the contractual stipulation was that reference would be made in the certificate of default to a 60 day demand for compliance having been served on the company, and would include confirmation of its failure to rectify the situation.  The defender was entitled to proceed upon the basis of the documentation presented to it, and was under no obligation to inquire into the underlying facts and circumstances.  It is accepted that the certificate of default need only be in "substantially the form" required by the agreement, but, given the absence of any reference to non-compliance with a 60 day notice, this has not been achieved. 

The terms of the bond
[5]        The relevant terms of the bond are as follows.  Sub-clause 2.1 provided:

"The cautioner hereby guarantees the performance and discharge by the operator of the restoration obligations and any liability or payment obligation of the cautioner hereunder shall be discharged and satisfied by payment to (or by direction of) the Council in accordance with sub-clause 2.2".

Sub-clause 2.2 stated:

"Subject to clause 3.1, following the service upon the cautioner of a certificate of default the cautioner shall within ten (10) business days pay the sum demanded to the Council in accordance with clause 4".

Sub-clause 2.4 provided:

"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 the sum thereby demanded to the Council, and any payments made to the Council shall constitute a full and sufficient receipt to the extent of such payment".

Sub-clause 3.4 stated:

"The cautioner shall not be bound or required to make any investigation or inquiry in respect of any certificate of default received pursuant to this guarantee bond and shall be entitled to discharge any demand so made which appears to be regular on its face by making payment to the Council without reference to any other party hereto".

[6]        Clause 6 provided that the obligations and liabilities of the cautioner shall not be released, discharged, etc by any one or more of certain events, which included any disclaimer, or the occurrence in relation to the operator of any insolvency event.   The bond defined "disclaimer" as meaning any disclaimer of the agreement or restoration obligations by a liquidator of the operator.

[7]        In the circumstances of the present action a "certificate of default" was defined as meaning a certificate in substantially the form set out in appendix II(A) of the bond.  The style set out in that appendix required the pursuer to certify three things, namely:

(a)   that the company had "failed to perform and discharge the restoration obligations in accordance with the terms of the agreement" and that the Council is entitled to the specified sum;

(b)   that "written notice of such failure has been given to (the company) not less than 60 business days prior to the date of the certificate, and (the company) has failed to rectify such failure" and

(c)    that the sum set out in the certificate is "accordingly due and payable to (the pursuer) under the terms of the guarantee bond".

The appendix also provided that payment by the defender as cautioner will "operate as a good and sufficient receipt and discharge to the extent of such payment for all purposes of the guarantee bond without any requirement for (the defender) to make further investigation or inquiry". 

[8]        The maximum sum payable under the bond was £3,344,607, which was payable in respect of a default occurring within the period of 18 to 24 months after the date of the bond, which was 8 June 2011.  Thereafter, for the period of 24 to 30 months, the sum payable on demand reduced to just over £1,672,000, and continued to reduce over time until the expiry of the bond in 2019.  The certificate of default was served on the eve of the 18 to 24 months period, thereby enabling the pursuer to call for payment of the maximum sum.

Submissions on behalf of the defender
[9]        Mr Keen QC drew attention to the timing of the certificate of default and to the step-down provisions in the bond.  Had the service of the certificate been delayed to allow the 60 day notice procedure to be carried out, the claim would have reduced from £3.334m to £1.672m.  That was the real reason for the omission of any reference to a 60 day notice.  No further certificate or certificates of default have been served upon the defender.  A valid certificate was "conclusive evidence of liability".  It followed that the defender was entitled to proceed upon the basis of the documentation, and refuse payment if the certificate was not consistent with the agreed requirements.  The certificate had to be regular on its face. 

[10]      The key task for the court is to interpret the agreement of the parties as set out in the bond.  The absence of any reference to service of a 60 day notice and subsequent non-compliance by the company meant that the certificate was not in "substantially the form" of the style set out in appendix II(A).  A valid certificate of default is a pre-condition to the defender's liability to make payment.  Mr Keen made reference to IE Contractors Ltd v Lloyds Bank plc [1990] CSOH 124.  It would have been pointless to serve a 60 day notice in the present circumstances.  The defender was under an obligation to make payment of the £3.344m within 10 days of the demand.  On any view the liquidators of the company could not have satisfied any 60 day notice without breach of the pari passu rule as between creditors of the insolvent company.  No preference could have been shown to the pursuer in respect of the mine at Dalfad.  In any event, the 60 day notice procedure was designed for relatively minor and remediable breaches in the designated progress of restoration as the mine was quarried.  In respect of such breaches a 60 day notice would allow remedial work before matters reached the stage of a call under the performance bond, which would trigger counter-indemnity obligations and other complications.  The procedure was intended for "temporary" breaches, not permanent disclaimers of the kind issued by the liquidators of the company.  In short Mr Howie submitted that, in the particular circumstances of this case, the written declaration envisaged by appendix II(A)(b) did not apply, thus its absence has no impact upon the validity of the certificate of default. 

[12]      Mr Howie submitted that a performance bond is a different creature from a letter of credit.  Another approach may be required in the realm of negotiable instruments and international trade.  However, for the parties' bond, strict compliance is not required.  The "substantially in the form of" qualification made it clear that there was no need for exact duplication of the terms of the style.  The absence of any reference to a 60 day notice was immaterial when set against the background circumstances of the liquidation of the company, thus the certificate of default was "substantially" as required. 

[13]      The court should concentrate on matters of substance, not form.  The parties cannot have intended that the pursuer would require to serve a notice on the company when it was clear that it would serve no practical purpose.  Rather the procedure was designed to deal with an accidental or temporary breach of the restoration obligations.  Nothing of materiality had been omitted from the certificate.  Reference was made to Barrett Bros (Taxis) Ltd v Davies [1966] 1 WLR 1334 at 1339;  and to  The "Mozart" [1985] 1 Lloyds Rep 239 at 245.

[14]      The problems faced by the company were notorious.  The defender cannot credibly claim ignorance of them.  Everyone knew that there would be no further implementation of the company's restoration obligations.  If the defender was uncertain about matters, it could have inquired of the liquidators as to the true position.  If the defender had asked the pursuer about the lack of a 60 day notice, it would have been told that it was a pointless procedure.  In short, the 60 day notice was not an absolute condition precedent to liability under the bond.

Submissions in response on behalf of the defender

[15]      Mr Keen submitted that there is no room for arguments about futility.  The terms of the contract are clear and should be applied by the court.  Some of the cases are to the effect that if a fact has already been communicated to the other party, it need not be repeated in the certificate or notice, but that is very different from the present case.  This case concerns a demand bond, and the authorities are clear that there is no liability to pay upon the demand unless it is in proper form.  A futility argument could equally be applied to a failure to comply with the terms of appendix II(A)(a).  It was not incumbent upon the defender to know about or inquire into the circumstances of any disclaimer by the liquidators, nor whether a 60 day notice was a potentially worthwhile procedure.  There might be easily recoverable seams of coal at Dalfad well worth exploiting.  Lord Hodge's opinion in the case cited was issued after the date of demand, and in any event is of no relevance.  The defender was entitled to rely upon the terms of the bond.  There was no obligation to inquire or look behind the terms of the certificate of default.

[16]      It would have been open to parties to vary the required style of certificate in the case of disclaimers or insolvency events, but they chose not to do so.  Mr Keen asked, how could the defender pay on such a certificate and be confident that the liquidators would accept their claim to rank in the company's liquidation?  The liquidators could reject the claim on the basis that the defenders paid on a defective certificate.

[17]      The true reason for the lack of the 60 day notice procedure was to avoid the consequences of the step-down provisions in the bond.  Otherwise there was no difficulty in complying with the terms of appendix II(A) in full.  There is nothing in the agreement to support the submission that paragraph (b) was designed for only accidental or temporary breaches.  The pursuer does not make any averments as to the state of the defender's knowledge of the circumstances of the breach of the restoration obligations, and it is idle to speculate upon their awareness or ignorance of such details. 

Some general propositions which can be derived from the case law
[18]      Although the bond calls itself variously a restoration bond, or a guarantee bond, counsel were agreed that it falls into the category of a performance bond, around which there is now an extensive jurisprudence in England and Wales.  So far as relevant for present purposes, the following can be drawn from the case law.

1.     The normal principles of construction of contract apply to performance bonds.  Thus to identify whether a demand has created a liability to pay depends upon the parties’ intentions in that regard as expressed in the terms of the agreement. 

2.     Unless there is special provision to the contrary, a performance bond is an autonomous contract which creates an absolute and unqualified obligation on the issuing bank (or insurance company) to pay if and when presented with a demand which complies with the requirements for such as agreed in the bond.  This is an independent obligation quite separate from the underlying guaranteed transaction.  Again subject to any contrary provision in the bond, the bank is expected to do no more than compare the demand with the agreed requirements.  Nothing depends upon the true position concerning any dispute between the beneficiary in the bond and the account party (here the company), nor on the bank’s knowledge of it.  And the bank need not and is not expected to make any inquiry on the matter. 

3.     In short, a performance bond is intended to be an immediately enforceable obligation of the grantor to pay against stipulated documents.  (The fraud exception is based on the general refusal of the court to facilitate a fraudulent gain.)  The other side of the coin is that, leaving aside trivial typographical errors which are obvious on the face of the document, the bank is not obliged to pay if a demand does not meet the agreed terms.  This remains true even if it can be proved that any differences are of no materiality.  It is often said that banks’ expertise is in documents, not as to the merits or circumstances of the underlying transaction or of the parties to it.  Should the bank pay out in respect of a non-compliant demand, for example because in the particular circumstances it seems fair and reasonable to do so, it may face difficulties in enforcing the counter indemnity obligation of the party in default, who is likely to argue that the bank exceeded its mandate. 

4.     Whether exact or strict compliance with any agreed style or form is required again depends upon the terms of the bond.  There are cases where it has been held sufficient for the demand to deal with the substance of what is required, rather than slavishly duplicate precise wording.  That approach has been expressly adopted by the parties to this bond.  They agreed that it would be sufficient if, in substance, the terms of appendix II(A) were met. 

Discussion and decision
[19]      The degree of formality, technical precision and strict accuracy required of a certificate, notice or demand provided for in an agreement, depends upon the proper construction of the parties' intention in this regard as expressed in the relevant deed, and with regard to the shared knowledge of the relevant surrounding circumstances, including the nature and purpose of the contract.  One can ask whether the parties intended that an omission of the kind involved in the present case would invalidate the demand?  Could the constituent elements of a valid demand vary according to the particular facts, and if so, did the circumstances in the present case permit such?  The parties agreed that exact duplication of the agreed style was not required, but can a certificate of default survive the absence of any reference to failure of the company to comply with a 60 day notice? 

[20]      The context is a performance bond of the kind discussed in the case law – sometimes called a demand bond.  The parties agreed for payment by the defender within 10 business days of service of a certificate of default.  There is no scope for argument over whether the demand is or is not well founded (other than in the case of alleged fraud – which does not arise in the present case).  The parties agreed that service of a properly drafted certificate of default would be “conclusive evidence” of a liability to pay within 10 days. 

[21]      The conclusive nature of the certificate of default is an important factor.  It operates in two ways.  The indemnifier cannot refuse to pay, and the party in default cannot question any counter-indemnity obligation on its part.  If compliant on its face, the defender was bound to pay the demand for £3.344m within 10 days, whatever the rights and wrongs of the underlying dispute.  The company was a party to the bond agreement, and could be expected to raise concerns if called on to reimburse the defender in the absence of a regular certificate of default.  Can it be said that the parties to the bond allowed the pursuer to determine, without consulting the others, that a constituent element of the agreed style for a certificate of default could be omitted without any prejudice to the parties' overall rights and obligations?

[22]      In my view, in the context of a demand bond of this nature, and unless the contrary appears from its face, if the parties agree that three matters require to be certified, then each is necessary for a valid demand.  The style in appendix II(A) requires there to be reference to a procedure designed to give clear notice to the company of its breach of the restoration obligations and an opportunity to rectify the position before the bond is called up.  The certificate of default was to contain certification of non-compliance by the company for at least 60 days.  That is a wholly understandable and significant element of a conclusive demand of the present kind.  It gives the company notice that the beneficiary is contemplating recovery under the bond and it provides some comfort to the defender that there has been a default.  To my mind it would be surprising if the beneficiary in the bond could simply decide that such a notice would achieve nothing, and therefore could be set aside with impunity. 

[23]      Notwithstanding the liability to pay on the basis of the agreed certificate, should the defender be taken as having agreed that there can be circumstances in which a 60 day notice procedure is not required, and if so, what are those circumstances?  As soon as one asks such questions, the difficulties and uncertainties are obvious.  It seems to me to be reasonable to conclude that the guarantor, who required to pay whatever the underlying situation, wanted some reassurance on the face of the certificate that there was good reason for the bond being called up.  Mr Howie submitted that the defender must have known that the liquidators would not comply with any such notice.  That may or may not be the case, but even assuming, as seems likely, that the defender was aware of the liquidation of the company, it does not follow that it must be taken as having agreed that in those circumstances a valid certificate could be served in the absence of the agreed certification of non-compliance with a notice to remedy.  The correct construction of the agreement cannot depend on what does or does not seem reasonable in the particular circumstances of a particular case.  That would be to risk re‑writing the parties' agreement on the basis of what, at this point in time, seems fair and equitable.

[24]      Mr Howie argued that the 60 day notice to remedy procedure was designed for minor, temporary or accidental breaches of the restoration obligations – not for seismic events such as the winding up of the Scottish Coal Company Limited.  The short answer to that submission is that there is nothing in the bond, nor in the relevant surrounding circumstances, to support it.  On the contrary it was agreed that the same style for a certificate of default would apply in the case of disclaimers and insolvency events.  In these circumstances it is difficult to conclude that the parties must be taken as having allowed a different form of certificate if the company was in liquidation and the liquidators had disclaimed its obligations.  The natural inference is that, even in the present circumstances, the notice to remedy certification is a required element of the demand.  The certificate of default has direct, immediate, and significant contractual effect.  In my view a reasonable reader of the bond would have understood that the substance of each and all of its constituent parts as per the agreed style had to be reflected in the demand. 

[25]      Mr Howie placed considerable reliance on the agreement that the certificate of default merely required to be in "substantially the form of" appendix II(A).  The submission was that, since it would have been pointless to serve a 60 day notice of compliance on the company, the certificate as served on the defender was substantially in the required form.  However, even assuming that a notice would have achieved nothing, it does not follow that the certificate was in substantially the form of the agreed style.  The alleged futility provides a potential reason for the decision not to serve a 60 day notice.  However, to decide whether the certificate is or is not in substantially the agreed form simply requires a comparison between the two documents, and a judgment as to whether any omissions or differences are on points of substance, or only as to matters of form.  In my opinion the omission of the second of the three matters which required to be certified cannot be categorised as a matter of form.  The bond allows the drafter of a certificate of default to use different wording, phrasing or structure, but it must convey the substance of appendix II(A).  The present is not such a certificate.  One of the three agreed matters of fact to be confirmed by the pursuer has been omitted.  I have already expressed the view that confirmation that the 60 day notice procedure had been followed cannot be dismissed as an insignificant or unimportant part of the agreed style of certificate of default.  In any event, in their agreement the parties expressly made it a material element of the requirements of a valid demand under the bond, even in cases of disclaimers by a liquidator. 

[26]      As to whether the deficiency in the certificate renders the certificate invalid, for the reasons already given, and by an application of the general principles summarised earlier, in my view the answer is yes.  The parties have so agreed, and it is not open to the pursuer to expect on demand payment unless the documentation is compliant with the bond.  As for Mr Howie's reliance upon cases such as The "Mozart" and Barrett Bros (Taxis), those and similar  decisions demonstrate that there can be cases where the court will overlook an omission in a contractual notice or demand, in particular when the omission of a statement as to a certain state of affairs is of no practical consequence because the recipient of the notice has already been given the specified information.  In such circumstances it would require clear wording in the agreement before the court would insist that the intention was that nonetheless the information should be repeated in the contractual document.  However none of this is of any relevance to the circumstances of the present case.  The defender was not otherwise aware of a failure of the company to respond to a 60 day notice of failure to restore.  This was for the very good reason that there was no such 60 day notice.  The certificate omitted paragraph (b) of the appendix because it could not truthfully be included, not because it had already been communicated to the defender in some other manner.  Even if the pursuer chose not to serve a 60 day notice because it was pointless – as opposed to a desire to claim £3.334m rather than £1.672m – this was not the kind of futility addressed in the cases relied upon by Mr Howie. 

[27]      In summary, the certificate of default required to include at least something along the lines of paragraph (b) in appendix II(A).  The defender was entitled to rely on the deficiency in the demand, and this remains so even if it knew that the company was unlikely to respond in a positive manner to a 60 day notice.

[28]      At the hearing there was some discussion as to whether, despite the invalidity of the certificate of default, the defender remains under an accessory obligation to indemnify to the specified sum in respect of a restoration failure in the 18-24 months period, albeit not subject to the requirement to make payment under the conclusive certificate of default procedure.  In other words, did the bond serve a dual purpose, covering both a primary and independent obligation to pay on receipt of a valid certificate of default, and a traditional accessory obligation to indemnify loss caused by a proven default by the company?  However Mr Howie stated that any such argument is for another day.  He confirmed that the present action depends upon the validity of the certificate of default.  I am of the opinion that it was invalid, thus the pursuer's claim fails.  In the particular circumstances of the case, there is at least room for discussion as to whether dismissal or absolvitor is the appropriate disposal.  I shall put the case out by order to allow parties the opportunity to make representations on the matter.