Construction Insurance and UK Construction Contracts
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CHAPTER 14
Bonds and insurance
Introduction
14.1 The reason for including a chapter on bonds in this book is that bonds have some superficial similarity to insurance contracts, mainly in the way that they are provided (some insurers will issue bonds) and because they provide a form of financial recourse in the event of risks occurring. 14.2 In construction, bonds are typically used as security for performance of the contractor but increasingly are provided as an alternative to a retention and also security for the employer’s performance. Where used as security for the contractor’s performance, they are often employed as an alternative to a guarantee from the parent company of the contractor’s group (for example where the contractor is itself the holding company of the group) and are often treated as an alternative to a parent company guarantee when, in fact, it is nothing of the sort. However, contractors are usually reluctant to offer both a parent company guarantee and a performance bond since both represent a cost to the contractor.The nature of a bond
14.3 Originally, a bond was issued as security for performance and simply imposed on the provider of the bond (the “surety”) a penalty if the obligation was not performed. Frequently, the surety was not required to check whether the relevant obligation had been performed or not but simply had to take the beneficiary’s word that the performer of the obligation (the “principal”) had failed to perform. Unlike most contracts, a bond is one form of contract where it is possible to require payment of a sum greater than the loss suffered because a bond such as this (known as a “single” bond) is not contractually connected to the underlying obligation. 14.4 There has developed a different type of bond known as a “double” bond, which adds to the pure obligation to pay on default conditions governing such payment. Typically, such conditions might require the beneficiary to prove or provide evidence of the principal’s failure to perform and might also require the beneficiary to establish the amount of loss suffered. 14.5 A bond is closer in nature to a guarantee than it is to a contract of insurance, as a bond provides security for performance, similar to a guarantee and the contract of insurance provides indemnity against certain risks occurring. In addition, at common law insurance contracts depend on two principles (although, as set outPage 234
- (1) They are contracts of the “utmost good faith”. This means, in effect, that the insured and the insurer must always act reasonably to each other in a wholly open and honourable manner. This is a continuing obligation during the subsistence of the policy (Orakpo v Barclays Insurance Services Limited)1 and is a mutual obligation of insurer and insured (Banque Financière de la Cité SA v Westgate Insurance Co Limited).2
- (2) The insured must make full disclosure of all material facts and must not misrepresent material facts. Non-disclosure or misrepresentation potentially entitle the insurer to avoid the policy.
The modern usage
14.7 Until comparatively recently, bonds were written in archaic language, which reflected the history that a bond was an instrument that imposed a penalty on the surety on the happening of an event. This language came in for severe criticism in Trafalgar House Construction (Regions) Limited v General Surety and the Guarantee Co Limited,4 in which Lord Jauncey of Tullichettle said that he found:great difficulty in understanding the desire of commercial men to embody so simple an obligation in a document which is quite unnecessarily lengthy, which obfuscates its true purpose and which is likely to give rise to unnecessary arguments and litigation as to its meaning.