Hackney Empire Ltd v Aviva Insurance UK Ltd

This is a claim under a bond. The claimant, Hackney Empire Ltd ("HEL"), owns the Hackney Empire Theatre in east London. In 2001 HEL decided to carry out extensive works of refurbishment to the theatre, a building of considerable architectural interest with many period features. The contractor was Sunley Turriff Construction Ltd ("STC"). Unfortunately, the contractor fell into considerable delay and was unable to complete the work. On 2 July 2003 STC went into administration.

During the course of the work STC made numerous claims, all but one or two of which were never properly substantiated. In December 2002, in an attempt to ensure that the works were completed as soon as possible, HEL agreed to advance STC £1 million in three instalments as a payment on account in respect of STC's claims. The first instalment of £500,000 was paid in December 2002, the second instalment of £250,000 was paid in February 2003 and the final instalment was never paid.

Following the signature of a letter of intent in May 2001 STC took possession of the site and commenced work at the end of that month. On 6 August 2001 the defendant, Aviva Insurance UK Ltd ("Aviva"), together with STC, executed a bond in favour of HEL in the sum of £1,106,852. The bond secured the due performance of STC's obligations under the building contract for the refurbishment works.

In fact, the building contract referred to in the bond was not entered into until some seven months later, 5 March 2002, but it is common ground that it is STC's obligations under that contract that form the subject matter of the bond.

The principal issue in the case is whether Aviva is liable under the bond and, if so, whether that liability extends to STC’s failure to repay the £750,000 that was advanced on account of its claims that were never, in the end, substantiated. In addition to the advance of the £750,000, HEL also agreed to pay for certain off site materials for which it was not contractually bound to pay under the terms of the building contract.

Aviva contends that the payment of the £750,000 and/or the payments in respect of off-site materials were the result of agreements between HEL and STC made with reference to the building contract but without the knowledge of Aviva in circumstances that were prejudicial to Aviva. The result, says Aviva, is that its liability under the bond was discharged. If it is wrong about this, its secondary case is that it cannot be liable for the default in respect of the £750,000 because that was not an obligation that came within the scope of its guarantee: in fact, it submits that its only liability would be in respect of HEL's accrued right to liquidated damages in the sum of £205,000.

HEL contends that Aviva is liable under the bond because the arrangements by which HEL agreed to pay the £750,000 and for the off-site materials were variations to the building contract or acts of forbearance that were permitted under the terms of what is often called an "indulgence clause" in the bond.

At this hearing I am concerned only with issues of liability. It is hoped that once the issues of liability have been determined the parties will be able to agree the remaining issues of quantum (if any).

On 24 April 2001 HEL sent STC a letter of intent in relation to the carrying out of the refurbishments and works "pending execution of a formal contract". The letter provided that the Contract Sum was to be agreed but was not to exceed "approximately £11,100,000” and authorised expenditure up to £500,000. The letter of intent was countersigned by STC and returned.

On or shortly before 31 May 2001 STC took possession of the site and commenced work. On 6 August 2001 STC and Aviva (then called Norwich Union Insurance Ltd) executed the bond in the sum of £1,106,852 in favour of HEL.

On 5 March 2002 HEL and STC entered into the building contract. It incorporated the JCT Standard Form of Building Contract 1998 edition Private with Quantities form with various amendments.

The building work fell broadly into three areas:

The Completion Date under the building contract was 2 September 2002. There was a provision for liquidated and ascertained damages (“LADs”) at a rate of £5,000 a week. HEL intended to re-open the theatre in the autumn of 2002, and had a major production booked for the end of that year.

By December 2001, some 6 months into the contract, STC was reporting a delay of 5 weeks. By early February 2002, this had doubled to 10 weeks. By the beginning of May 2002 STC was predicting completion at the end of January 2003.

The situation in relation to the claims being made by STC was discussed at a Project Committee Meeting held on 10 July 2002. Under the heading "Claims", it was noted that the architects had received 29 claims and had been notified of delays totalling 105 weeks. Mr Ronalds, the architect, made the following recommendations to the committee:

The possibility of STC referring a dispute to adjudication was discussed at the meeting, and the draft minutes record that HEL was advised (by Mr Neil Barbour of Arup, the Project Manager) that an analysis of referrals to adjudication had shown that claimants were successful in approximately 70% of adjudications and unsuccessful in 15%, the remaining 15% being settled before the hearing.

At a meeting held on 18 July 2002 at the chambers of Stephen Solley QC, who was a member of HEL's board, between representatives of the senior management of STC and members of HEL's board, together with Mr Ronalds and Mr Thomsett, there was a frank exchange of views by both sides. Mr Wolfe, STC's Managing Director, said that there were substantial matters in dispute with a value amounting to about £750,000, together with a further £500,000 in respect of work which STC said had been undervalued. It was noted at the meeting that arrangements for the payment of off-site materials were close to resolution and were subject to proper insurances and bonds being put in place.

In July 2002 STC submitted a 20 page document described as "Further and Better Particulars of Delays" in relation to piling and underpinning works to the Pepys building. STC claimed that these additional or varied works had caused 10 weeks delay, and the document included a one page Delay Analysis Programme showing how the events impacted on STC's programme for the works.

On 26 July 2002 the architect wrote to STC chasing particulars of 18 claims that had been submitted by STC. On 30 July 2002 STC submitted an "on account" submission, which was said to be in respect of disruption encountered up to and including 31 July 2002. The sum claimed was £548,718.

In August 2002 the Quantity Surveyors, in Progress Report No 13, reported that STC had made unsupported claims totalling about £1.3 million, including the £548,718 referred to above. At a site meeting on 5 September 2002 STC's estimate of the completion date was put back to 14 April 2003. Shortly afterwards the architect granted an extension of time extending the Completion Date to 23 September 2002. That was the third of four extensions of time that were granted to STC.

There were, of course, conflicting views as to the responsibility for the delays. The architect, Mr Ronalds, who gave evidence before me, thought that STC was incompetent and under-resourced and it is clear that the professional team took the view that STC was responsible for the lion's share of the delay. However, STC contended the contrary and continued to submit numerous claims for extensions of time and associated loss and expense. With one or two exceptions, these claims were never substantiated and STC did not provide the particulars in support of its claims that were required under the terms of the building contract. One of STC's particular complaints was that the project was meant to be fully designed, yet in the course of carrying out the works they received over 1,000 instructions.

By October 2002 STC was threatening adjudication. It was asserting that its final account would exceed the contract price by about £4 million (the Quantity Surveyors’ Progress Report No 17, of November 2002, recorded that STC’s prediction of its final account value was £15.25 million).

At this point one of HEL's benefactors, Sir Alan Sugar (now Lord Sugar) became involved. He visited the site on 22 October 2002, during which he was briefed by both parties. At the visit he offered to arbitrate between the parties and to that end he held a meeting with the parties on 13 November 2002, which was intended as a form of mediation. Lord Sugar proposed that HEL should make a payment on account to STC in respect of its claims in a number of instalments. After further discussions between the parties in November and December 2002, HEL offered to pay £1 million to STC in three instalments. However, STC wanted the full amount paid at once. It was accepted on both sides that the sum or sums advanced would be a payment on account in respect of STC's claims pending the provision of proper particulars.

At a meeting between the parties held on 16 December 2002, HEL agreed to pay £500,000 straight away and two instalments of £250,000 during the following year. The third and final instalment was to be paid only if Practical Completion was achieved by 31 May 2003.

Although the parties subsequently entered into a side agreement which covered the making of these payments, that agreement was not entered into until, at the earliest, after 26 February 2003 when the second instalment was paid. Mr Richard Wilmot-Smith QC, who, with Miss Alexandra Bodnar, appears for Aviva, submits that the circumstances in which the first payment of £500,000 was paid in December are in themselves sufficient to discharge Aviva from liability under the bond. It is therefore necessary to establish the arrangements or agreement under or by which the first payment was made.

There are two contemporaneous notes of the meeting of 16 December 2002. The first is by Mr Tim Ronalds, the architect, and the second is by an unidentified representative of STC. The first item in the note by Mr Ronalds reads as follows:

The notes made by the representative of STC recorded that the programme was to go to the architect and was to be in the post on Wednesday evening, 18 December 2002. I find, therefore, that it was agreed that a condition of the payment of the first instalment was the issue by STC of a revised programme.

In a letter dated 10 January 2003 Mr Kent, the Commercial Director of STC, acknowledged HEL's letter of 20 December 2002, which enclosed a proposed agreement, saying that the agreement needed “to be amended in order to bring it into line with [STC's] revised offer of 31 May (attached for reference)”. What this referred to was not an offer dated 31 May but the terms of a previous offer by STC to endeavour to complete the works by 31 May 2003 in return for the on account payment of £1 million. The letter concluded by saying:

“In the meantime, I would reiterate that we are continuing to progress the works to achieve Practical Completion on or before 31 May 2003, in line with the ‘spirit’ of our original agreement."

STC did indeed send a programme to HEL on 18 December 2002 and that showed a completion date of 31 May 2003. However, the two sets of notes do not suggest that any agreement was reached about the means by which STC's claims should be taken forward. According to the note by Mr Ronalds, STC called on the architects to make decisions "on account" or to reject the claims, giving STC detailed reasons for the decision or the rejection. The response by Mr Ronalds was that STC should provide particulars of their claims as required by the contract. At that point Mr Ronalds left the meeting; the STC notes describe him as having walked out.

Accordingly, and in spite of the suggestion to the contrary in the witness statement of Mr Thomsett, I find it impossible to conclude that on 16 December 2002 any agreement was reached about the manner of dealing with STC's claims. However, I consider that an agreement was reached to the effect that if STC provided a programme showing a completion date of 31 May 2003, and undertook to endeavour to complete by that date, HEL would make the first payment of £500,000. Although this was not expressly stated, I consider that it was also the mutual understanding of the parties that if an agreement was reached along these lines, STC would not refer any dispute about its claims to adjudication for the time being: this was quite clear from the evidence of Mr Thomsett (at Day 1/151). Mr Thomsett, HEL's General Manager, was the person who was in day to day charge of this project on behalf of HEL.

HEL duly made that payment, plus VAT, on about 30 December 2002.

It is of interest to note that at about the time of the meeting Boyden & Company, the project quantity surveyors, had been asked to give an estimate of the probable value of STC's claims. In a letter dated 2 January 2003 Mr Cameron Smith, of Boyden & Company, indicated that £1.8 million was a figure in the region of which a settlement might be achieved, although he warned that it was difficult to be precise in the absence of the claim details.

On 18 February 2003 Mr Thomsett replied to Mr Kent's letter of 10 January 2003 making various points in response to those raised by Mr Kent. The letter concluded by asking for confirmation that Mr Kent was content with these counterproposals. Mr Kent replied the following day, 19 February 2003, referring to ‘The Agreement’, suggesting further amendments and asking for Mr Thomsett’s comments.

On 26 February 2003 Mr Thomsett wrote again to Mr Kent saying "Following our recent discussions this letter provides details of the understanding we have reached". The letter concluded by asking Mr Kent to sign and return a copy of the letter to confirm STC's agreement. By a second letter of the same date, HEL sent STC a cheque for £293,750, being the second instalment of £250,000 plus VAT. This cheque appears to have been sent by HEL without waiting for confirmation from STC that the terms of HEL's first letter were agreed.

There does not appear to have been any reply from STC in response to the two letters of 26 February 2003 and receipt of HEL's cheque. However, on 6 March 2003 Mr Kent wrote to Mr Thomsett following a discussion between them about the Hackney siege (an incident when an armed man occupied a building in Graham Road, very close to the Hackney Empire Theatre, between 26 December 2002 and 10 January 2003 causing much disruption to local activity). The letter concluded as follows:

“In the meantime, I assume that you will be able to formally extend the date of the Employer/Contractor ‘Agreement’, by three weeks."

It seems to me that this request by STC to extend by three weeks the date by which STC had promised to complete constituted an acceptance by conduct of the terms of HEL's letter of 26 February 2003 (a conclusion to which Mr Wilmot-Smith was not inclined to make any serious challenge). It follows, therefore, that neither the payment of £500,000 on 30 December 2002 nor the payment of £250,000 on 26 February 2003 were made pursuant to any written agreement. In my view, both payments were made on the terms of the bare oral agreement that I have set out in paragraph 30 above.

In the meantime the delays on site continued. In early 2003 STC was losing about two weeks in every four.

On 27 February 2003 Mr Thomsett had lunch with a Mr Mike Greenhough, who had been brought in to sort out STC's seven projects in the South Region and to create an exit strategy for STC's founders by 2004. According to a contemporaneous note Mr Greenhough told Mr Thomsett that STC had taken on a series of projects that were very technical, including the Hackney Empire project. He said that in his opinion STC was not equipped to take on projects of this type and had been over ambitious in doing so.

On 11 March 2003 STC issued a further programme which showed a date for Practical Completion of 31 July 2003. At STC's request HEL agreed to amend the agreement of 26 February 2003 ("the Side Agreement") to reflect the new completion date. This was done by an exchange of letters dated 24 April and 6 May 2003. However, HEL's letter of 24 April 2003, which enclosed a revised version of the Side Agreement of the same date, made it clear that the extension of the target date for completion was not to be construed as an extension of time.

In his letter of 6 May 2003, acknowledging the revised Side Agreement, Mr Kent asserted that, as HEL had now formally extended the agreement, the third instalment was still due to be paid on 2 June 2003. This was clearly wrong, but since the third instalment was never paid the validity or otherwise of the amendment to the Side Agreement is of no relevance to the issues that I have to decide. In any event, Aviva no longer relies on it.

In the meantime, on 30 April 2003, the architect had granted a further extension of time of the Completion Date to 7 October 2002 as a result of the effects of the Hackney siege.

On 17 June 2003 Mr Kent wrote again to Mr Thomsett asking for immediate payment of the final tranche of £250,000. By this time further delays had occurred and STC was having trouble paying its sub-contractors and suppliers on time and site resources decreased in consequence. On 2 July 2003 an Administration Order was made in respect of all the companies in the Sunley Turriff Group, which included STC.

On 3 July 2003 the architect issued a Certificate of Non-Completion, recording that STC had failed to complete the works by the revised Completion Date of 7 October 2002. On 7 July 2003 HEL wrote to STC and demanded repayment of the £750,000 paid to STC under the Side Agreement. The demand was made under paragraph 7 of the Side Agreement, which entitled HEL to the return of the money advanced if STC did not comply with the terms of the Side Agreement.

On 21 July 2003 HEL wrote two letters to STC. The first required STC to pay LADs in the sum of £205,000. This was based on 41 weeks delay at £5000 per week (from the revised Completion Date of 7 October 2002 to 21 July 2003).

The second letter of 21 July 2003 determined STC's employment under the building contract pursuant to clause 27.3.4 of the Conditions. This provision entitled HEL to determine the employment of the contractor in the event of the appointment of an administrator. HEL claims also that STC's conduct in stopping work on site amounted to a repudiatory breach of contract and that HEL’s second letter of 21 July 2003 was an acceptance of that breach. This is strongly disputed by Aviva and gives rise to one of the agreed issues.

Following STC's departure from the site HEL engaged and paid others to complete the work. The productions that had been booked for the autumn and winter of 2003 were cancelled. The theatre eventually opened in January 2004, although the Pepys building was not ready until September 2004.

By a letter dated 5 February 2004 HEL notified STC's Administrator of its claim for losses, amounting to £3,154,142, resulting from STC's failure to complete the work.

On 8 March 2004 HEL made a formal claim under the bond, asserting that since its losses resulting from STC's breach of contract exceeded the amount of the bond it was entitled to recover the full amount of the bond. In the letter HEL claimed, amongst other things, that it was entitled to LADs as a result of STC's failure to complete by 7 October 2002, together with the £750,000 that STC was liable to repay under the Side Agreement, having failed to comply with its terms.

On 17 March 2004 Tozer Gallagher, Chartered Quantity Surveyors acting on behalf of Aviva, replied to HEL's letter denying that Aviva was liable under the bond. They took three points:

In November 2005 STC went into liquidation. HEL was an unsecured creditor with no expectation of receiving any dividend from the liquidation (leaving aside its claim under the bond).

The Bond provides that STC as Contractor and Aviva as Surety:

“are held and firmly bound unto [HEL] …in the sum of £1,106,852… for the payment of which sum the Contractor and Surety bind themselves their successors and assigns jointly and severally by these presents.”

The conditions of the bond were that if:

“(a)

the contractor shall subject to Condition (c) hereof duly perform and observe all the terms provisions conditions and stipulations of [the contract between STC and HEL for the construction and completion of works] on the Contractor’s part to be performed and observed according to the true purport intent and meaning thereof or if

(b)

on default by the Contractor the Surety “shall satisfy and discharge the damages sustained by the Employer thereby up to the amount of the above-written Bond or if

(c)

the Architect defined in the said Contract shall pursuant to the provisions thereof issue a Certificate of Practical Completion then upon the date stated therein (hereinafter called “the Relevant Date”)

this obligation shall be null and void but otherwise shall remain in full force and effect but no alteration in the terms of the said Contract made by agreement between the Employer and the Contractor or in the extent or nature of the Works to be constructed and completed thereunder and no allowance of time by the Employer or the Architect under the said Contract nor any forbearance or forgiveness in or in respect of any matter or thing concerning the said Contract on the part of the Employer or the said Architect shall in any way release the Surety from any liability under the above-written Bond.”

I shall refer to the last eight lines of this bond as “the indulgence clause”.

In its Defence in this action Aviva quite properly took no point that HEL was not a party to the bond. Indeed, it pleaded that the bond was in favour of HEL.

Clause 17 of the Conditions provided that when in the opinion of the architect Practical Completion of the works was achieved, he was to issue a certificate forthwith to that effect and thereafter Practical Completion of the works was deemed to have taken place on the date stated in the certificate. Clause 23 provided that from the Date of Possession of the site the contractor is regularly and diligently to proceed with the works and to complete them on or before the Completion Date.

The following summary of the other relevant provisions of the building contract is taken largely from HEL's skeleton opening, for which I am grateful. Clause 25 of the Conditions, which concerned extensions of time, contained the following provisions:

Clause 25.3.4 stated:

Clause 26 provided for the award of loss and/or expense to STC caused by matters materially affecting the regular progress of the Works as follows:

The Conditions contain no provisions for interim payments or payments on account of claims for loss and expense notified by the contractor under clause 26.

Clause 27 provided for the determination by the employer of the contractor's employment under the contract. For present purposes, the relevant provisions were as follows:

The terms of the Side Agreement, as set out in HEL's letter of 26 February 2003, were as follows:

“The understanding set out in this letter relates to the JCT form agreement dated 5 March 2002 between [HEL] and [STC] (“the Agreement”) [i.e. the Building Contract].

This letter sets out the basis upon which [HEL] will pay a sum on account to [STC] in respect of various claims. This sum is being paid to ensure that the Works are completed as soon as possible by [STC], in accordance with [STC’s] obligations under the Agreement [i.e. the Building Contract], without the Works being delayed prior to the resolution of certain matters arising from the Agreement. It is also intended that this will avoid the necessity for such matters to be decided upon by the appropriate third party at this stage.

[HEL] and [STC] agree the following:

1.

In the absence of details and substantiation against the Extension of Time notification/applications submitted by [STC] and backup and detail regarding the loss and expense or general claims for disturbance to the regular progress or disruption made by [STC] to date (together “the Claims”), [HEL] shall pay [STC] an “on account” sum of £1,000,000…(“the Sum”) (or as reduced in accordance with paragraph 3 below in relation to the third instalment) against the Claims subject to the terms and conditions set out in this letter.

2.

Subject to the conditions in this letter being met by [STC], [HEL] shall pay [STC] the sum in the following instalments on account of any sums which are or become properly due to [STC] in respect of the Claims and any further claims [STC] may make pursuant to or in connection with the Agreement:

•

First instalment of £500,000 to be paid on or before 31 December 2002.

•

Second instalment of £250,000 to be paid on or before 28 February 2003.

•

Third instalment of £250,000 to be paid on 2 June 2003 however, this third instalment shall only be paid if Practical Completion has been achieved by 31 May 2003 or by the Completion Date if, prior to 31 May 2003, the Completion Date has been formally extended in accordance with the Agreement to a date after 31 May 2003.

3.

[STC] shall, in accordance with the Agreement, progress the works and use his best endeavours to achieve Practical Completion on or before 31 May 2003. [STC] shall issue a target programme to completion and estimated cashflow projection before 31 December 2002.

4.

In addition to its obligations under the Agreement, [STC] shall attend meetings arranged by mutual agreement to discuss the Claims and provide details, substantiation and information in relation to them in accordance with the Agreement. These meetings are to be attended by [STC], Design Team and [HEL] as required with respective contractual roles maintained as per the Agreement.

5.

[STC] and [HEL] shall not initiate any dispute resolution mechanism (including adjudication, arbitration and litigation) in respect of any claim related item, which arises prior to 31 May 2003 at any time before 31 May 2003. For the avoidance of doubt, any such claims may be brought but only after this date has passed.

6.

Payments or deductions for Liquidated and Ascertained Damages due under Clause 24 of the Agreement will not be levied before 31 May 2003 and will not exceed £100,000…in total for any entitlement due for the period up to 31 May 2003. For the avoidance of doubt, [HEL’s] entitlements under the Agreement in respect of Liquidated and Ascertained Damages after 31 May 2003 is not affected by the letter.

7.

In the event that [STC] is in breach of any provision of this letter, any sum paid hereunder shall immediately be repayable and [STC] shall have no entitlement to any further instalment of the Sum which otherwise may have fallen due.

8.

The terms of this letter are supplemental to the Agreement and, save to the extent that it has been expressly amended by this letter, the Agreement shall remain in full force and effect. In the event of a conflict between the terms of this letter and the terms of the Agreement, this letter shall prevail over the Agreement.

Nothing contained in this letter or any part of it shall be considered to be either an express or implied acceptance by [HEL] of the legitimacy of any claim put forward by [STC] under the Agreement or otherwise and [STC] will be required to demonstrate the validity of any such claim in accordance with the terms of the Agreement. Nothing in this letter (including, for the avoidance of doubt, payment of the Sum) may be relied upon by either party as evidence of any such acceptance or as an instruction to vary the works or the manner in which they are to be performed.”

In my view, an agreement to make a payment on account in respect of loss and expense notified under clause 26 of the building contract does not conflict with the terms of the building contract because the Conditions are entirely silent on this: there is no contractual machinery for the making of payments on account in respect of claims. Further, I consider that the requirement for STC to attend meetings to discuss the claims and to provide details, substantiation and information in relation to them in accordance with the agreement was not in conflict with the terms of clause 26 of the building contract.

However, by contrast, the provision limiting any deduction for LADs in respect of delays prior to 31 May 2003 to £100,000 does conflict with the Conditions, under which there is no limit to the amount that can be deducted. Similarly, the mutual obligation not to initiate any dispute resolution process before 31 May 2003 is in conflict with the right of each party to refer a dispute to adjudication at any time. In fact, Mr Wilmot-Smith submitted that the provision was probably unlawful as being in conflict with section 108 of the Housing Grants, Construction and Regeneration Act 1996. However, for reasons that will be apparent later in this judgment, this is not a question that I have to decide.

Neither party has suggested that there are any other terms of the Side Agreement that conflict with, and therefore vary (by virtue of clause 8 of the Site Agreement), the terms of the building contract. In my view, the Side Agreement is a freestanding agreement that is related to the building contract, but does not vary its terms - save in the two respects that I have mentioned.

Insofar as the limitation on the right to claim or deduct LADs in respect of the period up to 31 May 2003 is concerned, this is clearly a provision that benefits STC. There is no way that it can be said to prejudice Aviva as the bondsman.

As to the mutual restriction on initiating any dispute resolution process prior to 31 May 2003, that appears to me to be neutral in terms of prejudice to either party. But even if I am wrong about that, in the context of the building contract as a whole, I consider that it is a variation that is of minimal consequence: neither party’s right to initiate any dispute resolution process was excluded, it was only restricted for a period of 3 months or so prior to 31 May 2003. I did not understand Mr Wilmot-Smith to challenge this. Further, insofar as STC was concerned, any detriment caused by that limitation was wholly or significantly offset by the proposed advance on account of its claims.

In any event, the variations fall within the scope of the indulgence clause and so could not give Aviva the right to treat itself as discharged.

These have been agreed by the parties. They are as follows:

For the reasons that I have already given, I consider that issue 1.3 does not arise in the form agreed. Since I have already decided that the Side Agreement was not concluded until after the second payment on 26 February 2003, the second payment falls to be determined under issue 1.1 (assuming that it adds anything). In addition, issue 1.4 does not arise because the amendment to the Side Agreement is no longer relied on by Aviva. Accordingly, the only issues that I have to address under issue 1 are issues 1.1 and 1.2. I did not understand this to be in dispute.

HEL called two witnesses: Mr Simon Thomsett, who was at the relevant time the General Manager of HEL, and Mr Tim Ronalds, the architect and contract administrator. Aviva did not call any evidence. There were several ring binders containing copies of the relevant contemporaneous correspondence.

I found both Mr Thomsett and Mr Ronalds to be honest witnesses. Mr Thomsett was essentially an arts administrator by background and he did not profess any special expertise in the management of building contracts; but, as he explained, he and his team at HEL knew the building and how it should work. However, since he had no legal training I do not feel able to place much reliance on his evidence about such matters as when a particular agreement was concluded.

It was reasonably clear, particularly from the cross-examination of Mr Thomsett, that HEL did not always accept the advice of its architect in matters relating to the project. For example, as I have already mentioned, at one stage Mr Ronalds advised HEL that it should seek specialist advice from a claims consultant or someone with experience of building contract claims. Mr Ronalds feared, probably with good reason, that STC was devoting resources to the preparation of claims and was likely to ambush HEL with a sudden referral to adjudication. He felt that HEL needed to be prepared for this and should take steps to that end. This advice was largely ignored.

When, in October 2002, HEL decided to instruct a solicitor to advise it in relation to the problems with the project Mr Thomsett instructed a Mr Lanny Silverstone. He was questioned on his reasons for doing so in the following passage of his cross-examination by Mr Wilmot-Smith:

It seems that HEL took the view that it was more likely to achieve its objectives through negotiation and, if necessary, some form of payment on account to STC, then by preparing a position in case it had to meet a referral to adjudication. By contrast, Mr Ronalds was a man who felt strongly that contractual procedures should be followed and that it was most unwise to engage in any form of dialogue outside the machinery of the contract. He was opposed in principle to making any payment on account to STC, and he made HEL aware of this view. However, in his witness statement he said that "I recognised then [December 2002] and recognise now that there was an exposure for HEL in respect of [STC's] claims”. This evidence was not challenged.

However, his view did not prevail. Having paid £500,000 to STC at the end of December 2002 HEL found that little improvement resulted. By the end of February 2003, HEL had lost a further four weeks. So when HEL paid the second instalment on 26 February 2003 it knew that the rate of progress on site was not improving. The essence of Mr Thomsett's approach to the problem of dealing with a contractor that was persistently failing to perform is perhaps given by the following passage in his cross-examination:

Whilst I accept that HEL was probably over optimistic in its dealings with STC, I consider that Mr Wilmot-Smith’s criticisms of Mr Thomsett's conduct are a little harsh. According to the evidence before me (and of course I did not hear from any witness from STC), STC was under resourced and its site management was poor and disorganised. In addition, it was getting into increasing financial difficulty as the work progressed. HEL's prime concern was to get the work completed so that it could open the theatre. Faced with a contractor that was alleging that it had suffered substantial losses as a result of the administration of the contract, one can see why HEL thought that paying some money on account of STC’s claims offered the best prospect of getting the job finished. Whether or not HEL would have been any better off if it had followed Mr Ronalds’s advice and stuck to the letter of the contract is, in my view, pure speculation. However, I consider that it was to some extent remiss of Mr Thomsett not to seek specialist advice sooner than he did.

There is no doubt that STC adopted a very aggressive and claims minded approach to this project and were prepared to take every advantage of HEL's lack of experience in this field. Against this background it is understandable that HEL thought that its benefactor, Lord Sugar, might be able to bring some pressure to bear on STC to improve its performance. As Mr Thomsett put it, Lord Sugar could be very persuasive and even STC's Mr Kent was not immune to Lord Sugar's powers of persuasion.

Whilst some aspects of HEL’s management of this project may be open to criticism, I am quite satisfied that it did not take any steps which, as a matter of probability, prejudiced Aviva's position as bondsman. Mr Wilmot-Smith advanced various ingenious arguments as to why paying money in order to keep an incompetent and under resourced contractor on site for longer than he would otherwise have been was likely to aggravate the position, rather than ameliorate it. For example, he submitted that if the contractor was steadily becoming further and further behind, the longer he stayed on site the greater would be the liquidated damages for which he would become liable. Further, he submitted that it might be increasingly expensive to secure a fresh contractor to complete the work as the quantity of work remaining outstanding diminished and, the longer the delay, the greater the risk that market conditions might have changed adversely by the time the employer went out to tender.

I am not persuaded that these arguments are sound in the case of this project: for example, the whole object of advancing a substantial sum of money to STC was to enable it to increase its resources on site. Nevertheless, I consider that it cannot be said that advancing money to STC was self-evidently, and without further inquiry, bound to improve the position (which, for reasons I shall discuss below, is in some situations the relevant test).

The submissions by Mr David Thomas QC, who, with Mr Rupert Choat, of CMS CameronMcKenna, appears for HEL, can be summarised as follows:

Mr Thomas's alternative submission is that the Side Agreement, or the payment of the £500,000 in December 2002, was outside the scope of the obligations guaranteed by the bond and therefore has no affect on Aviva's liability under it. This, of course, has the consequence that HEL cannot make any claim in respect of the £750,000 (which is why it is Mr Thomas's alternative case). In support of this submission he relies on the decision of the House of Lords in Trade Indemnity Company Ltd v Workington Harbour and Dock Board [1937] AC 1.

Mr Wilmot-Smith’s primary submission is that this case falls squarely within the rule in Holme v Brunskill (1878) 3 QBD 495, as set out in the judgment of Cotton LJ, at 505:

“The true rule in my opinion is, that if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and that if he has not consented to the alteration, although in cases where it is without enquiry evident that the alteration is unsubstantial, or that it cannot be otherwise than beneficial to the surety, the surety may not be discharged; yet, that if it is not self-evident that the alteration is unsubstantial, or one which cannot be prejudicial to the surety, the court, will not, in an action against the surety, go into an enquiry as to the subject of the alteration, or allow the question, whether the surety is discharged or not, to be determined by the finding of a jury as to the materiality of the alteration or on the question whether it is to the prejudice of the surety, but will hold that in such a case, the surety himself must be the sole judge whether or not he will consent to remain liable notwithstanding the alteration, and that if he has not so consented he will be discharged.”

(My emphasis)

Mr Wilmot-Smith’s submission is simply this. First, there was an agreement - that of 16 December 2002 and/or the Side Agreement - between the principals (HEL and STC) with reference to the contract guaranteed (the building contract). Second, Aviva did not consent to this agreement. Third, it is not self-evident that the alteration is "unsubstantial" or one which cannot be prejudicial to the surety. Accordingly, the court will not go into the merits of the alteration or the question as to whether or not it is prejudicial to the surety, but will allow the surety to treat himself as discharged if he so elects.

Mr Wilmot-Smith submits that the advance of the £500,000 in December 2002 was the result of an agreement falling within the rule. Alternatively, he relies on the making of the Side Agreement.

If he is wrong about this, Mr Wilmot-Smith submits that the actions of HEL in advancing money to STC on account of claims, if not amounting to a variation of the building contract, was conduct that was prima facie prejudicial to the interests of Aviva, as bondsman, with the result that Aviva is entitled to treat itself as discharged. In support of this submission he relies on the case of General Steam Navigation Company v Rolt (1858) 6 CB (NS) 556.

This alternative submission is really directed to the initial payment of £500,000 in December 2002.

Although not first in time, the appropriate starting point is probably Holme v Brunskill. The plaintiff let a farm, together with 700 sheep, on a yearly tenancy to Mr George Brunskill. George Brunskill, together with his brother Robert and others, entered into a bond to guarantee the redelivery at the end of the tenancy of the land and the flock in good order and condition. The plaintiff and George Brunskill subsequently entered into an agreement by which George Brunskill agreed to surrender a field, known as Bog Field, in consideration of a reduction in the annual rent of £10. George Brunskill subsequently went bankrupt and the tenancy was determined. Under the terms of the bond arbitrators were appointed to assess the condition of the flock, which they found to be reduced in number and in poor condition. Damages were assessed at £132. The plaintiff claimed this sum from Robert Brunskill under the bond.

Robert Brunskill denied liability on the ground that he had never given his assent to the variation in the terms of the tenancy. The defence was upheld by the Court of Appeal. Much of the argument in the case concerned the question of whether or not the variation in the tenancy altered the risk of default in a manner prejudicial to the surety. This question was left to the jury.

In the Court of Appeal Cotton LJ said that it could not be said to be evident that the surrender of the Bog Field could not prejudicially affect the surety (it was suggested that the loss of the additional pasture in the spring would reduce by 15 the number of sheep that the land could carry). He then went on to state the rule in the terms that I have set out above.

To the extent that the Side Agreement conflicted with the terms of the building contract and prevailed over them, Mr Wilmot-Smith was prepared to accept that it did so only in respects that were either self-evidently not prejudicial to Aviva (the restriction on claiming liquidated damages prior to 31 May 2003) or were "unsubstantial" (the restriction on initiating a dispute resolution process).

But Mr Wilmot-Smith relied on the Side Agreement in its entirety, because his sheet anchor was Cotton LJ’s phrase "if there is any agreement between the principals with reference to the contract guaranteed” in the passage quoted. On the basis of this it was submitted that the rule applied if any agreement was made between the principals to the contract guaranteed that was related to the principal contract. Accordingly, Mr Wilmot-Smith submitted that Aviva was entitled to rely on the Side Agreement irrespective of whether or not the extent to which it varied the terms of the building contract. The response from Mr Thomas was that “the alteration” to which Cotton LJ referred several times must be an alteration to the principal contract.

Although the argument was attractively and forcefully put by Mr Wilmot-Smith, I reject it. I am quite sure that what Cotton LJ meant when he said “any agreement . . . with reference to the contract guaranteed” was any agreement to alter the contract guaranteed. It seems to me, just as a matter of syntax, that the repeated references to "the alteration" in the passage quoted must refer to an alteration to the principal contract. In my view, in the context of this passage a separate agreement that was made in relation to the principal contract would only be relevant if it varied the terms of the contract guaranteed.

In reaching this conclusion I am fortified by the facts in Holme v Brunskill. It was a clear example of a variation to the contract guaranteed and so I think it most unlikely that Cotton LJ was intending to lay down a rule of much wider application than was necessary to decide the issue before him.

I now turn to the next authority relied on by Mr Wilmot-Smith, although earlier in time, General Steam Navigation Company v Rolt (1858) 6 CB (NS) 556. Once again, the facts of the case are important. The company contracted with a Mr Mare to build an iron paddle-wheel steamship to certain specifications. The price was £14,120, to be paid in four equal instalments (for some reason that is not apparent from the report each of the instalments was in fact in the sum of £3,500). The third instalment was to be paid when the vessel was launched and the final instalment when the vessel had been completely finished and delivered. Mr Mare's obligations under the contract were guaranteed by the defendant.

The third instalment was paid on 5 July 1855 when the vessel was ready to be launched, although it had not in fact been launched, and thereafter the company paid £1,000 on 11 August 1855 and £2,000 on 13 September 1855, by which time the vessel was still not completed. On 25 September 1855 Mr Mare was declared bankrupt.

The vessel was not completed until 22 November 1855 (I think that a separate reference in the report to December must be an error). The cost incurred by the company of completing the works was £1,629. In addition, the company claimed £700 by way of liquidated damages. Thus the sums paid in advance in August and September, which amounted to £3,000, exceeded the cost of completing the work and the associated damages for delay. It is therefore not difficult to see that the advance payments were likely to have prejudiced the surety.

The headnote states that the case is authority for the following proposition: "A material variation of the terms of the contract with the principal discharges the surety". However, it is difficult to discern from the report how the variation came to be effected: the pleaded case appears to have been that the payments were made "by arrangement" between the company and Mr Mare. In order for there to have been a variation to the contract, one would expect to see some consideration from Mr Mare in return for the advance payments. There is no mention of any consideration in the report.

In the absence of any more specific information, it looks as if the company, realising that Mr Mare was or might be in financial difficulty, paid the sums in advance of completion in the hope of keeping him solvent for long enough to enable him to complete the work. If this is correct, then the case is perhaps more aptly categorised as one where the contract was not performed according to its terms, rather than one performed in accordance with a variation of its terms. I am inclined to doubt whether Mr Mare could have compelled the company to make the payments in advance of the due date if it had changed its mind and had decided not to pay the money as promised.

Mr Wilmot-Smith relied very strongly on a passage in the short judgment of Pollock CB dismissing the appeal, in which he said this:

“Now, certainly, prima facie, the withdrawal of a fund which is a security for the thing in respect of the not doing of which he is now called upon to pay damages is a prejudice to the surety…he is deprived of the security of the fund out of which the company might in the first instance have indemnified themselves… Prima facie, the surety was prejudiced by the existing state of things. Whether there could have been any proof to shew, that, notwithstanding the appearance of prejudice, in reality none was or could be sustained, it is not at all necessary to inquire.”

The next case, this time strongly relied on by Mr Thomas in support of his alternative case, is Trade Indemnity Company Ltd v Workington Harbour and Dock Board [1937] AC 1. The facts are remarkably close to those of the present case. The Board entered into a contract for the enlargement of its dock. It required the contractors to procure a guarantee in the sum of £50,000 for the due performance of the contract. In the course of the work the contractors encountered an unexpected quantity of water in the soil, and the expense of pumping it out was such that they could not continue the work without further funds. By two separate agreements in writing, the Board advanced the contractors the sums of £20,000 and £25,000, to be repaid on certain terms. In spite of this the contractors went into liquidation and failed to complete the work.

The Board completed the work at its own expense and the engineer thereafter prepared a final certificate showing that £78,785 was due from the contractors to the Board: this sum included a proportion of the £45,000 lent to the contractors that remained unpaid at the date of their default.

The loan agreements provided that the loans were to be repaid by a deduction of 15% from each future interim payment under the building contract certified by the engineer, with interest at 5% on the amount of the loan remaining unpaid.

The real issue in the case was whether the bond was, on its true construction, a contract of insurance or a contract of guarantee. The second point raised by the surety was that, by lending the contractors the two sums of £20,000 and £25,000 during the progress of the works without the knowledge of the surety, the Board altered the contract and so discharged the surety from liability under the bond. Further, and in any event, it was argued that the engineer’s certificate for £78,785, on which the action was founded, could not support a judgment for £50,000 because the amount of the unpaid loan, for which the surety contended it was never liable, had not been ascertained. Accordingly, the true amount for which the contractors were liable under the principal contract, and hence the liability of the surety, had not been established.

At first blush this decision looks as if it presents a complete answer to the issues in the present case. Lord Atkin, who gave the leading speech in the House of Lords, said that whilst it was true that the terms of repayment of the loans involved an alteration in the deductions agreed in the contract, so that its terms were altered in this respect, the proviso (or indulgence clause) in the guarantee prevented the surety from relying on any such alteration. The proviso to the bond was in these terms:

“Provided always and it is hereby agreed and declared that the Surety shall not be released or discharged from the above written Bond by any agreement which may either with or without the assent or notwithstanding the dissent of the Surety be made between the Contractors and the Owners or between the Contractors and the engineers in the contract mentioned for any alteration in or to the said works or the contract or any forbearance by the Owners or by the said engineers whether as to payment time performance or otherwise howsoever or by any dealing or transaction which may take place between the Contractors and the Owners . . .”

The words of this proviso are very wide, particularly the inclusion of the phrase “or by any dealing or transaction which may take place between the Contractors and the Owners".

In relation to the issue of whether the surety was discharged by the making of the loans, Lord Atkin said this:

“It was then said by [the Board] that though the loans and the certificate could not be justified under the original contract yet the proviso to the condition of the Bond expressly preserves the liability of the surety. I will read it. [Lord Atkin then read the proviso]. The words "any arrangement (sic) . . . for any alteration in or to the said works” are very wide. Probably they would have to be cut down so as not to include such changes as had been suggested as substituting a cathedral for a dock, or the construction of a dock elsewhere, or possibly such an enlargement of the works as would double the financial liability. An author of great authority, happily still with us, suggests that such words only relate to alterations "within the general purview of the original guarantee". But in my opinion the loan contracts were not alterations of the original contract at all. The contract was for the construction of specified works at specified prices. The loans were independent borrowings to enable the contractors to perform the construction contract. The position is in my opinion just the same as if the contractors had borrowed the money from their bank, or directly from the Trade Facilities Board, and had charged their payments under certificate with repayment by proportionate deductions. The loans were, of course, connected with the contract and were made for the purpose of performing the contract. That does not make them alterations of the contract. It is true that the terms of repayment involve an alteration in the deductions agreed in the contract the terms of which are altered in this respect; and the proviso would prevent the guarantors from relying on any such alteration. But this is a form of repayment the opportunity for which is long past; and in my opinion it has no affect in altering the primary obligation which arises out of an independent contract with the guarantors never undertook should be performed.

. . . I think that the guarantors never came under any obligation in respect of the new and uncontemplated burden of loans for £45,000, and are not liable for any sum in respect of such sums or interest.”

Curiously, Holme v Brunskill was not cited in the argument before the House.

A fairly recent decision of the Court of Appeal, Triodos Bank NV v Dobbs [2005] 2 Lloyd’s Rep 588, was relied on by both parties. The law in relation to indulgence clauses was examined in that case. The clause in question stated:

“2.3

The Guarantor's liability under clause 2.1 is not affected by an arrangement which the Bank may make with the company or with another person which (but for this clause 2.3) might operate to diminish or discharge the liability of or otherwise provide a defence to a surety.

2.4

The Bank may at any time as it thinks fit and without reference to the Guarantor:

2.4.1

grant time for payment or grant any other indulgence or agree to any amendment, variation, waiver or release in respect of an obligation of the Company under the Loan Agreement;

2.4.4

compound with, accept compositions from and make other arrangements with the Company or a person or persons liable on other securities or guarantees held or to be held by the Bank.”

The facts were that the defendant, Mr Dobbs, executed a guarantee in April 1996 partly to refinance borrowings made by his company from Allied Irish Bank and partly to complete the first stage of a project to construct a "televillage" at Upper House Farm, Powys. The total amount of the loan (in two separate contracts) was £900,000 and the limit of Mr Dobbs' liability under the guarantee was £50,000.

By November 1998 the first phase of the project had been completed and the amount of the outstanding indebtedness to the Bank was about £800,000. The bank then agreed that it would finance phase two of the project. To do this it then made two further loan agreements on 4 November 1998 agreeing to lend a total of £1,980,000 to the company. The existing indebtedness continued, but it was now covered by these 1998 loan agreements with the raised borrowing limit. Each of these agreements said on its face that it replaced the earlier agreement. On 10 September 1999, the 1998 loan agreements were themselves replaced by a further loan agreement between the company and the bank. Under this facility the amount of the loan was raised from the £1.98 million permitted by the 1998 loan agreements to a maximum of £2.6 million. In addition, the nature of the development had altered significantly.

On 7 August 2000 the bank demanded repayment of the money from the company. Payment was not forthcoming and the bank claimed £50,000 from Mr Dobbs under the guarantee.

The bank brought an action in the Bristol Mercantile Court and obtained summary judgment. Mr Dobbs appealed on the ground that the replacement loans did not fall within the indulgence clause. At paragraph 12 of his judgment in the Court of Appeal Longmore LJ said that “the vital question for the court is whether the Company’s liability under this agreement is something which Mr Dobbs has guaranteed". He concluded that a replacement on terms so different from the original agreement, as occurred in that case, cannot be an "amendment or variation" of the initial contract (paragraph 13). It seems to me that the effect of this finding is that the presence or absence of an indulgence clause in the initial contract became effectively irrelevant.

Since Mr Wilmot-Smith relied on some passages from the judgment of Longmore LJ, with which Neuburger LJ agreed (Chadwick LJ gave a separate judgment agreeing in the conclusion), which he described as central to the analysis, I should set them out in full:

In my view this case is really authority - if further authority is needed - for the proposition that, where the bond provides that it will not be invalidated by any alteration or variation to the principal contract or the surety agrees to the variation, the surety will only be liable if the contract as varied remains a contract within the general purview of the original guarantee. What this means, in the words of Longmore LJ, is that the question for the court is whether the (new) agreement, for the breach of which the claimant is suing on the bond, is properly to be regarded as an amendment or variation of the principal agreement which is within the purview of that original agreement (paragraph 19).

I have already concluded that this payment was made pursuant to an oral agreement by which HEL agreed to make the payment at the end of December 2002 in return for the issue by STC of a revised programme showing a completion date of 31 May 2003 and an undertaking by STC to use reasonable endeavours to achieve that completion date.

In my view, this did not constitute a variation of the building contract. STC was already under an obligation to proceed diligently with the work and the production of a programme was part of the usual obligations of a main contractor (clause 5.3.1.2 provided that, as soon as possible after the execution of the building contract, STC was required to produce a master programme). I find that at the time when this payment was made there was no agreement to waive any entitlement to liquidated damages, either wholly or in part. There was just the bare agreement in the terms that I have outlined. In any event, if there had been any variation of the building contract it would have fallen within the terms of the indulgence clause.

In these circumstances I conclude that Mr Wilmot Smith cannot rely on the rule in Holme v Brunskill in relation to the first payment of £500,000. If he is to succeed in relation to that payment, he can only do so, if at all, by virtue of the decision in General Steam Navigation Company v Rolt.

The question here is whether the scope of the guarantee under the bond extended to the obligations assumed by STC under the Side Agreement at all. Although this is a question which does not arise on Mr Thomas's primary case, it is logical to consider it first.

The bond guaranteed the due performance of STC's obligations under the building contract. If the building contract was varied, then the surety would be discharged unless (a) one of the exceptions to the rule in Holme v Brunskill applied or (b) the variation fell within the purview of the indulgence clause or, possibly, (c), the variation only increased the extent of a potential default, not the risk of it occurring.

I have already stated my view that the extent to which the building contract was varied by the Side Agreement was either beneficial to Aviva or of minimal consequence and therefore fell within the exceptions to the rule in Holme v Brunskill. But this does not decide the question of whether on a true construction of the bond it covered STC's potential liability if it did not repay the sum advanced. Mr Wilmot-Smith accepted that the Side Agreement, once made, had retrospective effect.

It seems to me that the extent of the obligations that fall within the scope of the guarantee is basically a matter of impression. In Triodos Bank NV v Dobbs Longmore LJ appears to have made an overall assessment of the initial obligations and concluded that the new obligations were so different that they could not properly be described as an amendment or variation. In addition, he emphasised the distinction between a true variation of an existing obligation and the entering of what is in fact a different obligation even though it may purport to be no more than a variation Subject to the two minor variations already mentioned, the terms and operation of the building contract were left unaffected by the making of the Side Agreement. It was a separate and additional arrangement between HEL and STC containing an entirely new obligation to repay the advance immediately if the terms of the Side Agreement were not met.

I cannot see how the position in this case can be distinguished from the position in the Trade Indemnity case. If anything, this appears to be a stronger case for saying that the obligations under the Side Agreement are not within the scope of the bond. That is because in the Trade Indemnity case the payments were made on account of work that was yet to be carried out. In the present case the loss and expense had already been incurred. True it is that the amount of that loss and expense remained an unknown but, for the reasons that I give later in this judgment, there was reason to believe that the settlement value of STC's claims would be in the region of the £1 million that HEL was proposing to advance.

Leaving these points aside, I ask myself why should Aviva be deemed to have assumed, for no additional premium, the additional risk of STC not complying with the terms of the Side Agreement and being unable to repay the advance if called upon to do so as a result when the making of the advance (a) did not in any way limit or reduce the scope of STC's obligations under the building contract that it had guaranteed and (b) took place without Aviva knowing anything about it? The answer to this question, in my view has to be: “it should not”.

Accordingly, I consider that the obligations assumed by STC under the Side Agreement were not within the scope of the obligations guaranteed by Aviva under the bond. It follows, therefore, that Aviva has no liability in respect of STC's failure to repay the £750,000. This conclusion disposes of HEL’s primary case in relation to the Side Agreement.

This part of the judgment proceeds on the premise, which I have now held to be correct, that the obligation to repay the loan or advance (or any balance of it) falls outside the scope of the obligations guaranteed and that the surety has not assented to the making of the loan or the advance. In this situation Mr Wilmot-Smith submits that the question is whether the employer has acted in a manner that is prima facie likely to prejudice the surety.

Mr Wilmot-Smith submitted that there was a fundamental difference between a loan, which is repayable and will probably carry interest, and an advance on account against, for example, goods supplied or work done. I accept that there is a difference between the two situations, if only because in the case of an advance on account the payer will have already received, or at least will be expecting to receive, some benefit by way of either goods or services. But in either case there will be a repayment obligation: in the case of the loan, according to its terms, and in the case of an advance, of any balance still owing to the payer when the final account has been struck. However, I fail to see why this distinction is decisive when one is considering the question of whether or not the arrangement by which the loan or advance is made constitutes a potential source of prejudice to the surety, assuming that it does not amount to a variation of the contract guaranteed.

It seems to be self-evident that if an employer pays a contractor in full before he has completed the work, the incentive to the contractor to complete the work is much reduced. The risk that he may leave site never to return is increased. Alternatively, the contractor may have been on the verge of insolvency when the payment was made, as in the General Steam Navigation case, with the result that the money is effectively lost. This would, I readily accept, be prima facie prejudicial to any surety who had guaranteed the obligations of the contractor. However, if a contractor asserts that he has already been caused loss and expense as a result of the conduct of the employer or his agents, to pay him a reasonable sum on account of that claim pending its final resolution is not, I would have thought, necessarily prejudicial to any surety. The contractor’s cash flow may be very tight and he may be unable to absorb the loss and expense whilst at the same time maintaining the necessary resources on site to complete the contract in accordance with the programme. On the other hand, he may already be insolvent so that the advance will do no more than stave off the inevitable. In my view it is only in the latter situation, not the former, that there is any potential for prejudice to the surety.

As I have already indicated, I have reached the tentative conclusion that General Steam Navigation Company v Rolt is authority for the proposition that if an employer acts in a manner in relation to the principal contract which, whilst not amounting to an alterations 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). My conclusion is tentative because I accept the observation, forcefully made by Mr Thomas, that if my conclusion is right it is very strange that this potentially fruitful seed has not sprouted. General Steam Navigation Company v Rolt has not been referred to in any of the subsequent authorities cited to me, apart from Andrews and Millett, Law of Guarantees, 5^th edition, page 363 - which seems to treat it as an extension of the rule in Holme v Brunskill. However, for the reasons that I have given, I am not convinced that this is correct. It seems to me that the rule in Holme v Brunskill applies only where the principal contract has been varied.

Interestingly, in the same section the authors of Law of Guarantees refer to a decision of Mr Justice Christopher Clarke in ST Microelectronics NV v Condor Insurance Ltd [2006] 2 Lloyd's Rep 525, which concerned the question of whether the conduct of the parties had amounted to a variation of the principal contract. There was an application for summary judgment in a claim under a guarantee. It is not necessary to refer to the facts. Having cited the passage in the judgment of Cotton LJ in Holme v Brunskill, Mr Justice Christopher Clarke went on to say this:

“36.

The basic principle underlying these cases - which is one of strict application - is that a guarantor will only be liable in respect of the obligation that he guaranteed. Thus if X guarantees a debt agreed to be payable within a specified time he is not liable in at least two cases:

(a)

if the creditor advances money or supplies goods on terms that the money is repayable or the price payable immediately; or

(b)

if the creditor and his debtor agree a variation of the contract whereby the debtor is bound to pay earlier, unless such an agreement is, on the facts, obviously incapable of prejudicing the surety.

In both cases the transaction between the debtor and creditor which a guarantor is called upon to underwrite is not the one contemplated by the guarantee: in the first case because the transaction with the debtor was never that character; in the second because the debtor and his creditor have agreed a variation.

37.

But a debtor who is entitled to 55 days credit is not bound to wait until all of the 55 days have elapsed. He can, if he chooses, pay before then. The guarantor is not released because he does so, even if the early payment is made at the creditor's request. Such a payment is not inconsistent with the contract guaranteed and involves no variation of it.

38.

If, however, the debtor has undertaken a binding obligation to pay an early the contract will have been varied. The debtor is no longer free to choose whether to pay at the expiry of the credit period. He is bound to pay it before. The contractual obligations into which he has entered are not the same as those that the guarantor guaranteed.”

One of the central issues on the application in that case was whether the agreement between the parties by which an advance payment was made amounted to a legally binding agreement. Since Christopher Clarke J concluded that it could not be said that the guarantor had no realistic prospect of showing that there was a binding agreement, the application for summary judgment in the claim under the guarantee was refused.

A further submission was made on behalf of the guarantor to the effect that it was not necessary to establish that there had been a legally binding agreement to vary the contract: the real test was whether as a result of a change in the arrangements there was a real chance that the guarantor might have been prejudiced. Christopher Clarke J said, at paragraph 50: "So expressed, the proposition appears to me too broad". A variant of this submission was that if a debtor makes an advance payment in response to a threat by the creditor to break his contract with the debtor and the creditor (as was alleged in that case) threatens to refuse to supply on the contractual terms, or at all, then the guarantor is discharged. However, that is not a type of situation that arose in the present case and so I need not say anything about it: in any event, since Christopher Clarke J was not proposing to give summary judgment he did not consider that alternative submission at any length.

At this point it is important to recall the distinction, as I see it, between the rule in Holme v Brunskill and the rule, if it is a rule, in General Steam Navigation Company v Rolt. In the former, any alteration of in the terms of the principal contract will discharge the surety unless it is self-evident without inquiry either that the alteration cannot be prejudicial to the surety or that it is of no significance ("unsubstantial", to use Cotton LJ's word). However, in the latter Pollock CB set that the conduct of the employer must be prima facie prejudicial to the surety if it is to discharge the surety from liability. This is a higher threshold for the surety to cross. The observations of Christopher Clarke J in ST Microelectronics seem to me to reinforce the distinction between a variation of the terms of the principal contract and a (non-binding) variation in the mode of its performance.

In considering whether in the present case the application of the “rule” in General Steam Navigation Company v Rolt has the effect of discharging Aviva from liability I consider that the following factors are relevant:

I do not consider that HEL’s failure to engage an expert in contractual claims had any effect on the outcome of the discussions that took place in December 2002. HEL’s aim was to avoid adjudication, not to prepare for it. The advice that it was receiving from its own professional team was that STC’s claims had some value and that the likelihood was that STC would be successful if it referred its claims to adjudication, even if not to the full extent claimed. STC’s claims by then amounted to some £4 million.

In spite of the robust criticisms that were being made of STC’s site management, I cannot see how HEL could be criticised for thinking (if it did) that STC’s claims might have a settlement value in excess of £1 million. It is a fair inference that this is what HEL did think, otherwise it would probably not have agreed to make a payment on account of that amount. The fact that on 2 January 2003 the Quantity Surveyors suggested a figure of £1.8 million as a probable settlement value of STC’s claims suggests that a figure in excess of £1 million could well have been in HEL’s mind in December 2002.

In the circumstances I consider that it was not prima facie likely that a payment of £500,000 on account of STC’s claims would prejudice the surety. I reach this conclusion for the following reasons:

Of course I accept that there was a risk that, in some way - including those mentioned by Mr Wilmot-Smith, injecting funds into a contractor whose financial position was not good could make the situation worse, but I do not consider that this was the likely, or prima facie, position. As I have already indicated, on my reading of the judgment of Pollock CB in General Steam Navigation Company v Rolt that is what is required if the surety is to be discharged without any further investigation.

However, if I had to apply the rule in Holme v Brunskill, I might have concluded that it was not self-evident without inquiry that Aviva could not be prejudiced by the advance. This was a possibility, although not the likelihood.

But for the reasons that I have already given, the agreement reached on 16 December 2002 that preceded the first payment of £500,000 did not involve any material alteration to the terms of the building contract so that the rule in Holme v Brunskill does not apply. In any event, to the extent that the agreement of 16 December 2002 may have varied the terms of the building contract, such a variation would fall within the scope of the indulgence clause.

Since I have concluded that the only two respects in which the Side Agreement conflicted with, and therefore varied, the terms of the building contract were beneficial to Aviva and of minimal consequence, respectively, the rule in Holme v Brunskill does not apply. I have already rejected Mr Wilmot-Smith’s submission that the rule is engaged simply by the making of an agreement that is related to the principal contract.

To the extent that it is said that the payment of £250,000 on 26 February 2003 amounted to conduct that was prima facie prejudicial to Aviva, and consequently within the rule in General Steam Navigation Company v Rolt, I reject that submission also for much the same reasons as those I have given in relation to the payment of the first instalment of £500,000. In the following paragraphs I will explain further why I have reached this conclusion in relation to the £250,000.

In relation to STC’s financial position by the end of February 2003, Mr Thomsett’s cross examination included the following passage:

Although in this last passage Mr Thomsett agreed with Mr Wilmot-Smith’s first two questions, they were in my judgment based on a false premise. It is Aviva’s case, which is clearly correct, that the terms of HEL’s letter of 20 December 2002 were never agreed. Accordingly, as at 26 February 2003 HEL was not in a position to demand the repayment of the £500,000 on the ground of non-performance by STC because the term which subsequently gave rise to that right had not by then been agreed.

Mr Wilmot-Smith also asked Mr Thomsett about his understanding of the position in relation to sub-contractors being paid for off site materials. I then attempted to clarify the position in the following passage of the cross-examination:

From this it seems reasonably clear that by late 2002 a problem had arisen in relation to the payment for offsite materials. It is clear also that by early 2003 HEL was aware, if only in broad terms, of complaints by STC's sub-contractors that they were not being paid, although Mr Thomsett did not concede that STC was insolvent by the end of February 2003.

Whilst it is likely that, by the time HEL proffered the Side Agreement in its final form, STC’s financial position had probably deteriorated further, I do not consider that there is any evidence to support a suggestion that this deterioration was such as would justify me in altering the conclusions that I have reached in relation to the payment of the £500,000. In particular, there is no evidence that by the end of February 2003 STC was trading whilst insolvent. As Mr Thomsett said, the purpose of paying the second instalment was to prevent the works from coming to a halt.

For these reasons, I do not consider that either the payment of the second instalment of £250,000 or the making of the Side Agreement was an act that was prima facie likely to cause prejudice to Aviva as the bondsman. Accordingly, the making of the payment and the Side Agreement did not discharge Aviva from liability under the guarantee.

This ground of defence by Aviva was advanced by a last-minute amendment to the pleadings made on the first day of the trial. Mr Thomas had had barely 24 hours notice of it. However, having thought about it overnight he considered that he was prepared to deal with the point of principle, even though Aviva had not provided any details of the timing or the extent of the payments.

It was clear from the documents that HEL received various safeguards for its payment for the offsite materials. Where HEL paid for off site materials the relevant sub-contractor or supplier was required to sign a Certificate of Indemnity by which title in the materials passed to HEL and the sub-contractor undertook to keep the materials insured.

Accordingly in the light of these arrangements (which were not explored in any great depth) I consider that there was no potential for any material prejudice to Aviva by HEL's payments for offsite materials, even if the making of such payments amounted to a variation of the building contract. Anyway in the latter event, it would be a variation falling within the scope of the indulgence clause.

In the light of the conclusions that I have already reached, it is not necessary to consider the true ambit of the indulgence clause. However, since both parties dealt with it in some detail, I should briefly state my conclusions on the points raised.

For ease of reference I will set out the terms of the indulgence clause again, but for convenience I shall break it down into its component parts in the manner suggested by Mr Wilmot-Smith:

“. . . no alteration

(i)

in the terms of the said Contract made by agreement between the Employer and the Contractor or

(ii)

in the extent or nature of the Works to be constructed and completed thereunder; and

(iii)

no allowance of time by the Employer or the Architect under the said Contract nor

(iv)

any forbearance or forgiveness in or in respect of any matter or thing concerning the said Contract on the part of the Employer or the said Architect

shall in any way release the Surety from any liability under the above-written Bond.”

I have already found, in relation to (i), that there was no alteration in the terms of the contract upon which Aviva could rely even in the absence of this clause. As to (ii), this is clearly not applicable. Thus the argument concerns (iii) and (iv). The issue being whether the arrangements by which the payments of £500,000 and £250,000 were made fell within these provisions.

Mr Thomas submitted that what HEL did was to allow STC further time in which to substantiate its claims and/or that in not insisting on immediate substantiation of the claims it was forbearing to exercise its rights under the building contract. He submitted also that HEL refrained from insisting on the ascertainment of loss and expense under clause 26 and its subsequent inclusion in interim certificates under clause 30.2.2.2 before making payments on account of such loss and expense.

Mr Wilmot-Smith submitted that to make an advance of money on account of unsubstantiated claims cannot be described as "an allowance of time". As to forbearance or forgiveness, he submitted that this must involve forbearance in the sense of not insisting on something that the contract requires the contractor to do. A payment on account cannot be a forbearance, and in this case the contractor was never relieved of the obligation to substantiate its claims.

These are short points. I prefer the submissions of Mr Wilmot-Smith. Whilst I agree with Mr Thomas that STC was allowed more time in which to substantiate its claims, the essence of the Side Agreement was the payment of money in advance of that substantiation. I cannot see how the advance of the £1 million can possibly be described as "an allowance of time". It was not.

In relation to forbearance, whilst I agree with Mr Thomas that HEL did forbear to insist on its strict right to prompt substantiation of the claims, the second element of the deal, the payment of the £1 million, cannot in my view be described as a forbearance from insisting on anything.

Of course, Mr Thomas’s primary case was that the Side Agreement fell within (i), and he submitted that it did no more than increase the extent of any potential default and did not increase the risk of default. I have already effectively rejected this argument by another route, so I need say little more.

If the Side Agreement as a whole fell within the first part of the indulgence clause, then the variation plainly did increase the risk of default, namely by adding the risk of defaulting on the obligation to repay the money advanced if the terms of the Side Agreement were not met. So I reject Mr Thomas's submission that, if the Side Agreement was a variation of the building contract, it did not increase the risk of default.

Finally, for the reasons that I have already given, I do not regard the obligations assumed by STC when it entered into the Side Agreement as being within the purview of the building contract, which is what the bond guaranteed. Accordingly, the indulgence clause could not have the effect of imposing on Aviva any liability for STC's failure to repay the £750,000.

Since I have now held that Aviva has not been discharged from liability under the bond and that it is not liable for STC's default in failing to repay the £750,000 advanced, the remaining question is what losses HEL can recover.

Mr Wilmot-Smith accepts that HEL is entitled to recover the £205,000 claimed by way of LADs, since that right had accrued by 21 July 2003, the date on which STC's employment was determined. However, he submits that HEL cannot recover anything else because it has precluded itself from doing so by electing to determine STC's employment under clause 27.3.4 of the Conditions.

Before I consider this submission I should make some further findings of fact. Mr Thomsett’s witness statement contained the following evidence, which was not challenged and which I accept:

Mr Ronalds also confirmed that STC abandoned the works on 2 July 2003, and he then issued a Certificate of Non-Completion. His firm made a detailed survey of the works and produced a schedule of defects that existed at that time. In the Pepys building the lift, the installation of which had been sub-contracted, had been left on site unfixed and the rest of the lift installation was only about 20% complete. Even that work was not satisfactory and required remedial work by a different specialist lift contractor.

On 21 July 2003 HEL wrote to STC in the following terms:

“We refer to the above project and the Building Contract between us dated 5 March 2002.

This notice should be read after our first letter of today's date.

We, Hackney Empire Limited, hereby determine your employment under the Building Contract, pursuant to clause 27.3.4. In accordance with clause 27.1, this notice will take effect from this Wednesday, 23 July 2003.

We take this opportunity to remind you of the following:

● We may use all temporary buildings, plant, tools, equipment and Site Materials and you are not permitted to remove them unless you are required to do so by the Architect.

● We reserve the right to pay any supplier or sub-contractor for any materials or goods delivered or works executed for the purposes of the Building Contract before or after the determination of the Building Contract insofar as the price thereof has not already been paid by you. Any sum so paid, we will claim from you as a debt.

We will be sending a copy of this notice to your Bondsman's advisers, says Gallagher CS."

The first letter of 21 July 2003 referred to in the second paragraph was a letter requiring STC to pay £205,000 by way of LADs: these were for the period from 7 October 2002 (the extended Completion Date) to 21 July 2003, being 41 weeks at £5,000 per week.

So far as the factual position is concerned, it is quite clear from the evidence that I have summarised above that on or by 1 July 2003, if not earlier, STC was no longer able to continue work on site in any meaningful way and had no prospect of being able to do so in the future. It was therefore in breach of contract. Whilst the appointment of an administrator may not, in itself, have amounted to a breach of contract, STC's inability to continue to carry out the works by the time the administrator was appointed and the departure or absence of a substantial proportion of its workforce from site, in my view did amount to a breach of contract, and probably a repudiatory breach at that. Although there was not complete abandonment of the site by the time the administrator was appointed, the following observation of O'Donnell J in Galway City Council v Samuel Kingston Construction [2010] 3 IR 95, at 120, is not without relevance:

“It is difficult to conceive those circumstances where it could be said that notwithstanding abandonment of the site a contract still existed so that the employer must continue to perform it and would be left to its remedy in damages. I would not like to add further uncertainty to the area of building contracts by endorsing the suggestion that abandonment of the site can be either a repudiatory breach or a mere breach depending on the circumstances, some of which may not be known at the time and can only be determined after the fact by an arbitrator."

On or by 1 July 2003, therefore, HEL had an accrued right to damages for that breach of contract, irrespective of whether or not it chose to accept the repudiation. The reality of the situation was that by then STC was not going to perform its primary obligations under the contract any more because it was unable to do so.

The damages to which HEL was entitled would be likely to include the cost of completing the works (less such sums as HEL would have had to pay to STC if it had performed the works diligently from then on), the cost of rectifying defects and other costs thrown away as a result of the need to employ others to complete the work. Since I am not concerned with the assessment of HEL's loss, I will say no more - save to observe that I anticipate that claims for loss of revenue arising solely out of STC's delays might face difficulties in the light of HEL's entitlement to LADs.

However, Mr Wilmot-Smith has submitted that HEL cannot recover any damages at common law since it elected to determine STC's employment under clause 27.3.4 following the appointment of the administrator. He submitted that HEL's rights became governed by clause 27 of the building contract, namely the right to be paid the balance due once the account specified by clause 27.6.4.2 had been prepared. In support of this submission, he relied on the decision of the Court of Appeal in Perar BV v General Surety (1994) 66 BLR 72.

In Perar a building contract contained a provision, clause 27.2, that it would be automatically terminated if the contractor entered into administrative receivership, which it did on 7 June 1991. The employer claimed that the contractor had abandoned the works from 10 June 1991 and made a claim under the bond. The contract provided that if the employment of the contractor was determined under clauses 27.1, 27.2 or 27.3, and had not been reinstated, the following "shall be the respective rights and duties of the Employer and the Contractor".

Clause 27.1 of the contract opened with the words "Without prejudice to any other rights or remedies which the Employer may possess". However, there were no such words in clause 27.2, which was the relevant clause in that case.

The Court of Appeal held that, since the contract was automatically terminated on the appointment of the administrative receiver, the contractor was no longer required to proceed regularly or diligently with the works thereafter. Accordingly, abandoning the works on 10 June 1991 could not constitute a breach of contract and therefore could not give rise to a valid claim under the bond. It held that clause 27.2 was intended by the parties to be an exclusive code setting out the party's rights in the event of the appointment of an administrative receiver. After noting the fact that, in contrast to clause 27.1, clause 27.2 was not expressed to be without prejudice to any other rights or remedies which the employer may possess, Peter Gibson LJ said, at page 85:

In my judgment, that case turned on its facts. They are quite different from those of the present case; in particular, the facts that this building contract was not terminated automatically by the appointment of an administrator and that clause 27.8 of the present contract provided expressly that the remaining provisions of clause 27 were without prejudice to any other rights and remedies that HEL may possess.

However, it is true that, by clause 27.5.1, once an administrator was appointed and HEL thereupon became entitled to determine the STC's employment, STC was not bound to continue to carry out and complete the works until either there was a clause 27.5.2.1 agreement (to continue or novate the contract) or HEL determined STC's employment. But since I have found that STC was already in breach of contract before the administrator was appointed, this makes no difference.

In these circumstances I accept the submission of Mr Thomas that, whether or not there was a repudiatory breach by STC or an acceptance of it by HEL, HEL's right to recover damages for breach of contract - which I have found it had - was preserved by clause 27.8. It is therefore unnecessary to consider the more difficult question of whether HEL's letter of 21 July 2003 did or did not amount to an acceptance of a repudiatory breach by STC.

For the reasons that I have already been given, my answers to the agreed issues are set out below. However, in relation to issue 2.1, the answers to individual items are likely to depend on matters that are fact sensitive and so my answers must be regarded as provisional only. If the parties wish to obtain more detailed answers from the court, then directions will have to be given for further evidence and argument.

I will hear the parties on any questions of costs, if these cannot be agreed, and, if the parties wish, this may also be an appropriate time at which to deal with the question of interest.