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Guarantees: ensure good deeds unpunished

Early payments to help a contractor in financial difficulties can vary or even cancel any third party guarantees for completion of the work.

The problem with fixed term payment dates

Say you agree fixed term and payment dates at the start of any construction contract. However, as work progresses your contractor claims financial difficulties. It can be hard to resist paying more and earlier than you originally agreed, especially if the alternative is a contractor who goes bust and leaves you with a job half done.

Advance payments pre-completion of work

A payment ahead of the date originally due can cost you marginally more in interest, but if you have a third party guarantee in place for completion of the work, there is a risk that your advance payment might invalidate the guarantee, which could cost you substantially more.

Court interpretation of the issue

This is what was claimed against Hackney Empire, a historic East London theatre backed by Lord Alan Sugar. During refurbishment, Hackney Empire made some payments to the contractor in financial difficulties ahead of the dates scheduled in the construction contract. Aviva Insurance claimed that the payments made by Hackney Empire to the contractor ahead of the dates due amended the guaranteed obligations and so discharged (released) the liability of Aviva under the guarantee (in this case, a bond).

The case in question and the decision

Fortunately for Hackney Empire, the court held that the payments made to the contractor were a loan and they did not form part of the original contract sum by looking at all the circumstances around the early payments. This meant that Aviva was still bound to honour the terms of the guarantee.

Clarifying the intent and rationale of the advance

However, anyone thinking of helping out a contractor in financial difficulties should be especially careful if a guarantee is in place. You need to be sure that your goodwill gesture of moving payments about in the contract does not leave you with a worthless guarantee. You must make it clear that you are making the payment as a loan to the contractor out of the goodness of your heart and it is not a sum due under the contract.

Guarantee agreements in practice

In the 17th Century debtors went to prison. This was quite a harsh punishment, but for someone who was in debt only because they had stood as guarantor for a friend this was harsher still. Because of this, the laws regarding guarantees developed to protect the guarantor as far as possible. To protect guarantors, the general rule is that any amendments to the original guaranteed obligations made after the date the guarantee is given discharges (i.e. releases) the liability of the guarantor (unless the guarantor agrees of course, or if the amendment is insubstantial or not capable of affecting the guarantor adversely).

Risks of acting as a guarantor

Now that the risks of imprisonment are substantially lower, it is possible to get a more watertight guarantee to keep the guarantor on the hook by agreeing in advance that the guarantee still applies even if certain changes are made.

Helen Curtis is a partner in the commercial team. Helen advises both individuals and companies on commercial contracts that give rise to advance payments. There are intricacies. 

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