The engineer and performance bond



A RECENT HIGH COURT decision relating to Mainzeal’s construction of Vector Arena underscores the critical role of the engineer in construction projects and illustrates what can happen to security if an engineer’s certification arguably gets it wrong.

The long shadow of Mainzeal continues to loom large with the decision in QPAM v Great Lakes Reinsurance (UK) Plc.

In 2004, Auckland City Council contracted Quay Park Arena Management (QPAM) to develop and manage Vector Arena. In turn, QPAM entered into a design and construction contract with Mainzeal, which required Mainzeal to provide a third-party performance bond. The bond was to be released when a certificate of completion was issued. A $3.3 million bond was provided by Great Lakes Reinsurance under which it agreed to pay QPAM on demand, unconditionally and “without enquiry as to, and without having regard to, the position as between Mainzeal and the principal”.

Demands were to be accompanied by an engineer’s certificate stating that: (a) Mainzeal had defaulted, (b) that default had not been remedied, and (c) the sum demanded was reasonable.

When Mainzeal went into liquidation in 2013, a number of defects at Vector Arena remained unremedied and the certificate of completion was outstanding.

C_Feb_2015_Pg60_1In consultation with a quantity surveyor, QPAM’s engineer estimated the cost of remedying the defects to be at least $5.3 million. QPAM gave notice of default to Mainzeal and demanded the entire amount of the bond from Great Lakes. Great Lakes refused to pay, arguing that the engineer’s certificate was “incorrect and unreasonable” and that QPAM had claimed for matters not covered by the bond.

In response, QPAM asserted that it had met the requirements for payment and the bond was payable “on-demand”. As a result, QPAM argued, it did not have to prove to Great Lakes that Mainzeal had defaulted and Great Lakes could not question whether the amounts demanded were correct or reasonable, it simply had to pay.

The starting point for the court was to consider the “special character” of performance bonds, noting that where a bond provider made an unconditional promise to pay (as Great Lakes had done) it could generally not refuse a demand or inquire into the contract between the principal and the contractor, even if the contractor’s default was disputed. These rules underpinned the value of bonds as security and the risk allocation that the parties had agreed. The only instances where a bond provider could withhold payment, the court said, were if the party claiming payment had acted fraudulently or had contractually agreed not to call on the bond.

As the key requirement for payment of the bond was the engineer’s certificate, the parties were effectively relying on the certificate accurately reflecting the outstanding defects.

An issue for the Court, therefore, was whether it could review the engineer’s certificate. This, in turn depended on the engineer’s obligations to the parties. The Court found that by including a requirement in the bond for an engineer’s certificate, the parties had agreed to rely on the engineer’s skill and judgment and to be bound by his honest and impartial decision.

The engineer was therefore obliged to act reasonably, in good faith and within the parameters of his contractual authority. The engineer’s certificate could therefore be reviewed to ensure it met these criteria.

Importantly, the court recognised that an engineer’s certificate did not need to be perfect – errors would not necessarily invalidate a certificate, even if they related to the assessed quantum of defects. An engineer could also legitimately certify in respect of contentious items if this was a fair interpretation of the contract.

However, this did not mean that matters clearly outside the scope of a contractor’s obligations could be included as defects. In those circumstances, the Court ruled, the engineer’s certificate would be void.

As QPAM’s case was for summary judgment (rather than a full hearing), only Great Lakes’ evidence on the engineer’s certificate was before the Court, and this indicated that the certificate included items that were not Mainzeal’s responsibility. As a result, the Court found that Great Lakes had an arguable defence to QPAM’s claim, as the engineer’s certificate was arguably beyond the scope of the engineer’s contractual authority. The certificate was therefore reviewable and could be void.

The decision underscores the importance of an engineer’s role in construction contracts and the challenges engineers face in owing duties to multiple parties.

It also provides welcome guidance as to when an engineer’s certification can (and cannot) be challenged.

While on demand bonds remain the gold standard of performance security, particularly in cross-border transactions, principals must ensure that their rights to call on that security are sufficiently broad.

  • Doran Wyatt is a principal at Greenwood Roche Chisnall. He is a member of the New Zealand Society of Construction Law and regularly advises on construction and large scale property projects.

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