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Bank Draft

Posted on March 1, 2009 | Posted in Construction

Consider the following: an owner calls for tenders, a general contractor submits a bid and encloses a bank draft for bid security, the general’s bid is low, and the owner awards the contract to the general. That is the way it is supposed to work. However, what happens when the general supplies a bank draft that does not seem to be perfect on its face? This is the scenario in Good Mechanical v. Canadian Imperial Bank of Commerce, a 2005 decision of the Ontario Superior Court of Justice.

Form

The general had supplied a tender to the feds and was low. However, the bank draft it submitted as bid security was not quite right. It had lines for two signatures. The first was for an “authorized signature”; the second was for a countersigned signature. In addition, there was a space for the authorization number.

The teller who had given the draft to the general’s principal had signed the counter signature when she ought to have signed the authorized signature. No one signed the authorized signature and no authorization number was inserted.

The person receiving the tenders for the feds spoke to the bank manager. The manager ultimately gave him a letter in which she acknowledged that there was an error, but stated that, if the draft were deposited, she would sign it and the bank would honour it.

The feds’ agent concluded that the bank draft was deficient on its face; accordingly, he disqualified the general’s tender.

The general was not pleased and commenced an action against the bank.

Compliance

The bank took the position that the feds ought not to have rejected the bid and that, therefore, it was not liable to the general. The bank’s lawyers went so far as to stage an experiment. They gave a low value bank draft to the feds, deficient in the same aspects as the impugned draft, and then waited for the feds to negotiate the draft. It cleared in the normal course and, therefore, the lawyers said, “See. All you had to do was to deposit it.”

The judge dismissed that argument. The test was not whether the draft might have cleared, but whether the bank could have refused to honour it. She reviewed the bank’s internal policy, the manager’s letter to the feds regarding the draft, and, most importantly, the very form of the bank draft itself and concluded that the bank could have refused to honour it. Accordingly, the feds properly rejected it.

Breach

┬áThe judge noted that, “The relationship between a bank and its customer is a contractual relationship which includes a duty on the bank to take reasonable care in the carrying out for its customer of its customer’s business. The standard of that reasonable care and skill is an objective standard applicable to all bankers.”

The judge concluded that the draft was defective and that the bank’s employee negligently prepared it. Accordingly, the bank was liable for breach of its banking contract with the general.

The judge then had to determine whether the general suffered any damages from the bank’s breach and whether these damages were too remote (or unforeseeable). The general was suing for the profit and overhead that it lost because it was not awarded the contract. This is the same measure of damages applicable to a breach of tender action against an owner.

Remote

If damages are too remote, then, although there may be a contract breach, the person responsible is still not liable to pay. For example, assume that you and I have a contract whereby I agree to pay you $1.00 for a package of gum; I receive the dollar, I refuse to give you the gum, and you have an apoplectic fit and suffer a stroke. I may be liable for breach of contract, but I am not liable for your damages (other than a dollar) for the stroke. I could not possibly have foreseen that my breach of contract would result in your stroke.

The bank argued that the general’s damages were too remote (i.e. how would the bank know that a defective bank draft for $80,000 would somehow result in the loss of a contract?)

However, the bank knew that the general was a mechanical contractor and used the line of credit, which the bank had set up, to obtain bank drafts for tenders. Further, the general’s principal told the teller he was in a hurry because he needed to use the bank draft for an impending tender. The judge had no problem finding that the damages were foreseeable.

Quantification

The judge then had to quantify the damages. The general produced its tender takeoff. In it, it had allotted 37% for its fixed overhead and profit. That amount was $108,000. The general also produced its financial statements for prior years. These showed that its gross profit ranged between 15% and 25% and that its fixed overhead ranged between 15% and 16%. Accordingly, the judge felt that 37% for both was a reasonable estimate.

The parties adduced evidence indicating that there were numerous extras on the project resulting in 33% higher revenue (a positive effect on damages), but that the project was delayed by over 40 weeks (a negative effect). The judge reduced the damages to $100,000 to account for the increased revenue along with the extended construction schedule.

Finally, the bank argued that the general did not mitigate its damages (i.e. conduct itself in a manner that would reduce them). The judge held that the general had submitted numerous tenders on other projects to reduce the negative effect of the revenue it lost on the disqualified bid, but that the financial results for the original 30-week contract period showed a real loss of revenue. Accordingly, she rejected that argument also.

In the result, the judge awarded to the general damages of $100,000, pre-judgment interest, and costs that she fixed at $31,000.

Moral

Although the general was successful in its action against the bank, it still bore the difference between the solicitor-client costs it had actually paid to its lawyers and the partial indemnity costs that the judge awarded to it. Further, it had to spend the time and effort to pursue the litigation through trial and suffer the doubts and uncertainties that accompany any legal action.

It would have been far better had the general’s principal actually examined the bank draft and caught the errors. In doing so, he would have ensured that the general obtain a correct draft, be awarded the contract, and perform the work. Since other forms of security are also subject to drafting and completion errors, we suggest that, regardless of whether the security is by way of bond, bank draft, or letter of credit, you check the security carefully before you submit it with your bid.

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