In the current construction climate a growing number of principals (and head contractors) are calling on their unconditional bank guarantee, performance bond or undertaking (performance guarantee) provided by their contractors (or subcontractors). Performance guarantees are often for substantial sums and represent a significant financial commitment.
It is accepted law that if a principal has an entitlement to call on a performance guarantee then the principal should be able to do so without enquiry or qualification.1 However, in limited circumstances a contractor can successfully apply for an injunction to restrain recourse to the performance guarantee.
For a court to grant an interlocutory injunction restraining a demand on a performance guarantee, the contractor will need to show:
- There is a serious question to be tried, which has a sufficient likelihood of success justifying the preservation of the status quo pending the final resolution of the claims
- The balance of convenience favours the granting of an injunction
- Damages will not be an adequate remedy for the contracttor if the injunction is not granted2
The Federal Court decision of Clough Engineering Limited v Oil and Natural Gas Corporation Limited 249 ALR 458 (Clough) summarised and reinforced a line of decisions3 holding that a principal seeking recourse to a performance guarantee (and a financial entity to whom a demand for payment under a performance guarantee has been made) would not be restrained, subject to the following exceptions:
- The principal acting fraudulently (e.g. dishonest intent or recklessness as to the truth of statements or an unsubstantiated threat to call on a bank guarantee)
- The principal acting unconscionably
- Breach of a negative stipulation in the contract (i.e. an express or implied proscriptive condition is breached)4
The last exception recognises that in determining whether a party can call upon a performance guarantee, the primary focus will be the proper construction of the contract.
In addition to the exceptions outlined in Clough, the courts have also recognised the importance of reputational damage to the contractor as a result of calling on a performance guarantee in weighing the balance of convenience.5 The contractor must demonstrate that there is actual risk of reputational harm if the injunction application is dismissed.
However, these exceptions have been tempered over recent years.
In Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd  VSCA 98 (Sugar Australia), the Court of Appeal made clear that the courts will not restrain the issuing of a performance guarantee on the basis of reputational harm. In particular, Justice Kaye noted that by agreeing to the contractual clause governing the performance guarantee, Lend Lease assumed the risk that a call may be made on the performance guarantee. The court noted that disputes are extremely common under construction contracts and that a dispute in relation to the performance guarantee would therefore be unlikely to have any adverse impact on Lend Lease in the marketplace.
The Court of Appeal held that if a principal was restrained from having recourse to the security, this would undermine the purposes of the performance guarantee provision, which are to allocate cash flow risk to the contractor rather than the principal pending the resolution of any disputes between the parties.6
This was also held to be the position in the recent WA case of Duro Felguera Australia Pty Ltd v Samsung C & T Corporation  WASC 119.7 The applicant argued that if an injunction was not granted it would seriously adversely impact its ability to tender for work on future projects as the payment of the security would very likely have to be disclosed in any future tender. This would damage its reputation as the perception in the market place would be that it was an unreliable contractor. On this ground of reputational harm Justice Le Miere held:
“The risk of hardship and the risk of damage to reputation were risks assumed by Duro when it agreed to provide securities on terms that recourse could be had to them merely on Samsung considering bona fide that it is or will be entitled to the relevant amount.”8
His Honour then referred to Sugar Australia by stating a bald assertion of reputational harm is insufficient as it is notorious that disputes are commonly part and parcel of building contracts.9
This demonstrates that the courts are tempering back a contractor's ability to rely on reputational harm as a significant factor in considering the balance of convenience when seeking to restrain a call on a performance guarantee.
Contractors should be mindful that an application to restrain recourse to an unconditional performance guarantee is only granted in exceptional circumstances. Reliance on general reputational damage as a significant factor in support of an application for such a restraint is unlikely to be helpful to the application.