SUMMARY

Last year, the Australian construction sector was marked by a number of features:

  • the sector continued to move its focus away from engineering construction for major resources and energy projects towards commercial, residential and social infrastructure construction (stadia, hospitals, roads and the like);
  • the increasing appetite for sector participants to access the security of payments adjudication regimes in order to maintain cashflow; and
  • the appreciable fall in commodities prices (particularly iron ore) has heightened fears of insolvency events, even among established industry participants including principals.

These features have contributed to a renewed focus on the quality and availability of security provided by contractors under construction contracts.

Principals require contractors to provide security under construction contracts in order to secure the performance of the contractor’s obligations, particularly in the event of the contractor’s insolvency. Traditionally, security was provided in order to protect the principal from the damage actually suffered where the contractor breached its obligations. However, in recent times security has been used to secure the principal’s position in the event of a dispute as to whether the contractor has breached its obligations.

2015 saw a series of cases which provide valuable insight into the current attitudes of the Australian Courts as to the role of security held under construction contracts. The three cases discussed below, Yuanda Australia Pty Ltd v John Holland Pty Ltd [2015] WASC 453, Duro Felguera Australia Pty Ltd v

Samsung C&T Corporation and Ors [2015] WASC 484, and Fabtech Australia Pty Ltd v Laing O’Rourke Australia Construction Pty Ltd [2015] FCA 1371 all concerned whether interlocutory injunctions should be imposed to restrain principals from having recourse to securities until the substantive hearing of disputes arising under construction contracts. Further cases considering the role of security in the construction context included Best Tech & Engineering Ltd v Samsung C&T Corporation (No 2) [2015] WASC 447, Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98 and Saipem Australia Pty Ltd v GLNG Operations Pty Ltd (No 2) [2015] QSC 173.

The clear message from these cases is that the Courts will not restrain the conversion of security provided that:

  • the terms of the security clause can be clearly construed; and
  • the Court can satisfy itself as to the propriety of the conversion.

The Courts emphasised that in addition to the traditional security function, a security clause can also play an important role in allocating risk between the parties under a contract. Where the construction of the security clause provides for risk allocation pending dispute resolution then, absent compelling reasons, the agreed risk allocation should not be changed even on an interim basis. The fact that a contractor willingly agrees to assume this risk weighs heavily in favour of the principal being able to exercise its entitlement to the security.

The message for insurers and financial institutions issuing security (whether in the form of performance bonds, guarantees or the like) is to know the terms on which your customer contracts and to know who your customer contracts with. Both have a significant influence on the prospects of the security being called upon.

YUANDA V JOHN HOLLAND

John Holland engaged Yuanda to design and install the façade of the New Children’s Hospital in Perth. John Holland alleged that Yuanda’s work was defective and required replacement, at a cost exceeding the value of the security provided under the contract and an entitlement to liquidated damages for delay.

After notifying Yuanda of its intention to call on the security, on 17 November 2015, an officer of John Holland attended the Sydney branch of the guarantor to convert the security to cash. Yuanda’s solicitors sought an injunction the following day to restrain John Holland from taking any further action to apply the moneys to any alleged costs, expenses or damage suffered.

Yuanda contended that the security clause contained an implied term that John Holland not convert the bank guarantees to cash except to pay for costs, expenses or damage suffered as a result of a breach which required John Holland to make a claim for breach to Yuanda. The Court rejected Yuanda’s argument on the basis that this approach was inconsistent with the clause’s clear purpose to allocate risk between the parties in the event of a dispute, because the clause provided that the security could be converted into cash “at any time.”

The Court also decided that they were able to dismiss Yuanda’s claim without taking a view on the proper construction of the security clause as there was no evidence that John Holland had converted the security for any unauthorised purpose. Indeed, there was clear evidence of the defective nature of the facade and the delay in completing the contract works. As such, Yuanda failed to establish a prima facie case in favour of the grant of an injunction.

Finally, the Court decided that the balance of convenience would not favour the grant of an injunction in any event, as Yuanda failed to properly show any irreparable injury for which damages would be an inappropriate remedy if an injunction was not granted. Denying John Holland the benefit of the risk allocation in the security clause by granting relief was “a powerful consideration against the grant of interlocutory injunctive relief.”

DURO FELGUERA V SAMSUNG

This case confirms that undertaking contractual construction is paramount to determining the conditions precedent to entitlement to recourse to the security, followed by a careful consideration of the evidence to determine whether the principal has complied with those conditions.

Duro Felguera and Forge, through an unincorporated joint venture, entered into a contract with Samsung whereby they agreed to provide engineering, procurement, construction and commissioning for the Roy Hill Iron Ore Project. Duro and Forge as the “Subcontractor” were jointly and severally liable to Samsung for all of the Subcontractor’s rights and obligations.

Duro and Forge were required to provide security for performance to Samsung in the form of bank bonds, which were issued by CGU Insurance and AIG Australia. The contract provided that if an administrator was appointed to either Duro or Forge, Samsung could terminate the Subcontract. An administrator was appointed to Forge on 11 February 2014 and Samsung subsequently terminated the Subcontract on the 21 February 2014. Duro wished to continue to provide services to Samsung and entered into a new contract with Samsung for a portion of the remaining works.

On 3 November 2015, Samsung made a demand on the securities issued by AIG and CGU. An ex parte interim injunction was granted in favour of Duro to restrain Samsung from calling on the securities. Duro applied for an interlocutory injunction to restrain Samsung from calling on the securities and also to restrain CGU and AIG from paying any amounts to Samsung.

Duro argued that Samsung’s entitlement to call on the security had expired and did not continue under the subsequent term sheet agreed between Duro and Samsung, and alternatively that Samsung had not formed the requisite bona fide consideration that it was entitled to recourse to the security.

The Court found for Samsung on both matters of construction. First, the Court found that Samsung’s interpretation of the original Subcontract and subsequent term sheet was a more “business like” construction than that offered by Duro, and the expiry of the security under the Subcontract was extended. Second, the Court found that Samsung was not required by the terms of the contract to give notice to Duro that it considered that it was entitled to have recourse to the security. In any event, there was no evidence suggesting that Samsung was not acting bona fide.

As to the balance of convenience, the Court also observed that the risk that the security will be called upon was a risk that Duro assumed by entering into the Subcontract. The function of the security clause was clearly that Duro should carry the risk in the event of any dispute. If the injunction was to be granted Samsung would be deprived of its right to determine which party is out of pocket until the resolution of the dispute.

FABTECH V LAING O’ROURKE

Laing O’Rourke engaged Fabtech to supply and install pond liners and leak detection systems for two water treatment ponds in rural in Queensland.

On 27 October 2015, Laing O’Rourke notified Fabtech of various claims, including for recovery of overpayments and liquidated damages, for the purposes of recourse to the securities provided under the contract. On 28 October 2015, Fabtech obtained an ex parte interim injunction restraining conversion of the securities. In its submissions at the subsequent hearing at which Laing O’Rourke was present, Fabtech relied upon four grounds to support its argument that it had a prima facie case for the grant of an injunction, including that in seeking to call on the securities, Laing O’Rourke would be engaging in unconscionable conduct or acting in breach of an implied contractual obligation to act in good faith.

The Court decided that it was plainly clear on the wording of the security clause that Laing O’Rourke could have recourse to securities whenever it claimed to be entitled to payment of monies by Fabtech. Accordingly, the security clause was intended to operate as a risk allocation device as to which party would be out of pocked in the event of a dispute. The Court also observed that there was no express requirement that Laing O’Rourke act reasonably when having recourse to the security.

The Court emphasised that where a security clause is clearly designed to allocate risk, establishing that the principal is acting unconscionably or in breach of an obligation to act in good faith is extremely difficult. For such an argument to succeed, the conduct would need to be extreme and almost merge into bad faith exercises of the power.

Whilst the Court was not prepared to find that Fabtech had a prima facie case for an injunction, the Court nonetheless considered the balance of convenience and noted that the award of an injunction would “defeat an important purpose, if not the most important purpose”, of the securities, namely the risk allocation function.

COMMENTARY

These cases provide an insight into the manner in which principals are exercising contractual rights to security held under construction contracts in the present economic environment. They also demonstrate that Courts will uphold clearly drafted security clauses in order to protect the rights of the principal, but will scrutinise the construction of the clause and the evidence to ensure that principals have complied with relevant pre-conditions.

The cases also highlight that where the security clause clearly serves a function of risk allocation in the event of the dispute, this will give further strength to the case of the principal seeking to enforce the security.

A final point to observe is that the prevalence of cases suggests that principals appear to be using security more aggressively over their contractors as a form of private payment claim. This may reflect the fact that the payment claim adjudication system is seen to be “pro-contractor”, and a contractual mechanism of security held under construction contracts provides a means for principals to level the playing field of cash flow risk in the event of a dispute.