The recent Queensland Court of Appeal decision in Lucas Drilling Pty Ltd v Armour Energy Limited [2013] QSC 111 has affirmed that the primary focus for the courts when determining a party’s right to call on an unconditional bank guarantee will be the proper construction of the contract.

This case is an important reminder that termination of a contract will not necessarily affect a party’s right to call on security if, on a proper construction of the contract, that right has already accrued.

Introduction

As established by the long line of authority on bank guarantees, the Courts will be reluctant to interfere with a party’s right to call on an unconditional bank guarantee unless the party is found to be acting fraudulently, unconscionably or has made a contractual promise not to do so.

In the majority of cases, the courts are asked to consider this third exception, referred to as the ‘over-riding rule’, where a principal for a construction contract asserts a contractual entitlement to an amount payable by a contractor. These decisions will turn on how the principal’s entitlement to call on the security is expressed in the contract and whether the language used requires an actual and indisputable entitlement to the amount owing by the contractor, say, as a ‘debt due and payable’ and which is certified by a superintendent.

The decision by the Queensland Court of Appeal in Lucas Drilling Pty Ltd v Armour Energy Limited has once again affirmed this proposition.

In this case, it was the contractor, Lucas Drilling Pty Ltd (Lucas), appealing against an interlocutory injunction granted by the Supreme Court restraining it from calling on an unconditional bank guarantee after the principal, Armour Energy Limited (Armour), had terminated the contract. The purpose of the security had been to secure non-payment by Armour of undisputed invoices, but Lucas also had an obligation to return the bank guarantee in the event the contract was terminated.

In allowing the appeal, the Court held that, upon a proper construction of the relevant contractual provision, Lucas had accrued rights in relation to the security upon the non-payment of certain invoices by Armour. Those rights therefore survived the subsequent termination of the contract by Armour and relieved Lucas of its contractual obligation to return the security.

Background

Lucas and Armour were parties to a contract whereby Lucas undertook to provide oil and gas drilling services to Armour. Under the contract, Armour had procured a bank guarantee in favour of Lucas to secure any non-payment of undisputed invoices issued by Lucas. Relevantly, the contract contained a provision (clause 19.3) requiring that Lucas return the security to Armour within 3 days of termination of the contract ‘subject to any rights [Lucas] may have in relation to the [security]’.

The relevant facts were:

  • on 27 July 2012 and 13 August 2012, Lucas submitted invoices to Armour which were not paid nor disputed;
  • on 29 August 2012, Armour terminated the contract on the basis of various issues with Lucas’ performance; and
  • later that same day, Lucas gave notice under the contract of its intention to call on the security in respect of the unpaid invoices. Armour successfully sought an interlocutory injunction restraining Lucas from calling on the bank guarantee.

In granting the relief, the primary judge determined there was a serious question to be tried in respect of Armour’s claim that Lucas’ ability to call upon the security is directly attributable to its own breach of clause 19.3 of the contract by failing to return the security following termination. Lucas appealed.

Decision of the Court of Appeal

As this was an appeal from the grant of an interlocutory injunction, the question before the Court was whether the exercise of the discretion by the primary judge to grant the interlocutory relief miscarried.

The Court referred to the leading decision of the Full Federal Court in Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd [2008] FEAFC 136 which sets out the principles governing bank guarantees. The Court noted the general rule that a party is entitled to call upon an unconditional bank guarantee unless that party is acting fraudulently, unconscionably or has made a contractual promise not to call upon the guarantee and this is specifically stipulated in the contract. In respect of this third exception, the Court relied on the following observation in Clough (paragraph 77):

It may be preferable not to describe this as an exception but rather as an over-riding rule because it emphasises that the ‘primary focus’ will always be the proper construction of the contract …

With that in mind, the Court noted that, whilst the primary judge had based his determination upon the obligations imposed upon Lucas by clause 19.3 of the contract, those obligations (to return the security) were expressly stated in that clause to be ‘subject to any rights [Lucas] may have in relation to the [security]’.

In this respect, Armour argued that Lucas had not accrued rights in relation to the security at the time of termination as it had not at that time given notice of its intention to call on the security (as was required under the contract). Therefore Lucas had breached its obligation to return the bank guarantee following termination.

However, in allowing the appeal by Lucas, the Court held that at the time the contract was terminated, Lucas had accrued rights in relation to the security, as a plain reading of the contract reveals that the right to make a call on the security arose upon non-payment of invoices. Those rights were not then affected by the subsequent termination.

The Court relied on the recent NSW decision in Southern Cross Constructions (NSW) Pty Limited (Administrators Appointed) v Bucasia Pty Limited [2012] NSWSC 14191 which also considered whether a party was entitled to issue a notice of intention to call on security after the contract had been terminated.

In both cases, the decision turned on whether the notice of intention to call on the security was a condition precedent to the accrual of that right. If it was, then the right to call on the security would not have accrued at the time of termination.

As noted by Stevenson J in Southern Cross at paragraph 16:

The principle is that where one party to a contract terminates the contract for breach, the contract is not rescinded as from the beginning. Both parties are discharged from further performance of their obligations under the contract; but accrued rights are preserved.

In finding that Lucas’ right to call on the security had accrued at the time of non-payment by Armour, the Court agreed with the reasoning of Stevenson J in Southern Cross that the giving of the notice was not a condition precedent to a right but ‘merely the manner in which the right was to be exercised.’

On that basis, Lucas’ right to convert the security had accrued prior to termination and relieved Lucas of its obligation to return the security following termination.

What this decision means for you

Given that contracting parties typically have notice of any impending termination, it is important that, as the possibility looms, parties are alert as to the accrual of any rights to call on the security or to require its return.

A party that has provided security ought not assume that security will automatically be returned upon termination, even if notice of intention to call on the security has not yet been given. Similarly, a party wishing to call on security will only preserve its right to do so if that right has accrued by the time the contract is terminated.

A proper construction of the contract as regards these matters should inform how contracting parties position themselves in the event the relationship deteriorates.