Case Summary: Kawasaki Heavy Industries, Ltd v Laing O'Rourke Australia Construction Pty Ltd  NSWCA 291
Bank guarantees (and other instruments such as insurance bonds) are frequently used in construction projects to secure the contractor’s obligations. These guarantees have proven to be very effective and generally unable to be challenged by a contractor seeking to resist a call on the guarantee (through an injunction) by the principal. However, a recent Court of Appeal decision has shown that bank guarantees are not always immune from such challenges.
The Kawasaki Case
This case involved an appeal against an interlocutory injunction that was given in the primary judgement, which prevented Kawasaki from calling on surety bonds provided to it by Laing O’Rourke (LOR).
Both parties were subcontractors in a cryogenic tank project with the head contractor, JKC. Under the subcontract, JKC required performance bonds and advance payment bonds. Kawasaki and LOR entered into a Consortium Agreement in respect of their joint and several obligations in performance of the subcontract. Under the Consortium Agreement, Kawasaki agreed to take responsibility for providing the performance bonds and advance payment bonds on behalf of both itself and LOR (the Kawasaki Bonds), while LOR was to provide surety bonds to Kawasaki. A third agreement (the LOR Subcontract) provided that LOR would perform some of the work assigned to Kawasaki under the Consortium Agreement, to be secured by further bonds provided by LOR.
A dispute between the subcontractors arose after significant delays in the completion of the cryogenic tank project. While JKC asserted an entitlement to damages from the subcontractors, it did not call on the Kawasaki Bonds. Kawasaki made a call on the surety bonds issued in its favour. LOR sought to restrain Kawasaki from calling on the bonds, on the basis that there was a serious question to be tried about whether Kawasaki was entitled to call on the bonds when JKC had not yet called on the corresponding bonds provided to JKC under the subcontract. The primary judge of the Supreme Court of New South Wales ordered the continuation of the injunction.
The Court of Appeal had to determine whether the Consortium Agreement, in describing the parties’ obligations with respect to the provision of the surety bonds, supported the primary judge’s decision to continue an interlocutory injunction pending the determination of the substantive dispute between the subcontractors. Accordingly, the key issues were:
- whether there was a serious question to be tried that, on the proper construction of the Consortium Agreement and the LOR Subcontract, Kawasaki was not entitled to call on the surety bonds until JKC had called on the Kawasaki bonds;
- whether the primary judge should have determined the proper construction of the Consortium Agreement and the LOR Subcontract “as if on a final basis”; and
- whether the primary judge erred by finding that the balance of convenience favoured the continuation of the interlocutory injunction.
The Court of Appeal granted leave but ultimately dismissed the appeal, holding that the primary judge did not err in continuing the restraint imposed on Kawasaki.
Kawasaki had argued that a special rule of construction exists for contracts which provide for the issue of performance bonds being that:
only ‘clear words’ in such a contract can support a construction that prevents the beneficiary from calling on the performance guarantee.
It was contended that the inherent nature of a performance bond as a “risk allocation device” necessitates such an approach.
However, the Court of Appeal did not agree with the characterisation as merely “risk allocation devices”. Instead, the Court considered it more relevant to establish the particular risk against which the bonds were designed to give protection to Kawasaki.
This issue turned on whether the bonds merely secured LOR’s obligation to reimburse Kawasaki for part of the liability arising from a call by JKC on the Kawasaki Bonds (as LOR argued), or whether they secured LOR’s performance to Kawasaki under the Consortium Agreement and the LOR Subcontract (as Kawasaki argued).
The Court of Appeal favoured the view that they were for the purpose of securing against a call on the Kawasaki Bonds. To support this finding, there were various indications within the Consortium Agreement showing the parties’ intention that LOR’s surety bonds be security for Kawasaki’s liabilities, which could only be engaged upon JKC making a call for the Kawasaki Bonds. Further, the terms of the LOR Subcontract did not demonstrate that the parties intended to change the circumstances in which Kawasaki could call on the surety bonds. Accordingly, the Court of Appeal supported the primary judge.
Lessons from the case
Bank guarantees (and similar instruments) are an important part of the overall risk mitigation in any project. However, care needs to be taken to ensure that if the beneficiary wants them to be truly unconditional this must be made clear and the underlying contracts and project documents must not suggest a contrary intention suggesting conditionality to a call under the guarantee.
The authors acknowledge the assistance of Rory Gunn in the preparation of this article.