The return of security held under construction contracts signifies the works reaching practical completion and then, finally, the end of the contractual relationship.

A party’s right to the return of its security is often prescribed by the contract. But what happens to the security if the contract is terminated or the works are taken out of the contractor’s hands prior to the works reaching completion? A contract is more often than not completely silent as to what happens.

The recent case of Galileo Miranda Nominee Pty Ltd v Duffy Kennedy Pty Ltd [2019] NSWSC 1157, considered these issues and identified a number of questions that both principals and contractors should consider at the time of negotiating the contract when it comes down to security rights.

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In April 2017, Galileo Miranda Nominee Pty Ltd (Galileo) the Principal, entered into a $66 million design and construction contract with Duffy Kennedy Pty Ltd (Duffy) the Contractor, for a residential multi-tower development, consisting of 197 units, at Miranda in Sydney (Project).

Duffy failed to meet the February 2019 date for practical completion and Galileo levied liquidated damages in respect of the delay.

According to Duffy’s claims, as at February 2019, the works were 99.9 per cent complete with only $56,000 worth of work to be completed, which included the provision of an occupation certificate.

In March 2019, Duffy suspended work as a result of Galileo failing to pay interest in respect of Duffy’s February progress claim. Notably, the interest in question was nominal, amounting to a few hundred dollars at best.

In response to Duffy suspending works, Galileo issued a default notice and subsequently issued a further notice taking the works out of Duffy’s hands.Duffy disputed the validity of these notices and alleged that Galileo had repudiated the contract and purported to accept that repudiation.

The contract provided that in the event that the works were taken out of Duffy’s hands, Duffy was required to deliver up drawings, certificates, other specified documents, copies of all Duffy’s subcontracts for the Project and provide settlement bags for each unit (containing keys, manuals and warranties).

Whilst Duffy delivered up the settlement bags and some of the required documents, it failed to provide Galileo with copies of its subcontracts and the balance of documents required to be delivered under the contract.

Galileo commenced proceedings seeking copies of Duffy’s subcontracts and the other documents which Duffy was required to provide pursuant to the terms of the contract.Duffy cross claimed seeking a declaration that it had validly terminated the contract and, importantly, sought the return of its security (in the form of bonds) which was still held by Galileo under the contract.

Return of security

The contract provided for the reduction of security at practical completion and release at final completion, however, did not stipulate how security would be dealt with if the works were to be taken out of the contractor’s hands.

The contract in this case described the provision of security as being provided “as security for the performance of the Contractor’s obligations”.

Duffy argued that as work had been taken out of its hands, it was no longer performing obligations under the contract and as such, was entitled to the return of its security.

This argument was rejected by the Court. Although the take-out notice ended Duffy’s obligations to execute the works, there remained a contractual relationship with Galileo whereby Duffy had ongoing obligations, including to provide the occupation certificate and other documents.

The Court finding that despite the works being 99.9 per cent complete (with only administrative obligations relating to the provision of documents outstanding), the contractor was not entitled to the return of its security despite having had the works taken out of its hands. There was simply no contractual entitlement which gave Duffy any right to the return of its security.

Suspension of works

Another key determination in this decision was with respect to a contractor’s rights to suspend works. The Court determined that a contractor is required to utilise such a contractual right in a reasonable manner, proportionate to the circumstances giving rise to the suspension.

The Court found that the failure of Galileo to pay interest of a few hundred dollars, in the context of a $66 million contract, did not constitute a reasonable cause to suspend works. It was determined that whether Duffy’s actions in suspending the works were reasonable had to be construed in a “business-like way” and in a commercial context.As such the Court determined that suspending works on the basis of being owed a few hundred dollars, was “completely disproportionate” and, accordingly, a breach of contract.

On this basis, the Court determined that both the default notice and the notice taking work out of Duffy’s hands were validly issued by Galileo.

Practical considerations

The Courts are prepared to enforce a strict contractual interpretation when considering a party’s entitlement to the return of its security. If security is only to be returned upon reaching practical completion and final completion, security will not be required to be returned until such times – this is regardless of whether the works are 99.9 per cent complete. Near enough simply is not good enough.

If parties wish a contract to provide otherwise or wish to give one another specific rights and remedies to the security following termination (or the works being taken out of contractor’s hands), this should be negotiated at the outset and clearly set out in the contract.

This decision is also an important reminder of the need to take a commercial approach when attempting to assert contractual rights, such as suspending works. In this case, a wrongful suspension gave rise to a right to terminate the contract and retain security.