Principals (or main contractors) often require the contractor performing the works to provide security in the form of unconditional bank guarantees, insurance bonds, cash retention or similar.
1
They do so out of concern (or
purported concern) that the other parties will not be able to complete what they have commenced and have been
progressively paid for.
When the security provided is in the form of bank guarantees or other performance bonds, the principal will expect
“a form as good as cash”
2
which means truly unconditional and payable on demand.
Many would say that providing security is simply a cost of doing business in the construction industry. However, it
is regularly provided by contractors without a real understanding of the risks involved.
An unfair or unexpected calling on the security can promptly lead to financial distress or failure.
Preventing an unfair calling on the bond
In the case of unconditional performance bonds, preventing recourse can be very hard indeed.
The bonds are “unconditional” after all. The purpose of such bonds is essentially to “secure” timely and proper
performance of the contractor’s obligations - often an express term of the contract.
3
This seems fairly benign but
can take on a harder edge. That is, to allocate to the contractor the risk of being out of pocket pending resolution
of a dispute.
The courts have found limited avenues for a contractor to intervene and restrain a principal from calling upon an
unconditional performance bond. Courts will grant an interlocutory injunction only where a contractor has
established that:
1. there is a serious question to be tried;
2. if the injunction is not granted the contractor will suffer loss, for which damages will be an inadequate
remedy; and
3. the balance of convenience favours granting the injunction.
4
It is the first test that contractors often fall down on. Given the commercial purpose of an unconditional bond, it can
be hard to establish that there is even a serious question whether the principal can take the cash pending
resolution of the dispute (leaving the contractor out of pocket).
1
This article focuses on security provided by a contractor or subcontractor. Although principals can, and often do, provide security, this is far
less common.
2
Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443 at 457 (Stephen J).
3
For example, Clause 5.1 of AS4300-1995.
4
Australian Broadcasting Corporation v O’Neill [2006] HCA 46.Page 2 of 5 www.mcw.com.au
©McInnes Wilson Lawyers 2014
Security in construction contracts – securing
performance or guaranteeing misery? (cont.)
The limited circumstances under which an injunction might be granted are when:
5
1. there is a clear case of fraud by the principal;
2. the principal has engaged in unconscionable conduct under the Australian Consumer Law (formerly the
Trade Practices Act); or
3. the contract contains an express or implied promise from the principal not to call on the bond.
Outcomes are unpredictable
Of the avenues listed above, the only realistic one appears to be when there is an express or implied restriction
from calling on the bond in the underlying contract. Extreme commercial pressure, or unfairness, does not amount
to fraud. In addition, the courts have questioned the likelihood of unconscionable conduct applying in the absence
of fraud.
6
It will always depend on the terms of the contract in question. Slightly different wording, and slightly different
surrounding facts, can lead to surprisingly different outcomes.
The terms of the contract might not protect the contractor even when the words appear, at first blush, to do just
that. For example, in Redline Contracting v MCC Mining (Western Australia)
7
, the contractor sought to restrain the
principal from cashing unconditional bonds after a notice of recourse was given. Siopis J of the Federal Court
considered the following wording in clause 5.2 of AS4000:
Security shall be subject to recourse by a party who remains unpaid after the time for payment where at
least 5 days have elapsed since that party notified the other party of intention to have recourse.
(Underlining added)
His Honour held that “remaining unpaid after the time for payment” did not mean that the debt had to be undisputed
or finally determined. Accordingly, no injunction was granted.
In other cases, where the wording was not much different, injunctions have been granted. For example, in Lucas
Stuart v Hemmes Hermitage
8
, the contractor successfully restrained the principal from calling on the bond. The
New South Wales Court of Appeal considered a clause which provided (among other things) that:
If the contractor has not materially complied with its obligations under this contract, the principal may give
a written notice to the contractor … If the contractor fails to comply with the terms of the notice given … the
principal may convert any unconditional undertaking into cash…
(Underlining added)
The Court held that the ability to cash the bond is conditioned upon the “objective fact” of non-compliance with a
material obligation, not the principal’s bona fide belief of the non-compliance.
9
5
Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd 29 ALR 458 at 477.
6
Clough, at 494.
7
[2011] FCA 1337.
8
[2010] NSWCA 283.
9
Lucas Stuart at [36] (Macfarlan JA).Page 3 of 5 www.mcw.com.au
©McInnes Wilson Lawyers 2014
Security in construction contracts – securing
performance or guaranteeing misery? (cont.)
An even more “contractor-friendly” approach was taken in a recent ACT Supreme Court decision where the Court
surprisingly granted an injunction to the contractor despite there being no express restriction in the contract. In
Walton Construction v Pines Living
10
, the principal was restrained from calling upon the unconditional bank
guarantees on the basis that the parties were engaged in a genuine dispute and contract did not expressly allocate
the risk of security as the principal’s benefit until the dispute was resolved.
This is in stark contrast to the approach taken in Redline v MCC and the similar hard-line (arguably “principalfriendly”) approach taken in other cases.
11
It is perhaps also cause for concern for all principals whose contracts
are based on or adopted from the PC-1 (2008) standard contracts and Department of Defence construction
contracts. These contracts contain no express provision dealing with recourse and (it can be presumed) were
drafted on the basis of the cases that held that only very clear restrictions in the underlying contract are able to cut
across the unconditional nature of performance bonds. The decision in Walton v Pines challenges this
assumption.
12
Managing risk
With all of this unpredictability – from the contractor’s perspective, the safest approach is to insist on very clear
words to overcome the risk of an unwelcome calling on unconditional (“as good as cash”) performance bonds.
For example, consider provisions to the effect that the principal’s right to recourse only arises when:
■ either:
o the contractor is insolvent; or
o an undisputed debt is due from the contractor to the principal, and
■ the principal has given the contractor reasonable prior notice informing the contractor of its intention to call
on the security.
Statutory intervention in Queensland
Even if a contractor fails to negotiate adequate restrictions in its contract, not all hope is lost for contractors carrying
out ‘building work’
13
in Queensland.
The tentacles of the Queensland Building and Construction Commission Act 1991 (Qld) (QBCC Act) cut across
freedom of contract and voluntary assumption of risk, in favour of vulnerable parties lower down the contracting
chain.
Section 67E of the QBCC Act provides that any term of a building contract which is inconsistent with a provision of
Part 4A of the QBCC Act is void to the extent of the inconsistency. This extends to a principal’s (or any superior
contractor’s) ability to have recourse to security or retention.
10
[2013] ACTSC 237.
11
Including Clough; Redline v MCC; Ceresola AG v Thiess Pty Ltd & John Holland Pty Ltd [2011] QSC 115; Lucas Drilling Pty Ltd v Armour
Energy Ltd [2013] QCA 111; Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812.
12
For now at least, as an appeal has been filed against this decision.
13
As that term is defined in the Queensland Building and Construction Commission Act 1991 (Qld). Page 4 of 5 www.mcw.com.au
©McInnes Wilson Lawyers 2014
Security in construction contracts – securing
performance or guaranteeing misery? (cont.)
Section 67J (Part 4A) of the QBCC Act provides that:
(1) The contracting party for a building contract may use a security or retention amount, in whole or in part,
to obtain an amount owed under the contract, only if the contracting party has given notice in writing to the
contracted party advising of the proposed use and of the amount owed.
(2) The notice must be given within 28 days after the contracting party becomes aware, or ought
reasonably to have become aware, of the contracting party’s right to obtain the amount owed.
This section ensures that a principal can only use the security to obtain an ‘amount owed’ under the contract.
An ‘amount owed’ means a debt due under the contract.
This statutory intervention was recently illustrated in the Queensland Supreme Court decision of Beyfield v
Northbuild Construction Sunshine Coast.
14
In Beyfield v Northbuild, the subcontractor entered into a subcontract with the builder to carry out mechanical works
for the construction of a government project on Thursday Island. The subcontractor provided the builder with two
bank guarantees as security for the performance of its works. Disputes arose and the builder gave notice to the
subcontractor of its intention to call on the bank guarantees, alleging breaches of the subcontract that had resulted
in the builder incurring costs which it claimed as damages. Provisions of the subcontract gave the builder
extremely broad rights to cash the bank guarantees "in respect of any claim to payment (liquidated or otherwise)
the builder may have against the subcontractor under the subcontract or otherwise”.
The subcontractor applied to the Supreme Court for an injunction restraining the builder from cashing the bank
guarantees.
The Court held that:
■ section 67J of the QBCC Act restricted the operation of security or retention clauses to ‘debts due’;
■ that a party attempting to call on security or retention money under a construction contract must strictly
comply with section 67J of the QBCC Act (including the 28 day written notice requirement); and
■ the builder could not use the securities for its unliquidated claims.
Accordingly, the injunction was granted.
Practical tips
For contractors (and subcontractors) seeking to prevent an “unfair” calling:
1. At the negotiation stage – seek advice to help you understand, negotiate and draft suitable protections in
the contract that clearly provide when a principal can cash in the security.
2. Throughout the project – if the relationship turns sour, seek urgent advice on your risks and options,
including under what limited circumstances an injunction could be granted.
14
[2014] QSC 12.Page 5 of 5 www.mcw.com.au
©McInnes Wilson Lawyers 2014
Security in construction contracts – securing
performance or guaranteeing misery? (cont.)
For principals seeking to preserve the “as good as cash” nature of security (if you intend it to operate that way):
1. At the negotiation stage – seek advice to make your contract very clearly preserve the unfettered right of
recourse.
2. Throughout the project – if you are considering recourse, seek advice to help you:
■ Assess the reasons for wanting to have recourse to the security. Consider any reasonable
alternatives – cashing security is a very serious step to take and can irreparably damage your
commercial relationship.
■ Understand the procedural steps required under the contract.
■ If the QBCC Act applies, understand and comply with those additional hoops to ensure valid recourse.
The contributions to this article by Katharine Chapman and Tim Sexton are gratefully acknowledged.
