Providing security under a construction contract is an important risk allocation mechanism that can give rise to disputes between parties. Although bank guarantees are a popular way of providing security, when misused under a contract, they can have large implications for a party’s reputation and future borrowing ability. This often gives rise to parties disputing how and when bank guarantees should be released or retained in accordance with the contract.
Most construction contracts require the contractor to provide some form of security to the principal, with the usual position requiring 50 per cent of the held security to be released upon practical completion, with the remainder to be released upon the expiry of the defects liability period or soon after.
It has largely been uncontroversial that the contractor’s obligation to provide security continues until the security is due for release under the contract, unless the security is called upon prior to that time. However, the main contractor performing the refurbishment of Day Dream Island in the Whitsundays recently challenged this position in the Supreme Court of Queensland in the case of CCIG (Australia) Pty Ltd v Amicus Hospitality Group Pty Ltd  QSC 232 (CCIG v Amicus).
The principal sought an order for specific performance that the contractor provide the principal with a substitute bank guarantee pending expiry of its right to hold security under the contract, and sought a declaration of its entitlement to that effect under the contract.
Towards the commencement of the project on Day Dream Island, the contractor provided the principal with two bank guarantees, which each had an expiry date which respectively accorded with the date for practical completion of the last separable portion, and what would be final completion. In its first progress payment to the contractor, the principal had essentially given the contractor a deposit for the bank guarantees to allow it to procure the issue of the bank guarantees from the Commonwealth Bank of Australia in favour of the principal.
Upon receipt of the original bank guarantees the principal locked them away for safekeeping and there was no express communication with the contractor thereafter either approving or disapproving the form of the bank guarantees.
The contractor commenced work, and the scope subsequently increased significantly, with the result that the date for practical completion was also extended accordingly. Consequently, the defects liability period was not due to expire until quite some time after the second bank guarantee expired, leaving the principal unsecured for most of the defects liability period.
The principal requested that the contractor provide replacement security pursuant to the contract, which the contractor refused, submitting that its obligation under the contract to provide the security had been discharged on account of the principal’s approval at the commencement of the project of the security then provided.
The principal applied to the court for:
- urgent declaratory relief that upon proper construction of the contract, the contractor was required to provide the security until 14 days after the issue of the final certificate pursuant to clause 42.8
- an order for specific performance that the contractor provide the security.
The court refused to provide urgent relief and instead listed the matter for trial before Justice Mullins.
The contractual obligation to provide security
The contract incorporated, largely unamended, the AS2124-1992 General Conditions. Clause 5 of the General Conditions required the contractor to provide security to the principal, relevantly:
- Clause 5.1 Security, retention moneys and performance undertakings: Security, retention moneys and performance undertakings are for the purpose of ensuring the due and proper performance of the contract
- Clause 5.2 Provision of security: If it is provided in the annexure that a party shall provide security then the party shall provide security in the amount stated in the annexure and in accordance with this clause
- Clause 5.3 Form of security: The security shall be in the form of cash, bonds or inscribed stock issued by the Australian Government or the Government of a State or Territory of Australia, interest bearing deposit in a trading bank carrying on business in Australia, an approved unconditional undertaking given by an approved financial institution or insurance company, or other form approved by the party having the benefit of the security. The party having the benefit of the security shall have a discretion to approve or disapprove of the form of an unconditional undertaking and the financial institution or insurance company giving it or other form of security offered. The form of unconditional undertaking attached to these General Conditions is approved.
Annexure Part A to the General Conditions provided that the contractor was to provide two unconditional bank guarantees each for 2.5 per cent of the contract sum. Clause 5.7 provided for the reduction of security and retention monies by 50 per cent upon the works reaching practical completion, and clause 5.8 together with clause 42.8 required that the remainder of the security held by the principal be released to the contractor within 14 days of the issue of the final certificate which certifies a balance owing from the principal to the contractor.
The principal submitted that:
- the contractor had a continuing obligation to comply with clause 5 of the contract in the provision of security, the purpose of which, as expressly stated in clause 5.1, is to secure the benefit of the principal to the due and proper performance of the contract by the contractor
- the contractor was in breach of its obligations under clause 5.3 of the contract as a result of the bank guarantees containing the expiry dates.
The contractor submitted that as the principal had not objected to the two original bank guarantees with expiry dates when they were provided, it had impliedly approved them with the consequence that the contractor had complied with its obligations under the contract and was not required to provide further security after the bank guarantees expired. The contractor submitted that:
- pursuant to the second paragraph of clause 5.3, the principal had the discretion to approve the form of security provided, and upon receipt of the bank guarantees did not object to the fact that they contained an expiry date
- pursuant to clause 20.3 of the contract, the principal was not liable to pay any amounts included in a payment claim that was submitted in circumstances where the contractor had not provided the principal with approved security for the amount required
- despite the principal’s right under clause 20.3, over the course of the project the contractor submitted payment claims which were paid by the principal without any issue being raised about the adequacy of the bank guarantees
- the principal had therefore impliedly approved the bank guarantees in circumstances analogous to those in PHHH Investments No 2 Pty Ltd v United Commercial Projects Pty Ltd [No 2]  VSC 92 (PHHH Investments), where Riordan J held that the owner had approved the bank guarantees that had been provided with expiry dates and that the builder had complied with its obligation to provide unconditional guarantees
- the contractor’s obligation to provide the security is a once-off obligation, supported by the fact that pursuant to clause 44.2 of the contract, a failure lodge security in breach of clause 5 is a substantial breach of the contract.
The contractor’s case therefore centred on implied approval by the principal. The principal rejected the contractor’s submissions submitting that there is no scope for an implied approval where the contract provides expressly:
- in clause 20.5(iii) that any payment of moneys by the principal is not approval by the principal of the contractor’s performance or compliance with the contract
- in clause 48 that any variation, waiver, release or discharge of the terms of the contract must be with the prior written consent of the principal.
Justice Mullins preferred to treat the issue as the question of whether there had been a once and for all breach or a continuing breach of clause 5.3, and determined that the situation was analogous to that in Larking v Great Western (Nepean) Gravel Ltd (in liq)  64 CLR 221 (Larking), which concerned an obligation of a party under a licence agreement to erect fences and a gate by an unspecified time. In that case, Stark J at 230 identified the question for consideration as whether the covenants to erect the fences and the gate could only be breached “once and for all” or whether a breach of each covenant was of a continuing nature. Stark J at 231 found that the relevant terms of the licence agreement pointed to “an obligation that should be performed completely and effectively within a limited time, which as the agreement is silent, is within a reasonable time having regard to all the circumstances of the case.”
Justice Mullins held that the obligation to provide bank guarantees in the amount and in the form that complied with clauses 5.2 and 5.3 of the contract was a once and for all obligation, and that unless the principal approved the bank guarantees with expiry dates, the contractor failed to perform fully its obligations under clauses 5.2 and 5.3 of the general conditions when it provided the bank guarantees with expiry dates.
However, while the question for consideration in CCIG v Amicus was held to be that posed in Larking, the outcome was not. In Larking, the owner knew that the fences and gate had not been erected but allowed the operations under the licence to continue. The High Court held that in those circumstances, the owner affirmed the agreement and waived his right to determine it for the breach by the company to whom the licence had been granted. No such waiver was found to have occurred in CCIG v Amicus in circumstances where the contract included such provisions as clauses 48 and 20.5(iii), which Mullins J held (at ):
- are directed at ensuring that the principal retains full control over what departures from the performance by the contractor of the obligations under the contract have effect between the parties and the action taken by the principal in response
- overcome the possibility of the principal waiving a breach of a once and for all obligation by continuing to treat the contract as subsisting.
Mullins J distinguished PHHH Investments because the contract in that case did not include a provision like clause 20.5(iii) and because approval of the bank guarantees in that case could be inferred in circumstances where:
- the owner had initially rejected the bank guarantees for reasons other than the fact that they had an expiry date
- upon being given revised guarantees that still contained expiry dates, the owner paid the builder an outstanding progress claim which it had been entitled to withhold until it approved the guarantees.
In CCIG v Amicus, the principal’s silence relied upon by the contractor as implied approval, was held to be unclear in the context of the terms of the contract. Further, in the absence of implied approval, it was held that the fact that the defects liability period had commenced did not make it too late for the principal to seek to enforce the contractor’s obligation under clause 5.2 and 5.3 of the contract.
Security under a contract operates as a risk allocation device between parties until any disputes are finally determined. This position would have been undermined had the contractor in CCIG v Amicus been successful. However, the decision does not explicitly address the situation where a bank guarantee has been provided and approved under a contract (and there is therefore no breach by the contractor at the time of initially providing the security), but the financial institution giving the bank guarantee in the principal’s favour subsequently goes insolvent. Will the contractor be in breach if it does not provide a replacement bank guarantee from a solvent financial institution within a reasonable time? On the basis that the court in CCIG v Amicus did not treat the issue as a “once and for all obligation”, but rather as a “once and for all breach of an obligation”, it is arguable in the author’s opinion, that a breach will arise upon the failure of a contractor in those circumstances to provide replacement security within a reasonable time following the insolvency of the financial institution.
If it were not the case, no principal would ever accept security other than in the form of cash to avoid the risk of insolvency. However, this will likely turn on the specific drafting of the clauses requiring the provision of the security. Principals will arguably have greater certainty if the contract contains an express term that allows the principal to revoke an earlier approval given by the principal of the security provided and expressly requires the contractor to provide replacement security in a form acceptable to the principal, where directed by the principal.
Following the decision in CCIG v Amicus, it is also important for all principals or head contractors to ensure that their contracts contain provisions akin to clauses 20.5(iii) and 48, to avoid falling into the trap of impliedly approving bank guarantees or other forms of security that contain limitations such as an expiry date where such is not expressly permitted under the contract. Contractors should also beware of the fact that where they provide a guarantee with an expiry date and the contract does not explicitly allow for this, unless they obtain approval from the principal they will be in breach of the contract, and potentially in substantial breach giving the principal an entitlement to terminate the contract.
- This article was originally published in the October 2019 Australian Construction Law Bulletin.