Chapter 7 Calling on security

A party may have access to the security where the contract and the terms of the security allow for that to occur. Access to security may either be unconditional or conditional.

Even though security provided may be unconditional, there are often restrictions in contracts which may prevent or restrict the ability to call on the security.

EXAMPLE

AS 2124 clause 5.5

A party may have recourse to retention moneys and/or cash security and/or may convert into money security that does not consist of money where:

(a) the party has become entitled to exercise a right under the Contract in respect of the retention moneys and/or security; and

(b) the party has given the other party notice in writing for the period stated in the Annexure, or if no period is stated, five days of the party’s intention to have recourse to the retention moneys and/or cash security and/or to convert the security; and

(c) the period stated in the Annexure if no period is stated, five days has or have elapsed since the notice was given.

In the example of a conditional security set out above, there are three conditions that must be satisfied before a call can be made on the security: firstly, the principal has an entitlement to do so, secondly, notice has been given, and finally, that the notice period has elapsed.

Importantly, if the contract requires a principal to show an ‘entitlement’, and not just a ‘claim’, to be paid by the contractor, no call on the security can be made until the entitlement has been established.

If the contractor wishes to prevent the principal from calling on the security, it may bring court proceedings seeking an injunction to restrain the principal. It is also possible (but much more difficult) to obtain a ‘mandatory’ injunction, which in circumstances such as these might be sought to require a principal who has already made a demand and received payment to place the money obtained into a separate bank account.

It is generally difficult to obtain court orders granting an injunction stopping the security from being called unless:

  • there is a serious question to be tried as to whether the principal has a right to call on the security;
  • damages would not be an adequate remedy if the security is called; and
  • the ‘balance of convenience’ favours leaving the security intact until the dispute is resolved.

The starting point is that the beneficiary of an unconditional security should have a right to call on the security because the security should be ‘as good as cash’ and the beneficiary should not be deprived of its ‘commercial currency’ (Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443).

Very clear words are needed to stop a beneficiary from calling on a performance guarantee where a breach of contract has been alleged (Clough Engineering v Oil and Natural Gas Corporation Limited [2008] FCAFC 136).

CASE STUDY

Ceresola TLS AG v Thiess Pty Ltd & John Holland Pty Ltd  [2011] QSC 115

Facts
  • The principal applied for an injunction against the contractors to restrain the contractors from calling on performance security.
  • The principal had contracted to supply the contractors eight tunnel forming machines for use associated with the construction of major infrastructure.
  • The contractors submitted that due to the unconditional nature of the bank guarantee, there was no contractual restriction on the call.
Result
  • The court dismissed the application on the grounds that there was no proper basis for the grant of an injunction.
  • The court held that clear words are required to prevent the beneficiary of an unconditional bank guarantee from calling on that guarantee.
  • The court further held that in the absence of any allegation of fraud or unconscionability, there was no reason on a proper construction of the agreement to deprive the contractors of the opportunity to call on the unconditional bank guarantee.

The approach of different courts has been inconsistent and often contradictory. That is, generally because an injunction is a ‘discretionary’ remedy, and different courts will take different views on what the critical and decisive issues are in the cases before them.

CASE STUDY

Redline Contracting MCC Mining (Western Australia)  [2011] FCA 1337

Facts
  • Under the contract, the contractor was required to construct and install pipelines in Western Australia.
  • A dispute arose between the contractor and the principal, leading to the principal terminating the contract.
  • The principal issued a notice to the contractor claiming costs to rectify allegedly defective works, as well as claims for other debts allegedly owing such as for the cost of re-tendering remaining works.
  • The contract was the standard form AS4902-2000, where clause 5.2 provides: ‘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.‘
  • The form of the security was specified as an unconditional performance bonds.
  • The principal issued a notice of intention to cash the unconditional performance bonds and the contractor applied for an injunction
Result
  • The court refused to grant an injunction.
  • The words ‘remains unpaid after the time for payment‘ did not mean that the debt had to be undisputed or finally determined because an unconditional security should not deprive the principal of its benefit as commercial currency.

Often, the real issue is whether the principal should or should not have access to the security before the dispute between the parties has been resolved. A court may be required to consider not only whether there are any express preconditions to entitle the principal to have recourse to the security, but also any implied preconditions.

CASE STUDY

Kawasaki Heavy Industries Ltd v  Laing O’Rourke Australia Construction Pty Ltd [2017] NSWCA 291

Facts
  • Kawasaki Heavy Industries Ltd (Kawasaki) and Laing O’Rourke Australia Construction Pty Ltd (Lorac) were both subcontractors in a cryogenic tank project with a head contractor.
  • Kawasaki and Lorac entered into a ‘Consortium Agreement’ and Kawasaki agreed to provide the performance bonds on the parties’ behalf, while Lorac provided ‘unconditional’ and ‘irrevocable’ surety bonds to Kawasaki. A dispute arose between JKC and the subcontractors. Kawasaki called the surety bonds against Lorac.
  • Lorac applied for an injunction to restrain Kawasaki.
Result
  • The court granted the injunction.
  • There were serious issues to be tried as to whether Kawasaki was entitled to call upon the performance bonds issued on behalf of Lorac where the head contractor had not made a call upon the Kawasaki bonds. The surety bonds were to provide for a situation where Lorac would be required to reimburse Kawasaki if the head contractor made a call on the performance bonds against it.
  • This was so even where there was a risk that the surety bonds might expire pending determination of the dispute at arbitration.

One important consideration to keep in mind is the operation of the security of payment legislation and whether the release of the security is a voidable ‘pay when paid’ provision.

CASE STUDY

Maxcon Constructions Pty Ltd v Vadasz [2018] HCA 5

Facts
  • The subcontract in question provided:
  • ‘Subject to [Maxcon’s] rights to any deductions made or pending deductions which are likely to be made under the [subcontract], retention shall be released:
    (a) 50% of retention within the time nominated in Schedule E
    (b) Remaining 50% within the time nominated in Schedule E.’
  • Schedule E provided for 50% to be released 90 days after the certificate of occupancy for the project (i.e. head contract works) was achieved, with the remaining 50% released one year after the date of the certificate of occupancy.
  • The subcontractor completed work but the certificate of occupancy had not been issued for the project. Therefore, the head contractor refused to return security.
Result
  • The High Court held that the retention clause in the subcontract was a prohibited ‘pay when paid’ provision under s12(2)(c) the Building and Construction Industry Security of Payment Act 2009 (SA) because the due date for payment of the security was dependent upon the operation of another contract.
  • This was because the release was dependent on the issue of a certificate of occupancy, and this certificate could not be issued until completion of the whole project, in accordance with the head contract.
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