Article

Factual Summary: After tenders, Owner awarded Contractor a construction contract for engineering, procurement, installation and commissioning contract for the development of certain oil and gas fields in the Krishna Godavari basin off the coast of India, for US$215,351,156.33. At the request of Contractor/ Applicant, banks issued performance guarantees pursuant to the terms of the contract.

The overall project also included certain drilling and well-completion work, both in the shallow water field and in the deep water field. This work was not within the scope of Contractor's obligation. Owner was to carry out the drilling and well-completion work itself before Contractor could complete its offshore work. Owner had not effected well-completion which delayed the project's completion.

The contract contained certain provisions for liquidated damages, as a genuine pre-estimate of damage rather than a prohibited penalty, to apply if completion was delayed beyond 15 April 2006. As a result of delay by Owner, on Contractor's request, the agreement was extended until 13 April 2007. Owner delayed further. Contractor sought further extension, and Owner said that it provisionally extended the completion date to 30 April 2008, but no agreement between concerning the potential application of liquidated damages to any delays occurring after 13 April 2007 or 30 April 2008.

Contractor made various claims on Owner, including for delay costs, in the total sum of about US$125m. Owner has rejected these claims.

By letters of 29 January 2007 and 8 February 2007, Owner threatened to call on the performance guarantees. The application for injunctive relief was brought ex parte. Owner in fact drew on the performance guarantees shortly before the matter came before the Court.

Action

The court had previously on 5 June 2007 made interim interlocutory injunctive orders restraining each of the three respondent banks from making payment to Owner under their respective performance guarantees.

The declaratory relief sought was that the contract and subsequent events which happened, Owner by demanding and threatening to make a demand on the performance guarantees granted by the second, third and fourth respondents amounted to unconscionable conduct in contravention of § 51AA of the Trade Practices Act 1974 (Cth) (the Act).

Reasons

Contractor sought injunctive relief to enjoin Owner from serving demand under the performance guarantees. This relief was claimed in futuro even though demand had already been made in respect of each of these.

Gilmore J stated "Even though the performance guarantees are given in favour of [Owner] by the banks, and even though [Contractor] is a third party to the banks' promise to pay, (item 3 of the agreement) is in my opinion wide enough to cover [Contractor's] claim to enjoin conduct in relation to the performance guarantees". (para 30)

The threshold required at this interim level was "that a prima facie case is made out". Gilmore J regarded Owner as "arguably be in breach of the contract and acting contrary to the express terms of the performance guarantees and acting unconscionably, in contravention of § 51AA of the Act, if it were to take further steps in making demands or obtaining payment under the performance guarantees". (para 37)

The contract provided that Contractor was requested to furnish an unconditional Performance Guarantee for the performance of the contract, for a sum equivalent to 10% of the contract price and if the reason for delayed completion of the works was attributable to Owner, then Owner would bear the cost of procuring the extension of the term of the Performance Guarantee. Accordingly, Contractor submitted that Owner only has the right to call on the Performance Guarantee in circumstances which did not include Owner's delay.

Gilmore J stated there is clear authority for the propositions that:

(1) a bank is required to pay on demand under an unconditional performance guarantee or bond: citing Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] 1 QB 159; Esal (Commodities) Ltd v Oriental Credit Ltd [1985] 2 Lloyd's Rep 546; IE Contractors Ltd v Lloyds Bank plc [1990] 2 Lloyd's Rep 496; Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443; Hortico (Aust) Pty Ltd v Energy Equipment Co (Aust) Pty Ltd [1985] 1 NSWLR 545.

(2) a contractor cannot, therefore, obtain an injunction to restrain payment under an unconditional performance guarantee or bond without generally showing or pointing to fraud: citing Bolivinter Oil SA v Chase Manhattan Bank NA [1984] 1 WLR 392, 393; Themehelp Ltd v West [1996] QB 84; Solo Industries UK Ltd v Canara Bank [2001] 1 WLR 1800.

However, Gilmore J stated that it is always, first, a matter of construing the relevant performance guarantee to determine whether it does indeed create an unconditional or conditional obligation. Questionably Gilmore J states: "If the entitlement to call on the performance guarantee is conditioned by the terms of the contract, it cannot be called unless the condition is met, and an injunction restraining an incorrect call may be obtained". (para 65) His honour does not address the terms in which the three guarantees were issued, nor the bank's obligations. His honour stated: "Suggestions that performance guarantees or bonds should be treated as 'good as cash' should not, therefore be regarded as conveying some proposition of general legal application. The question remains, fundamentally, what was the intention of the parties, on the proper construction of the relevant contract." (para 68) His honour then concluded that as the conditions were not satisfied, Owner may not make a call under the performance guarantees, and should be enjoined from taking any further steps to demand or obtain payment.

Unconscionability

Section 51AA of the Act provides that a corporation must not, in trade or commerce, engage in conduct that is unconscionable within the meaning of the unwritten law.

Gilmore J referred to the equity jurisdiction stating that equity has traditionally exercised its jurisdiction to curtail an exercise of a right to terminate if that right is sought to be used arbitrarily, or capriciously or unreasonably or in bad faith. Because the issue as to the width of § 51AA has been left open by parliament and because equity has traditionally protected against unconscionable conduct, s 51AA "does extend to cover this sort of unconscionability".

The claimed unconscionable conduct was:

(a) Owner is itself in breach of the contract by failing to effect well-completion and by failing to pay some US $7 million;

(b) the works are 83% complete and Contractor has only been paid 65% of the original contract price;

(c) Contractor cannot complete the offshore work in the manner it was agreed;

(d) Contractor has offered to do the shallow water work for extra cost but Owner neither accepted this proposal nor directed that the shallow water work should be done in any event, and that the parties could resolve price later.

Gilmore J concluded that he was "satisfied" that it is arguable that there has been an improper exercise of power by Owner to take advantage of the banks' propensity to pay, despite, again arguably, there being no right to call on the performance guarantees, amounting to unconscionable conduct.

Gilmore J added that the balance of convenience favours the grant of an injunction because Contractor will be irreparably affected financially and through an adverse impact on its reputation. Conversely, his honour added that because the performance guarantees will remain intact for valid calls Owner will not suffer irreparable loss by the grant of an injunction.

Comments:

1. Interlocutory ex parte application:

This was an interlocutory ex parte application. The matter subsequently came before the court again for further argument.

2. Condictional:

Gilmore J examined the underlying contract and construed it as containing conditions upon which the performance guarantees may be called and held that these impacted the performance guarantees. However Gilmore J did not address the terms of the actual guarantee issued nor the rights and obligations of the banks.

3. Unconscionability:

This is another Australian case which accepts the concept that unconscionable conduct is sufficient to found an injunction restraining acclaim by the beneficiary. Gilmore J only examined unconscionability in equity and under general principles. His honour did not analyse or consider pre-existing cases relating to letter of credit or guarantees to reach his conclusion. Gilmore J made no attempt to discuss or analyse the principle of autonomy on which performance guarantees rests.

Comments by DCW:

This decision relies on an Australian statute as a basis for enjoining payment on an LC on the basis of unconscionability. Unconscionability is a doctrine applicable to contracts and consumer law. It draws on the inherent power of equity to intervene in situations which shock the conscience of the court. This doctrine has no place in letters of credit or similar independent undertakings issued by major institutions to other institutions or persons who are engaged in serious transactions in trade and finance. Only were consumers to be involved, not the situation in this case, would unconscionability have a potential role. For a court to apply the doctrine of unconscionability, it would have to weigh issues of fairness, balance, and other equitable considerations, matters within the bargaining power of the parties.

It has long been accepted that the only basis for interfering with the obligation of the issuer of an independent undertaking is letter of credit fraud, that is forgery or fraud that is so serious as to vitiate the underlying transaction or where there is simply no colorable basis on which a claim can be made. Short of these requirements, judicial interference would undo the independence of the letter of credit and expose beneficiaries to actions by applicants in every situation where a drawing was challenged due to a dispute in the underlying transaction. While some of these cases would not yield injunctive relief, the resulting delay and expense would provide the applicant/principal with a tactical advantage.

Interestingly, the Contractor decision does provide a basis for injunctive relief predicated on traditional LC principles, namely that the drawing is the result of an action caused by the beneficiary itself. Known as abus de droit, injunctive relief is appropriate where it is the beneficiary itself that by its misconduct sets into motion the train of events which permits it to draw on the LC. Although the doctrinal origins of this aspect of LC fraud have not been explored, most courts have assumed that such an action is fraudulent even where the beneficiary's action constitutes a breach of contract and not fraud with respect to the underlying transaction. This assumption is proper since improper actions that trigger the drawing are the functional equivalent of LC fraud and should be subject to judicial oversight. There is a difference between drawing despite beneficiary breach of the underlying contract being fraud and an action in breaching the contract which provides an excuse for drawing on the LC. The court in Contractor could have drawn on this doctrine of LC fraud to justify its ruling rather than relying on the notion of unconscionability, an approach that will undermine the reputation of Australian independent undertakings

* Dr Alan DAVIDSON is a Professor at the TC Beirne School of Law, University of Queensland

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