Article

Factual Summary: After tenders, ONGC awarded Clough, 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. Performance guarantees were granted by each of the three respondent banks in January 2005 pursuant to the terms of the contract between Clough and ONGC.

Under each performance guarantee the guaranteeing bank undertook to pay immediately on first demand in writing the moneys demanded to the extent of the limit of the guarantee "... on breach of contract by Contractor without any demur, reservation, contest or protest or without any reference to the Contractor." Any demand made by ONGC on the bank by serving a written notice was to be "... conclusive and binding, without any proof on the bank as regards the amount due and payable, notwithstanding any dispute(s) pending before any Court, Tribunal, Arbitrator or any other authority ...".

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 part of Clough's scope. ONGC was to carry out the drilling and well-completion work itself and this had to be carried out before Clough could complete its offshore scope of work. ONGC has not effected wellcompletion which delayed the project's completion.

Gilmore J at first instance rejected Clough's submissions as to the construction of the Contract. He also found that ONGC did not engage in unconscionable conduct by invoking the performance guarantees. His conclusion, in that respect, did not turn upon whether ONGC was responsible for Clough's breaches. Rather, he held that Clough had breached the Contract in two further important respects relating to the extension of the guarantees and certain insurance policies. In addition, the primary judge considered that the claim for injunctive relief should be rejected on discretionary grounds.

Clough appealed against each of these findings, including the findings of fact that it was in breach of the Contract.

Appeal

The two principal issues on appeal were whether upon the proper construction of the Contract, ONGC was entitled to invoke the performance guarantees and whether a call on the performance guarantees contravened s 51AA of the Trade Practices Act 1974 (Cth) (TPA) on the ground that it was unconscionable within the meaning of the unwritten law of Australia.

(A) Breach of a Negative Stipulation

Clause 3.3.3 "The Company shall have the right under this guarantee to invoke the Banker's guarantee and claim the amount there under [sic] in the event of the Contractor failing to honour any of the commitments entered into under this Contract."

Clough argued that clause 3.3.3 allocated risk to it in the specified circumstances. The clause otherwise provided ONGC with the capacity to have recourse to the banks in the event that Clough was slow to, or unable, or unwilling to pay ONGC where ONGC had established that Clough had failed to honour its commitments. Clough submitted that its construction was in harmony with the proforma performance bank guarantee (see end of this extract) which conditioned a call on "breach" not "asserted or claimed breach".

The question of whether the Contract contains an express or implied negative stipulation which qualified the entitlement of ONGC to call upon the performance guarantee turns upon the proper construction of clause 3.3 of the Contract. Gilmore J held at [53] that upon the proper construction of the clause, ONGC was entitled to call upon the performance guarantees where it had a "bona fide belief" in its claim that Clough was in breach of the Contract.

This was considered by Gilmore J to be "powerful indicator that a mere claimed breach of contract, not fraudulently asserted, was sufficient to trigger an entitlement to call on the guarantees." (54) Gilmore J considered that a commercial object of the performance bank guarantees under the Contract was to allocate the risk of a party being out of pocket pending the resolution of a dispute and that ONGC was entitled to call upon them even where a genuine dispute existed as to whether or not Clough was in breach and whether or not damage had been suffered. (57)

The court Full Court "Performance guarantees play a critical part in international commerce and in international construction contracts, in particular."

The Full Court discussed general principles relevant to the construction of contract provisions relating to performance guarantees.

The Full Court quoted Stephen J in the High Court of Australia in Wood Hall Ltd v The Pipeline Authority (1979) 141 CLR 443 that to introduce a qualification on the entitlement of the owner to call upon the performance guarantees "would be to deprive them of the quality which gives them commercial currency." (At 457) Nevertheless, the Full Court accepted the three exceptions by Austin J in Reed Construction Services Pty Ltd v Kheng Seng (Aust) Pty Ltd (1999) 15 BCL 158 at 164-165: Fraud, Unconscionability within section 51AA TPA and enforcement by injunction of negative stipulations in contracts.

The Full Court stated it may be preferable not to describe this as an exception but rather as an overriding rule because it emphasises that the "primary focus" will always be the proper construction of the contract: Bateman Project Engineering Pty Ltd v Resolute Ltd (2000) 23 WAR 493 per Owen J at [30].

On the issue of constructional principles relating to performance bank guarantees the Full Court cited supporting cases Bachmann Pty Ltd v BHP Power New Zealand Ltd [1999] 1 VR 420 at [28]; Baulderstone Hornibrook Pty Ltd v Qantas Airways Ltd [2000] FCA 672 at [10] and Rejan Constructions Pty Ltd v Manningham Medical Centre Pty Ltd [2002] VSC 579 at [37].

The Full Court considered that in determining whether the underlying contract confers an unfettered right to call upon the performance guarantee, the importance of such instruments in the construction industry, both nationally and internationally, is a factor which bears upon the question of construction of the Contract. The Full Court cited:

(1) In Wood Hall Ltd 141 CLR at 457-458, Stephen J referred to English authority which described the performance guarantee as standing on a similar footing to a letter of credit.

(2) Callaway JA in Fletcher Construction [1998] 3 VR at 827 emphasised the importance of commercial practice in construing the contract.

(3) In Bachmann [1999] 1 VR 420, Brooking JA referred at [51] to "the practice in the United States. He said that the generally accepted view in that country is that standby letters of credit (and hence, performance guarantees) are intended by the parties to the underlying contract to require the supplier or contractor to: '... stand out of the amount of the credit in favour of the buyer pending resolution of the underlying dispute.'"

(4) Hobhouse LJ in Toomey v Eagle Star Insurance Co Ltd [1994] 1 Lloyd's Law Rep 516 at 520.

The Full Court stated that "clear words will be required to support a construction which inhibits a beneficiary from calling on a performance guarantee where a breach is alleged in good faith, ie, nonfraudulently." (83) "The question of construction as to whether the underlying contract contains a qualification on the right to call upon the security must be determined in light of the contract and the form of the performance guarantee as contained in the contract. This accords with the basic principle of construction that the terms of an instrument must be read as a whole."

The Full Court while accepting the exception held that on a proper construction of the Contract, there was no such right, and that the guarantee was properly invoked.

The condition upon which ONGC was entitled to call upon the guarantees was expressly stated in clause 3.3.3. The critical condition was stated to be "in the event of the Contractor (Clough) failing to honour any of the commitments entered into under this Contract". The Full Court stated that these words do not specify events "bona fide believed" to be breaches; they refer to actual failures to perform the Contract.

The Full Court stated that once a demand was made under the performance guarantees the banks were obliged to make payment in accordance with the terms of the security, but that "ONGC's entitlement to call on the guarantees depended upon the terms of the Contract ... it is almost trite to say that the contractual arrangements between the parties must be considered as whole." (91)

The Full Court concluded that upon the proper construction of clause 3.3.3 of the Contract, when read together with the performance guarantee, ONGC was entitled to invoke the guarantee notwithstanding the existence of a dispute between Clough and ONGC as to whether Clough had failed to honour any of its commitments under the Contract.

(B) Unconscionability

Section 51AA of the Trade Practices Act (Cth) provides: A corporation must not, in trade or commerce, engage in conduct that is unconscionable within the meaning of the unwritten law, from time to time, of the States and Territories.

The Full Court without consideration or discussion blindly accepted Austin J's statement in Reed that "the party in whose favour the performance bank guarantee has been given may be enjoined from acting unconscionably in contravention of s 51AA of the TPA. The Full Court cited : Olex Focas Pty Ltd v Skodaexport Co Ltd [1998] 3 VR 380. On this point, different views have been expressed about the reach of s 51AA. The Full Court noted that the High Court has not determined which of these views is correct: Australian Competition and Consumer Commission v CG Berbatis Holdings Pty Ltd (2003) 214 CLR 51 at [44]-[45]. The Full Court held that "in any event, none of the categories of unconscionable conduct recognised in Australian Competition and Consumer Commission v Samton Holdings Pty Ltd (2002) 117 FCR 301 at [48] apply in this case."

The Full Court accepted that a party alleging a contravention of s 51AA must be able to identify conduct which is unconscionable in a sense known to the "unwritten law, from time to time, of the States and Territories". Under the unwritten law, which is the common law of Australia, unconscionable conduct will be such conduct as would support the grant of relief on principles set out in specific equitable doctrines.

Equity does not provide a remedy in respect of conduct in trade or commerce which is, in the opinion of a judge, unfair. It does not apply to unconscionable conduct at large: Australian Broadcasting Corporation v Lenah Game Meats Pty Ltd (2001) 208 CLR 199 at 245 (Gummow and Hayne JJ).

Comments:

The early cases of Clough caused concern for advocates of the independence principle and the integrity of the performance guarantees (and letters of credit) by apparently confirming both the exceptions of a negative express stipulation and Unconscionability under the Australian Trade Practices Act. Both the final decision of Gilmore J and this decision by the Full Court of the Federal Court of Australia apparently accept these exceptions. However, the point obiter dicta in the cases, that is, unnecessary to decide on the facts. Both decisions concluded that on construction on the this contract, there was no negative clause, and there was no Unconscionability within the meaning of the statute. The letter of credit community remains concerned about these developments in the Australian courts. Until the matter is decided on the facts by a Full Court or the High Court of Australia, the issues will remain questionable internationally.

Pro forma for performance guarantee letter

The General Conditions of Contract set out a pro forma for the performance guarantee letter between any relevant bank and ONGC. It was in the following terms:

To: Oil and Natural Gas Corporation Limited 15- E, Maker Towers Cuffe Parade, Colaba, Mumbai - 400 005 (India) Dear Sirs,

1. In consideration of Oil and Natural Gas Corporation Ltd incorporated under the Companies Act 1956 having its registered office at Jeevan Bharati, Tower-II, 124 Indira Chowk, New Delhi - 110 001, India and one of its offices at 15-E, Maker Towers, Cuffe Parade, Mumbai- 400 005 & Rajahmundry Asset situated at Godavari Bhavan, ONGC Base Complex, Rajahmundry - 533 106, AP (hereinafter referred to as "Company" which expression shall unless repugnant to the context or meaning thereof includes all its successors, administrators, executors and assigns) having entered into a Contract No ... dated ... (hereinafter called "The Contract" which expression shall include all the amendments thereto) with M/s ... having its registered/ head office at ... (hereinafter referred to as "The Contractor") which expression shall, unless repugnant to the context or meaning thereof include all its successors, administrators, executors and assigns) and Company having agreed that the Contractor shall furnish to Company a performance guarantee for Indian Rupees/US$... for the faithful performance of the entire Contract.

2. We ... (name of the Bank) registered under the laws of ... (name of the country) having head/ registered office at ... (hereinafter referred to as "the Bank") which expression shall, unless repugnant to the context or meaning thereof include all its successors, administrators, executors and permitted assigns) do hereby guarantee and undertake to pay immediately on first demand in writing and any/all moneys to the extent of Indian Rs/US$... (in figures) (Indian Rupees/US Dollars ...) (in words) on breach of Contract by Contractor without any demur, reservation, contest or protest and/or without any reference to the Contractor. Any such demand made by Company on the Bank by serving a written notice shall be conclusive and binding, without any proof, on the bank as regards the amount due and payable, notwithstanding any dispute(s) pending before any Court, Tribunal, Arbitrator or any other authority and/ or any other matter or things whatsoever, as liability under these presents being absolute and unequivocal. We agree that the guarantee herein contained shall be irrevocable. This guarantee shall not be determined, discharged or affected by the liquidation, winding up, dissolution or insolvency of the Contractor and shall remain valid, binding and operative against the Bank.

Company shall have the unqualified option to operate this bank Guarantee to recover Liquidated Damages as leviable under the Contract.

3. The Bank also agree that Company at its option shall be entitled to enforce this Guarantee against the Bank as a principal debtor, in the first instance, without proceeding against the Contractor and notwithstanding any security or other guarantee that Company may have in relation to the Contractor's liabilities.

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