Article

Factual Summary: The agreement between contractor and subcontractor to install pond liners and leak detection systems in a water treatment plant project required Subcontractor to provide two bank guarantees totaling AUD 1,121,146.33 in favor of Contractor. The subcontract agreement was within the scope of the BCIP and Subcontractor claimed that payment was due pursuant to the Act. The adjudicator under the BCIP awarded Subcontractor AUD 4,019,863.73 plus interest and 75% of costs, which Contractor paid. Contractor then commenced these new judicial proceedings, seeking a declaration voiding the adjudicator’s decision, but the next day it discontinued the proceedings. Shortly after, Contractor wrote to Subcontractor summarizing both recovery and liquidated damages claims and giving notice of its intention to call on the bank guarantees due to overpayments to Subcontractor. Subcontractor applied for an interlocutory injunction to prevent Contractor from drawing on the bank guarantees. The Judge denied the application for injunctive relief.

Legal Analysis:

1. Bank Guarantee as Risk Shifting Mechanism

Subcontractor argued that Contractor’s claim on the bank guarantee was not within the terms of the contract. The Judge ruled it was clear from the language of the agreement that the bank guarantees were a “risk allocation device as to which party should be out of pocket pending the resolution of a dispute.” As such, the Judge ruled that it was not unconscionable for Contractor to draw on the bank guarantee while litigation regarding a dispute was pending. He stated that this was just the sort of risk that could be contemplated when requiring a bank guarantee.

2. Injunction, Factors

The Judge noted that to determine if an injunction should be entered, he would have to consider whether the Subcontractor advanced a prima facie case and whether the balance of convenience favored the grant of injunction. The Judge ruled that there was not a prima facie case advanced by Subcontractor because the contract allowed for Contractor’s damages claims to be paid by the bank guarantees, recourse to the bank guarantees did not change the effect of the BCIP adjudication, it was not unconscionable for Contractor to have recourse to the bank guarantees, and Contractor’s recourse to the bank guarantees was not in bad faith.

Subcontractor argued that the balance of convenience should favor granting an injunction because its parent company is publicly traded and would have to report the call on the bank guarantees. This report might cause stock prices to fall, the effect of which would be mainly felt by the shareholders. The Judge noted that even though Subcontractor and its parent company were separate legal entities, it would take that into consideration. The Judge also stated that he believed the most important purpose of the bank guarantees was to provide Contractor with the benefit of the monies, even if a court later ordered the repayment of them. The Judge ruled that the balance of convenience did not favor granting an injunction because it would undermine the primary purpose of the bank guarantees.

3. Attempt to Improperly Avoid Statute

Subcontractor argued that Contractor’s claim on the bank guarantees immediately after making payment due to an adjudicator’s decision was an attempt to improperly avoid the BCIP statutory scheme. While admitting that Contractor had the right to appeal the decision and recover the monies paid, Subcontractor argued that the BCIP does not allow parties to avoid the Act by contract which would be the effect if the draw were permitted. Citing cases which ruled that bank guarantees were intended to provide quick payment of disputed claims and thus could be used to cover disputes that could be litigated, the Judge stated that once Contractor made payment pursuant to the adjudicator’s decision “the Act ceases to have any effect on events thereafter and [Subcontractor’s] rights under the Subcontract Agreement are expressly preserved by s 100(1) of the Act.” The Judge ruled that Contractor did not improperly avoid the statute.

TERMS OF CONTRACT REGARDING PROVISION OF BANK GUARANTEES:

The opinion contained excerpts from the contract providing for bank guarantees at paragraphs 8 and 15.

6. Retention

6.1 Amount and time for Provision

The Contractor will be entitled to retain from any payment made under the Subcontract or otherwise, the percentage stated in Item 12 of Schedule 1 of the Subcontract. The Contractor may accept the provision by the Subcontractor of Bank Guarantees in lieu of retention for the amount stated in Item 12 of Schedule 1 of the Subcontract. Without limiting the Contractor's discretion to approve the terms of a Bank Guarantee not provided in the form set out in Schedule 8, if the Subcontractor provides a Bank Guarantee that has an expiry date, the Subcontractor must replace the Bank Guarantee with another Bank Guarantee on the same terms no later than 45 days before its expiry. If the Subcontractor fails to replace a Bank Guarantee no later than 45 days before its expiry, the Contractor may convert the Bank Guarantee to cash.

6.2 Recourse to Bank Guarantees and Retention

The Contractor may have recourse to the Bank Guarantees or any sum retained pursuant to the preceding clause whenever the Contractor claims to be entitled to claim the payment of monies by the Subcontractor.

6.3 Release of Bank Guarantees

Subject to clause 6.5, within 10 working days after the later of the Date of Substantial Completion and date of Practical Completion for the whole of the Head Contract Works, the Contractor will release the percentage stated in Item 13 of Schedule 1 of the Bank Guarantees then held. The Contractor will release the balance promptly once the Subcontractor's obligations are complete and the Defects Liability Period has expired.

6.4 Release of Retention

Subject to clause 6.5, within 10 working days after the later of the Date of Substantial Completion and the date of Practical Completion for the whole of the Head Contract Works, the Contractor will release the percentage stated in Item 14 of Schedule 1 of any amount then held which has been retained under clause 6.1. Subject to clause 6.5, within 10 working days after the Contractor's Representative issues a Final Certificate under clause 14.16, the Contractor will release the balance of any amount held which has been retained under clause 6.1.

6.5 Unsatisfied Claims

If, at any time when the Contractor is required to release Bank Guarantees or retention money to the Subcontractor, the Contractor considers it has any unpaid moneys due or unsatisfied claims against the Subcontractor, the Contractor shall only be obliged to release the Bank Guarantee or retention moneys to the extent that the aggregate of the Bank Guarantee and the retention moneys exceeds the aggregate of:

(a) the amount the Contractor is otherwise still entitled to retain under the Subcontract; and

(b) the amount of the Contractor's unpaid moneys due and unsatisfied claims,

but the Contractor shall release the excess amount of Bank Guarantee and/or retention moneys held under this clause (if any), within 10 working days of the unpaid moneys due and unsatisfied claims being paid or satisfied.

“Under cl 6.2 of the Subcontract Agreement, the Contractor is entitled to have recourse to the Bank Guarantees whenever it claims to be entitled to claim the payment of monies by the Subcontractor.”

TERMS OF BANK GUARANTEES:

The opinion excerpts from the contract that contained the form of the bank guarantees.

“The Bank Guarantees were provided in accordance with the form set out in Schedule 8. They are in wide terms. For example, clauses 1 and 2 in each guarantee are as follows:

‘1. In consideration of the Beneficiary agreeing at the request of the Customer and the Bank to accept this guarantee in connection with the Agreement, the Bank undertakes to pay the Beneficiary an amount or amounts not exceeding the Amount in total.

2. Payment of the Amount or any part or parts of the Amount will be made by the Bank to the Beneficiary:

a) upon the Bank receiving at any NAB branch located within Australia while this guarantee remains in force an unconditional written demand from the Beneficiary accompanied by this guarantee; and

b) whether or not the Bank gives prior notice of the payment to the Customer; and

c) despite any notice given to the Bank by the Customer not to pay to the Beneficiary any moneys payable under this guarantee; and

d) irrespective of the performance or nonperformance by the Customer or the Beneficiary of the Agreement in any respect; and

e) with no obligation on the Bank to enquire as to the performance or non-performance of the Agreement in any respect by the customer or Beneficiary; and

f) with no obligation on the Bank to enquire as to the correctness or validity of any demand pursuant to subclause 2(a) of this clause;

g) at the Bank's election in cash, bank cheque or funds transfer into the beneficiary's nominated account.’”

Comment: “Risk Shifting Device”. The parties relied on a troublesome distinction in Clough Engineering Limited v Oil and Natural Gas Corporation Limited, [2008] FCAFC 136, summarized at 2009 Annual Review of International Banking Law & Practice 410. Using this distinction, the parties disputed whether the bank guarantee “acts as the provision of security and not as a risk allocation device as to which party should be out of pocket pending the resolution of a dispute.” The Judge stated that “it is even plainer in this case that the Bank Guarantees are a risk allocation device as to which party should be out of pocket pending the resolution of the dispute.”

Except for recourse to the tortured line of cases in wake of Clough, it is difficult to understand this distinction, much less its significance. Apparently, it stands for the proposition that if the bank guarantee is only a security and not a “risk shifting device”, presentations on it can be enjoined more readily. By their nature, independent undertakings necessarily shift the risk of who holds the funds pending resolution of any underlying dispute. They can also serve as security, but not necessarily. If the question is whether or not they are independent, the Clough distinction is a bizarre way of making that determination.

[ZTS]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.