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Note: In connection with a contract to construct a gas pipeline and related infrastructure, Saipem Australia Pty Ltd (Contractor/Applicant) agreed to provide two “bank guarantees” in favor of GLNG Operations Pty Ltd (Company/Beneficiary), the agent for the owners of the pipeline, the contract required two “original unconditional bank guarantee[s]” each for 5% of the pipeline as security for Contractor/Applicant’s timely performance of Mechanical Completion and Practical Completion.

Clause 5 of the contract set up two bank guarantees, both for 5% of the contract price. Clause 5.5 stated the following:

  1. “Notwithstanding anything else to the contrary in this Contract, the Company may demand, receive and use the proceeds of any Performance Security to recover any Loss suffered or incurred by the Company as a result of Contractor's default under this Contract or to recover any debt due from the Contractor to the Company.
  2. The Company may, in its absolute discretion, call on the whole, or any part, of any Performance Security under clause 5.5(a). If the Company calls on any part of any Performance Security it retains the right, in its absolute discretion, to call on the whole, or any part, of the remainder of that Performance Security.
  3. The contractor covenants with the Company that the Contractor will not institute any proceedings, exercise any right or take any steps to injunct or otherwise restrain:

(1)  the financial institution that issued the Performance Security from paying the Company pursuant to the Performance Security;

(2) the Company from taking any steps for the purpose of making a demand under any Performance Security or receiving payment under any Performance Security, or otherwise exercising its rights under any Performance Security; or

(3) the Company using the money received under any Performance Security,

even where the Contractor disputes the Company's right to payment (including where dispute resolution proceedings have been commenced under this Contract).”

The contract also provided for liquidated damages in the event that the Contractor/Applicant failed to perform by a certain stated deadline for Mechanical and Practical Completion.

When Contractor/Applicant was delayed in performance, Company/Beneficiary set off the claimed liquidated damage claim against amounts owed Contractor/Applicant and demanded payment of the balance of AUD 1,316,103.87 for Mechanical Completion and AUD 11,250,000 for Practical Completion, threatening to draw on the bank guarantees. Contractor/Applicant, however, claimed that it was entitled to an extension of time. Contractor/Applicant sued Company/Beneficiary seeking a declaration that Company/Beneficiary was not entitled to draw on the bank guarantees and an order restraining it from demanding payment on the bank guarantees. The Supreme Court of Queensland, McMurdo, J., granted an interlocutory injunction restraining Company/Beneficiary from drawing on the bank guarantees for 14 days.

Contractor/Applicant argued that (1) clause 5.5 only allowed Company/Beneficiary to recover debt due and liquidated damages are not debts due, (2) s 67J of Queensland Building and Construction Commission Act 1991 prevents a party from using a security where no debt is due, and (3) under s 67J(2), Company/Beneficiary can only draw on the bank guarantee if it gives notice to Contractor/Applicant.

The Judge deferred ruling on the first argument, pending the conclusion of the arbitrator. He rejected Contractor/Applicant’s argument that liquidated damages are not money owed under the regulation. The Judge also noted Contractor/Applicant’s argument that Company/Beneficiary was too late was persuasive with regard to Mechanical Completion but weak regarding Practical Completion. The Judge said that notice had to be given in 28 days once Company/Beneficiary was aware. The court said that notice for Mechanical Completion was outside the 28 days but was within the time period for Practical Completion.

The Judge then considered the balance of convenience, noting that Contractor/Applicant alleged that it would suffer damage to its reputation and credit rating if there was a draw on the bank guarantees. Contractor/Applicant also submitted evidence that it had made large payments in the past to prevent draws on bank guarantees. Although recognizing that there was no proof that Contractor/Applicant would pay, the Judge allowed 14 days in which payment could be made. McMurdo, J., stated “The interest of justice favour that outcome on the Practical Completion claim…they do not favour the the same outcome on the Mechanical Completion claim, where [Contractor/Beneficiary] has demonstrated a strong case for challenging a call upon the guarantees.”

Legal Analysis:

Comment: This decision raises the question of whether the undertaking is independent. While an “unconditional bank guarantee” is not necessarily an independent undertaking, it is usually so treated. However, the Judge ignored a fundamental feature of an independent undertaking, the principle of autonomy, namely that a demand for payment should not be enjoined unless there is fraud. In this opinion, there is no suggestion of fraud. What is involved is a contract dispute. If the undertaking is dependent, there would be no difficulty in granting an injunction on equitable grounds. If it is independent, however, there is great difficulty. Such a decision undermines the nature of letter of credit type undertakings, adding one more blow to Australian bank instruments.

Some of the provisions of the contract are worth noting. It purports to prohibit the party obtaining the bank guarantee from enjoining drawing or paying under it. It is doubtful that such a provision would be enforceable even were the undertaking independent. In any event, the provisions did not prevent the judge from entering an injunction.

[SJD]

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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.