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Factual Summary: Subcontractor contracted with Supplier to provide modular steel for mining project for USD 1-4,329,706.01. Clause 3.1 of the contract required Supplier to provide security acceptable to Subcontractor. Clause 3.2 of the contract stated that the security shall be subject to recourse by the purchaser after Subcontract has given at least 10 days’ notice of its intention to draw on the Guarantees “where 10 days have elapsed since the purchaser has notified the supplier of its intention to recourse subject to the purchaser showing any losses, damages or substantial breaches of [Supplier]'s scope of works as a result of actions by [Supplier].” It also provided that “Recourse to security shall only occur when there are losses & costs due to demonstrated and fully documented defective workmanship by the supplier or money owing due to costs caused by the supplier to the purchaser that fall into the responsibility of the supplier.” The Contract also required that “prior to any recourse to security in relation to defective workmanship the Purchaser must provide the Supplier with documentation which provides for an independent third party assessment of any defect. Such assessment is to detail the nature of the defect, the reasons for responsibility being assigned to the Supplier and an estimated cost to rectify the defect [¶ 6]

Guarantor provided Guarantees. Claiming that Supplier/Applicant failed to provide manufacturer’s data reports, to comply with contract scheduling, supplied materials that contained substantial defects, and wrongfully suspended performance under the contract, Subcontractor/Beneficiary gave notice of its intention to draw on the Guarantees. While the Notice set forth several bases for claiming on the Guarantees, Subcontractor/Beneficiary later relied on the alleged overpayment in the amount of USD 2,489,775.88 which it asserted that it was “entitled to reconcile in respect of the account which details have previously been provided to [Supplier/Applicant]” [¶13] as the basis for its drawing.

Having received this Notice, Supplier/Applicant applied for an ex parte interlocutory injunction, which was granted. At a subsequent hearing for continuance of the injunction, the court granted the continuance.

Legal Analysis:

Overpayment. Samsung argued that they had overpayments in the sum of USD 2,489,775.88, which provided a basis for calling on the security, and requested the injunction be lifted. Since the parties were unable to explain the significance or meaning of the provision in the notice regarding reconciliation, the Judge ruled that “the reference to overpayment should be construed as being a claim to an entitlement to a refund of the amount overpaid.” [¶15]

Injunction. The Judge summarized the exceptions under which an “unconditional obligation” could be enjoined. They were fraud by the beneficiary, “unconscionability in contravention of trade practices legislation”, and breach of a contractual promise not to call upon the undertaking. [¶ 22] The Judge explained that the latter ground would permit a court to issue an injunction to enforce negative stipulations in the contract. Under this line of decisions developing this exception, the Judge explained that no injunction should issue if a) the clause in the contract is “designed to allocate risk between parties as to who shall be out of pocket pending resolution of the dispute between them” [¶ 26] and b) if Subcontractor/Beneficiary has complied with the requirements of the contract regarding notice and when a drawing is permitted. On the other hand, the Judge stated that if Supplier/Applicant “has established a serious question to be tried as to whether Samsung has complied with cl 3.2, then, because cl 3.2 contains, in effect, a promise not to exercise the security without fulfilling the specified requirements, it is open to grant an injunction restraining recourse to the security.” [¶27]

Construction of the Contract. Subcontractor/Beneficiary agreed that the contract contained a promise not to call on the Guarantees if the conditions contained in Clause 3.2 were not met. The issues addressed by the court were: i) whether the contract requires that the notice demonstrate the losses claimed; ii) whether the overpayment constitutes a loss for purposes of the clause regarding when a drawing may be made; iii) whether a claim that money is owed must be demonstrated and fully documented; iv) whether a claim for refund of overpayments was money owing under the contract clause; and v) whether the clause is designed to allocate risk in the event of a dispute.

Noting that the contract clause is “poorly drafted”, the Judge indicated that it contained two limitations on the right to draw, that there must be 10 days; notice and that the Subcontractor/Beneficiary must “’show’ the losses, damages or breaches which provide the foundation for recourse to the security.” [¶33] The Judge accepted Supplier/Applicant’s interpretation that “the purpose of the requirement for 10 days' notice is to enable it to consider its position in light of the claim being made against it.” [Id.]

The Judge ruled that overpayments constituted the type of losses covered and constituted money owing under the contract clause. The Judge also ruled that a claim for money owing need not be demonstrated and fully documented under the better construction of the contract clause and that proof that the requirements of the contract clause have been met would defeat a request for an injunction.

Subcontractor/Beneficiary argued that a letter sent 21 days after the notice met the requirement that it show its losses. Since the Judge had ruled that the notice must show the losses, it followed that there existed a basis for granting an injunction.

Balance of Convenience; Irreparable Harm

Having concluded that there was a basis for an injunction, the Judge inquired whether there was an equitable basis. Supplier/Applicant asserted that it would suffer irreparable harm “in its standing with its bankers, to its commercial reputation and in relation to a proposal for it to proceed to a public listing.” [¶50] The Judge stated that there things “are consequences which Best Tech has accepted by agreeing to the provision of the security in the Contract” [¶53] but nonetheless concluded that the balance of convenience favored continuation of the injunction since the drawing prevented Supplier/Applicant “from enjoying its contractual entitlement” [¶61] However, the Judge narrowed the scope of the injunction, permitting Subcontractor/Beneficiary to give notice of intended drawing on the basis of overpayments and to draw on the Guarantees subsequently on this basis.

Comments:

This opinion leaves one to wonder why anyone would take a guarantee under Australian law. The entire analysis was on the terms of the contract and not the guarantee. Were it dependent, that approach would make sense. Since it appears that the court regards it as independent, the question remains as to why we are looking at the contract to determine compliance.

A simple solution would be to insert the text of any notices in the contract and to insert the text of drawing documents in the independent undertaking. Another sensible option would be to use a standby letter of credit, ideally subject to ISP98. There is possibility that such an undertaking would not be tainted by this line of case law, particularly were it subject to another legal system, such as Singapore, with exclusive jurisdiction in that forum.

EXCERPTS FROM TEXT OF GUARANTEES:

The Undertaking. At the request of the Supplier and in consideration of the Purchaser accepting this undertaking by way of security to the Purchaser for the performance by the Supplier of its obligations under the Agreement, the Bank undertakes unconditionally and irrevocably to pay the Purchaser on demand any sum or sums which may from time to time be demanded by the Purchaser to a maximum aggregate of the Amount. . [¶ 8]

By cl 4(b) of the undertaking, the bank acknowledges that its obligations constitute direct primary, irrevocable and unconditional obligations. [¶ 9]

Excerpts from TEXT OF CONTRACT:

Clauses 3.1 and 3.2 of the Contract provides:

“3.1 Provision

Security shall be provided by the Supplier to Purchaser in accordance with Item 12.

The Purchaser shall have a discretion to approve or disapprove of the form of security and the financial institution giving it.

3.2 Recourse

(a) Security shall be subject to recourse by the Purchaser where at least 10 days have elapsed since the Purchaser notified the Supplier of its intention to have recourse subject to the purchaser showing any losses, damages or substantial breaches of BTE's scope of works as a result of actions by BTE. If the Purchaser converts any security into money in accordance with this clause and it is subsequently determined that the relevant amount was not payable by the Supplier under or in respect of the Subcontract then:

(i) the Purchaser must pay back the relevant amount to the Supplier;

(ii) the Purchaser must pay an amount to the Supplier that is calculated by multiplying the relevant amount by the percentage rate of 1% above the current LIBOR;

(iii) costs, fees or charges incurred as a result of the security being converted by the Purchaser to a maximum amount of three percent of the converted amount; and

(iv) the Purchaser will have no further liability to the Supplier in relation to the conversion of the security into money.

(b) Recourse to security shall only occur when there are losses & costs due to demonstrated and fully documented defective workmanship by the supplier or money owing due to costs caused by the supplier to the purchaser that fall into the responsibility of the supplier. Not for any losses caused by third party companies or individuals. However prior to any recourse to security in relation to defective workmanship the Purchaser must provide the Supplier with documentation which provides for an independent third party assessment of any defect. Such assessment is to detail the nature of the defect, the reasons for responsibility being assigned to the Supplier and an estimated cost to rectify the defect.”

“Security” is defined to mean either cash, retention moneys, an interest bearing bank deposit, an approved unconditional undertaking or other forms of security approved by Samsung (cl 1). A form of security set out in annexure Part B of the contract is an “approved” unconditional undertaking for the purpose of the definition of “security”. It is that form of security which was provided by Best Tech to Samsung in compliance with the requirement in cl 3.1.

Excerpts from TEXT OF NOTICE:

“The Purchaser refers to previous correspondence herein and notes that the Supplier is in breach of the Supply Contract as follows:—

1. Has failed to provide MDR's [manufacturers' data reports] in accordance with the Contract or at all. (Costs being estimated)

2. Has failed to comply with the Contract schedules causing the Purchaser loss and damage in respect of Demurrage charges as previously set out.

3. Has failed to comply with the Contract in respect of the supplied materials which have required substantial defect rectification as previously advised to the Supplier.

4. Has wrongfully purported to suspend the Contract and accordingly is in ‘substantial breach’ of clause 25.2(b).

In addition to the above on a re-measurement of the Supply Contract there was a significant overpayment ($2,489,775.88) which the Purchaser is entitled to reconcile in respect of the account which details have previously been provided to the Supplier.

The total costs excluding the defect rectification costs significantly exceed the balance of monies due to the Supplier and the amount of the performance bond held as security.

The Purchaser hereby notifies the Supplier that it will have recourse to the Security on demand Bond at the expiration of 10 days from receipt by the Supplier of this letter. Please note that this is a formal notification pursuant to clause 3.2 of the Supply Contract. Please note further that for the purposes of the bond call the Purchaser is not reliant on the defect rectification costs and accordingly is not required to comply with clause 3.2(b). In addition to the bond call the Purchaser will refer all outstanding matters to dispute under the Contract.

Finally, the Purchaser would advise that, strictly without prejudice to the above position, if the Supplier complies fully with its obligations to provide MDR's prior to the expiration of the notice then the Purchaser will postpone a bond call and enter discussions with a view to resolving any outstanding issues.”

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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.