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Note: RCR O’Donnell Griffin Pty Ltd (Subcontractor/Applicant) entered into a Subcontract with Forge Group Power Pty Ltd (Contractor/Beneficiary) to perform electrical work in connection with Contractor/Beneficiary’s construction of a power station. Under the terms of the Subcontract, to secure the performance of the electrical work, Subcontractor/Applicant was to provide “two unconditional bank guarantees” in favor of Contractor/Beneficiary, each in the amount of AUD 2,238,345.45 issued by “a first class registered bank or financial institution approved by [Contractor/Beneficiary].” The guarantees were issued, and expired on 3 June 2014 and 16 July 2016.

During Subcontractor/Applicant’s performance of the Subcontract, Contractor/Beneficiary became insolvent. The parties then entered into a Deed of Novation on 22 April 2014 (Novation Date) which superseded the Subcontract and provided that Contractor/Beneficiary would “return or cancel” the guarantees within 30 days from the Novation Date, unless it “considered that it may have a claim against [Subcontractor/Applicant] or [Contractor/Beneficiary] believed that [Subcontractor/Applicant] would pursue a claim against it.”

Subsequently, Contractor/Beneficiary did not return the guarantees and claimed liquidated damages of AUD 2,588,068.20 for delay in work performance, informing Subcontractor/Applicant of its intention to draw on the 2014 guarantee in order to “hold it as cash security, pending the resolution of issues.” Subcontractor/Applicant then applied for an interim injunction to enjoin the drawing. Subsequently, Beneficiary/Contractor agreed not to draw on the guarantees until 10 July 2016 and Subcontractor/Applicant agreed to have the 2014 guarantee extended.

In 2015, Subcontractor/Applicant sued Contractor/Beneficiary and its receivers for a declaration that Contractor/Beneficiary was not entitled to draw on either guarantee. The Supreme Court at Brisbane concluded that a drawing was proper. On appeal in 2016, the Supreme Court of Queensland reversed in opinions of McMurdo, JA., and Applegarth, J., with a dissent by Morrison, JA..

The appellate court determined that the essential issue was whether Contractor/Beneficiary “had been entitled as against [Subcontractor/Applicant] to demand payment under the guarantees,” concluding that “from and after 22 April 2014, [Contractor/Beneficiary] has not been and is not entitled to call upon or seek to have recourse” to either Guarantee, and therefore set aside the Brisbane court orders.

The Subcontract provided that the guarantees should be “subject to recourse by [Contractor/Beneficiary] where [Contractor/Beneficiary] remains unpaid after the time for payment,” and the Deed of Novation superseding the Subcontract, did not affect “any accrued rights, obligations, claims, or liabilities arising under the Subcontract in connection with the performance of the Subcontract before the Novation Date which [Subcontractor/Applicant] and [Contractor/Beneficiary] may have against each other.” The appellate court determined that the issue was whether there was an accrued right or liability in respect to the liquidated damages, and that “if the existence of a right, obligation, claim or liability depended upon some further performance of the Subcontract, it could not be said to be ‘accrued’ in the relevant sense.”

Subcontractor/Applicant claimed that Contractor/Beneficiary could not draw on the guarantees unless there was money due and payable to Contractor/Beneficiary that remained unpaid, and that the liquidated damages claimed by Contractor/Beneficiary were not due and payable. Contractor/Beneficiary argued that it could draw “without there being, in truth, any amount payable” because its “right of recourse to the security was dependent upon a bona fide claim by [Contractor/Beneficiary], rather than the existence of a debt due to it.” The appellate court determined that the Subcontract did not permit Contractor/Beneficiary to convert the guarantees to cash, and that Contractor/Beneficiary is not entitled to recourse unless “money remained unpaid to [Contractor/Beneficiary].” The court further rejected Contractor/Beneficiary’s construction of the “recourse” clause as “a risk allocation device…pending resolution of the dispute,” because Subcontractor/Applicant sought not an interlocutory injunction but a final determination of Contractor/Beneficiary’s entitlement to draw on the guarantees.

Comment: Applicant’s strategy is another blow to the independence of the Australian “guarantee,” if, indeed, it was independent. To consider whether Beneficiary was entitled to draw on an independent undertaking requires construction of the underlying contract and the facts surrounding the drawing. This process delays payment, rendering the guarantee dependent. The only analysis that a court should entertain regarding an independent guarantee is whether there is letter of credit fraud.

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