Australia: Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98: Accss to security
Construction Law Update - October 2015

KEYWORDS: CALLING ON SECURITY

KEY TAKEAWAY

The case reaffirms the established Australian common law principles that were previously summarised in the Clough decision, namely that a principal's right of recourse to a contractor's bank guarantee securing a genuine claim under a construction contract will not be restrained unless:

• the principal has fraudulently sought to have recourse against the bank guarantee;
• the principal has acted unconscionably under the Australian Consumer Law in seeking to have recourse to the bank guarantee; or
• the parties have contractually agreed that the principal will only be entitled to access the bank guarantee in particular circumstances, and the relevant circumstances fall outside
• that agreement.⁴⁴

Significantly, the Court of Appeal made it clear that it is incumbent on courts in determining interim injunction applications such as this to interpret the provisions that deal with accessing bank guarantees or other security, rather than deferring any such decision to the trial of the underlying disputes. This is particularly required where the purpose of the security is to allocate risk between the parties while the underlying dispute is finally determined. Failure by courts to interpret the provisions will deny the parties of the principal benefit of those provisions.

The facts

In 2007, Lend Lease Services Pty Ltd (Lend Lease) agreed to design, construct, supply and install a new refined sugar plant for Sugar Australia Pty Ltd (Sugar).⁴⁵ It was agreed that Lend Lease would provide Sugar with security in the form of two unconditional bank guarantees for five percent of the contract sum.

Disputes arose during the works regarding the conduct of the principal's representative: Lend Lease asserted that the principal's representative had improperly suspended the work; Sugar asserted that Lend Lease had failed to comply with his directions. This resulted in both parties purporting to terminate the contract. Almost three years later, Sugar notified Lend Lease of its intention to cash the bank guarantees on the basis that it was entitled to recover amounts for completing the contract works and for rectifying defects. Lend Lease applied to the Victorian Supreme Court for an urgent interim injunction restraining Sugar from cashing the bank guarantees.

The Victorian Supreme Court (Vickery J) granted the injunction, which restrained Sugar from having recourse to the bank guarantees before the trial of the underlying disputes regarding the project, including Lend Lease's liability for the cost of completing the works and for defects in the work.⁴⁶

Sugar appealed to the Court of Appeal, which reversed the Supreme Court's earlier decision and discharged the injunction. Therefore, Sugar was entitled to cash the bank guarantees without having to prove its underlying claims against Lend Lease.

Findings

The underlying purpose of bank guarantees

The Court of Appeal discussed the underlying purpose of security, usually in the form of bank guarantees, in the construction industry. Specifically, security operated in one of two ways. First, it acted as security for a valid claim where there were likely to be difficulties in recovering from the defaulting party (for instance, if the defaulting party had gone into liquidation). Secondly, it acted as a risk allocation device, determining which party would be worse off pending resolution of an underlying dispute.⁴⁷

A court must determine which of these purposes the parties intended (although it could of course be both). If the purpose of the bank guarantee is to allocate risk pending resolution of an underlying dispute, then limiting a party's ability to cash the bank guarantees would deprive that party of the commercial bargain it made in the contract, thereby defeating the purpose of providing the bank guarantee.⁴⁸

The performance bond provision

Part of the Supreme Court's original reasoning in granting the injunction was that there was a serious question to be tried as to the construction of the security provision itself.⁴⁸ The provision in question was based on standard form contract drafting but had been amended to import a requirement that the principal act "reasonably" in seeking to cash the bank guarantee. Given the limited evidence available to the Court and the short time available to make the determination, Vickery J determined that he was not able to come to a final view on the operation of the provision. Such a determination would have to wait until the trial of the matter, when sufficient evidence would be available.

The Court of Appeal rejected this finding. Vickery J's failure to construe the recourse to security provision was an error in the exercise of judicial discretion. In the case of applications for interlocutory injunctions that restrained recourse to security, the Court should determine controversial issues of law if that determination is a necessary step in deciding whether an applicant is entitled to an injunction.⁵⁰

If the security provision was intended to operate as a risk allocation device pending final determination of a dispute between the parties, then that intention must be fundamental to a consideration of the justice of an application made to restrain recourse to that bond pending final determination of the dispute.⁵¹ Failure to construe the provision, thus delaying the determination to the time the underlying dispute was resolved, would deprive the parties of the principal benefit of the provision that they bargained for.⁵²

Importantly, the Court of Appeal acknowledged that the ordinary principles governing interlocutory injunctions applied to the present case notwithstanding the fact that these principles were being applied to "an unusual form of contract".53 This was particularly so if the commercial purpose of the bank guarantee was to allocate risk pending final determination of the dispute. Granting an injunction under these circumstances would be going against the purpose of the provision, which would be a substantial injustice.

The need to construe the clause to access the evidence

One of the purposes of the security provision was to allocate risk pending resolution of an underlying dispute. The qualification imposed by the provision only required the principal to act reasonably in asserting an entitlement, not that the entitlement be judged objectively valid. The provision thus allocated to the contractor the risk that the principal's claims might not ultimately be successful.⁵⁴ Accordingly, the Court was required to construe the provision in order to give effect to the contract.⁵⁵

The Court of Appeal held that the operation of the provision required that the principal act reasonably, in an objective sense, in making the claim the subject of the recourse, based on the facts and circumstances which it knew or ought to have known at the time concerning the validity of the claim.⁵⁶ Further, claims were not limited to costs which had already been incurred, but included all damages or liabilities which may arise in the future as a consequence of the asserted breach.⁵⁷

Having made that determination, the Court of Appeal was then able to assess whether there was a serious question to be tried as to whether the principal had complied with the provision in making the call on the bank guarantees. Based on the evidence submitted to the Supreme Court, the Court of Appeal found that there was a serious question to be tried as to whether the principal had acted reasonably in respect of some, but not all, of the amounts claimed in the recourse notice (which included amounts for costs to complete and to rectify defects). However, the amounts for which there was no serious question to be tried were greater than the amount for which Sugar sought to have recourse against the bank guarantees. Therefore there was no serious question to be tried as to whether the principal had acted reasonably in issuing the recourse notice.⁵⁸

Balance of convenience

As to balance of convenience, Vickery J had determined that the balance of convenience favoured the granting of an injunction based, in part, on a finding that Lend Lease was likely to suffer reputational damage if the bank guarantees were cashed. Lend Lease had relied on two affidavits, one from the chief operating officer of Lend Lease Construction and Infrastructure and one from the group treasurer of Lend Lease, both stating that they considered a call on the bank guarantees would harm the reputation of Lend Lease.

The Court of Appeal rejected the argument that the issue of reputational damage was sufficient to tip the balance of convenience in Lend Lease's favour.59 The matters deposed by the Lend Lease witnesses were substantially assertions, and there was doubt that the existence of the dispute would have any reputational impact on Lend Lease. Further, by agreeing to the security provisions in the contract, Lend Lease had assumed the risk that a call may be made on the bank guarantees (and presumably, any reputational damage that my go with such a call).

The Court of Appeal's approach to balance of convenience issues is also likely it harder for contractors to resist calls on bank guarantees. The standard practice of submitting affidavits from the contractor's senior officers asserting probable reputational damage is no longer likely to be sufficient to obtain an injunction. Detailed evidence of actual reputational damage likely to be suffered will be required. This evidence will need to be of sufficient weight to dislodge the assumption that by agreeing to the security provisions in the contract, the contractor took the risk of the bank guarantees being called pending final resolution of the underlying disputes, and any reputational damage that goes along with such a call.

http://www.austlii.edu.au/au/cases/vic/ VSCA/2015/98.html

See further the note in this update on the decision of the Queensland Supreme Court in Saipem Australia Pty Ltd v GLNG Operations Pty Ltd (No 2) [2015] QSC 173.

Footnotes

⁴⁴ Ibid at [138], referring to the principles set out in Clough Engineering Ltd v ONGC (2008) ALR 458
⁴⁵ Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98
⁴⁶ Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2014] VSC 476 (Vickery J)
⁴⁷ Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98 at [21], referring to Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812 at 826–7 (Fletcher)
⁴⁸ Ibid at [29]–[31]
⁴⁹ Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2014] VSC 476 (Vickery J)
⁵⁰ Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98 at [53]– [54]
⁵¹ Ibid at [21]
⁵² Ibid at [29]
⁵³ Ibid at [31]
⁵⁴ Ibid at [37]–[38], [68]
⁵⁵ Ibid at [65]
⁵⁶ Ibid at [144]
⁵⁷ Ibid at [147]
⁵⁸ Ibid at [197]–[198], [230]
⁵⁹ Ibid at [233]

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