Focus: Support for principals with bank guarantees
25 June 2015
In brief: A principal has successfully challenged a decision to grant an interlocutory injunction restraining it from calling on performance bonds. The Victorian Court of Appeal's decision reaffirmed the court's general approach in favour of rejecting such applications where, as in many cases, the purpose of the bond is to provide security and allocate cash flow risk. Partner Nick Rudge (view CV) and Senior Associate Julian Berenholtz report on the Victorian Court of Appeal decision in Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd and its implications.
How does it affect you?
The Court of Appeal has given the following guidance:
- Where a contractor seeks to prevent a call on an on-demand bank guarantee by raising questions of construction, a court of first instance should ordinarily determine those questions at the interlocutory stage rather than deferring them to trial.
- A court of first instance should consider the commercial purpose of a guarantee and whether it is intended to allocate financial risk to a particular party without the need for the party calling the bond to demonstrate entitlement.
- Where such an intent is shown, the grant of an injunction preventing a call will defeat the commercial purpose of the bond.1
- Whether a principal has acted reasonably in calling on a bank guarantee is an objective assessment based on the circumstances of the case.
In 2007, Sugar Australia entered into a contract with Lend Lease for the design and construction of a refined sugar plant in Yarraville, Victoria. The contract required Lend Lease to provide two unconditional bank guarantees as security for performance. General condition 5.2 of the contract defined the circumstances under which Sugar Australia could make a call. It required Sugar Australia to give Lend Lease five days' notice of its intention to call on the security, to allow Lend Lease to replace the security with cash, and to act reasonably in doing so.
In 2011, the relationship between Sugar Australia and Lend Lease broke down, with both parties purporting to terminate the contract. Sugar Australia notified Lend Lease of its intention to call the guarantees and Lend Lease applied for an interlocutory injunction restraining Sugar Australia from doing so.
Lend Lease argued that an interlocutory injunction should be granted on the basis that:
- there was a serious question to be tried as to whether Sugar Australia had acted reasonably within the meaning of general condition 5.2;
- if the injunction was not granted, Lend Lease would suffer injury for which an award of damages would not be an adequate remedy, including injury to its reputation; and
- the balance of convenience favoured the grant of the injunction.
Sugar Australia argued that, upon the proper construction of general condition 5.2, it had acted reasonably in seeking recourse to the bank guarantees by bringing a bona fide claim.
Justice Vickery declined to construe general condition 5.2 at the interlocutory stage, deciding that the construction question was best left to the trial for final determination. His Honour based this decision on four factors:
- the difficulty involved in determining the construction question;
- general condition 5.2 was a 'standard' clause and that a final construction would potentially have ongoing precedent effect;
- the limited time available to the court; and
- determination of the question may lead to a degree of hardship in light of the significant monetary sums involved.
Despite declining to construe general condition 5.2, Justice Vickery was satisfied that there was a serious question to be tried as to whether Sugar Australia had acted reasonably in seeking recourse to the bank guarantees, that the balance of convenience favoured granting the injunction, and that if the injunction was not granted, Lend Lease would suffer injury for which damages would not be an adequate remedy.
Accordingly, His Honour decided to grant the interlocutory injunction restraining Sugar Australia from having recourse to the bank guarantees.
The Court of Appeal held that where a party to a construction contract has applied for an interlocutory injunction restraining the other party from having recourse to a security provided under the contract, the court should ordinarily determine any issues necessary in order to decide whether the applicant is entitled to the injunction.
It followed that the construction of general condition 5.2 was critical to any decision and, on this basis, the Court of Appeal held that the factors considered at first instance were not applicable and incorrectly applied.
The Court of Appeal held that:
- the question of construction of the provision involved familiar legal concepts and was not of unusual difficulty;
- general condition 5.2 was a bespoke clause, the construction of which would not have any significant precedent value; and
- the court at first instance was not under any particular time pressure.
Justices Osborn and Ferguson highlighted the importance of construing general condition 5.2 in order to determine its commercial purpose. Citing the cases of Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd4 and Clough Engineering Ltd v Oil & Natural Gas Corporation Ltd [No 3] 5,their Honours stated that there are two reasons why parties to a construction contract may seek provision of a bank guarantee. The first is to provide security, so that if the beneficiary of the guarantee has a valid claim but there are difficulties in recovering moneys from the defaulting party, the beneficiary can seek recourse against the bank. The second reason is to allocate risk between the parties in terms of which party will be 'out of pocket' pending final resolution of the dispute at trial.
Justices Osborn and Ferguson stated that it is a matter of construction whether the guarantee is stipulated only for the purpose of providing security, or whether it is also intended to serve as a risk allocation device. Their Honours concluded that it is necessary for a court of first instance to determine whether the guarantee is intended to allocate the risk of being 'out of pocket' pending trial. If the guarantee is so intended, the failure of the court to determine its construction before trial effectively subverts the commercial purpose of the guarantee in this respect.
Having identified Justice Vickery's error in failing to construe general condition 5.2, the Court of Appeal went on to consider the clause, in particular the requirement to act reasonably. Sugar Australia argued that it was only required to have a bona fide arguable claim, in a subjective sense, in order to be eligible to access the guarantee. Lend Lease argued that Sugar Australia must be acting reasonably, in an objective sense, in all the circumstances of the case. Justice Kaye noted that general condition 5.2 was a 'bespoke' clause, and that the parties had chosen to use a phrase that ordinarily involves an objective standard. His Honour held that the clause required Sugar Australia to 'have acted reasonably in making the claim, based on the facts and circumstances, which it knew, or ought to have known, concerning the validity of the claim'.6
Justice Kaye concluded that, although there were serious questions to be tried in relation to whether Sugar Australia had acted reasonably in seeking recourse to the guarantee, the balance of convenience did not favour the grant of the injunction.
The Court of Appeal has given further support to the effect that accepted principles governing the grant of injunctions and the ordinary practice adopted in performance bond cases will require a court of first instance to construe any fetters on the call of a bond in order to determine the success or failure of an injunction application.
The commercial purpose, in this case (and in many that we see), was to provide an on-demand 'shoot first and ask questions later' solution to the question of which party bears financial risk.
Principals should derive further comfort from another decision supporting the right to call on-demand bonds without demonstrating an entitlement and without the risk of an injunction preventing such a call.
Parties must also exercise caution in departing from the language employed in standard form construction contracts, in order to avoid the risk of dispute on the proper interpretation of such language in the future.
- We note recent judicial support from the Supreme Court of Queensland in Saipem Australia Pty Ltd v GLNG Operations Pty Ltd  QSC 310, indicating a trend towards upholding the sanctity of bank guarantees.
-  VSCA 98.
- The decision was unanimous, Justices Osborn and Ferguson broadly agreeing with the reasons of Justice Kaye
-  3 VR 812.
- (2008) 249 ALR 458.
- At .
- Nick Rudge Partner,
Ph: +61 3 9613 8544
- Andrea MartignoniPartner,
Ph: +61 2 9230 4485
- Michael IlottPartner,
Ph: +61 7 3334 3234
- Jeremy Quan-SingPartner,
Ph: +61 8 9488 3790
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