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Can a Subcontractor prevent a call being made on a performance bond?

Case Note: CPB Contractors Pty Limited v JKC Australia LNG Pty Limited [2017] WASCA 123,

Performance bonds given by a Subcontractor, usually in the form of a bank guarantee, are an important and integral feature of most major construction contracts.

A recent decision of the Court of Appeal in Western Australia has highlighted the reluctance of courts to stop a beneficiary from having recourse to a performance bond unless the contract contains clear provisions preventing the beneficiary from calling on the guarantee in the circumstances.

The Appeal

In CPB Contractors Pty Limited v JKC Australia LNG Pty Limited [2017] WASCA 123, a Subcontractor (CPB) appealed a decision of the Supreme Court which denied the application for an injunction restraining the Contractor (JKC) from having recourse to the performance bonds provided under the subcontract until after resolution of the Subcontractor’s notified disputes.

The Court of Appeal dismissed the appeal finding that on a proper reading of the contract, JKC had the right of recourse performance bonds, if the contractor had an honest claim (ie a bona fide claim) to immediate payment under the contract.

The fact that the Subcontractor disputed that claim was insufficient to prevent the recourse to the bonds.

Although the decision turns on the specific provisions of the relevant contract, it is useful to examine the Court’s reasons as the relevant provisions relied upon in this specific contract are not uncommon to most large construction contracts and would be familiar to most Contractors and Subcontractors.

What happened?

CPB was subcontracted by JKC to perform certain on-shore works for the LNG plant in Darwin.

The relevant provisions Clause 35 of the subcontract contained the following:

35.3(a) Contractor may have recourse to the Bank Guarantee(s) at any time in order to recover any amounts that are payable by Subcontractor to Contractor on demand; and

35.3(b) Subcontractor waives any right it may have to obtain any injunction or other remedy or right against any party in respect of contractor having any recourse to the Bank Guarantee(s).

 

[Note: This provision was found by the trial judge to be void as an ouster of the court’s jurisdiction.  The Court of Appeal disagreed with the Trial Judge’s view on this issue, but decided it was unnecessary to determine the issue for the purposes of the appeal reasons].

The form of the bank guarantee was provided in the subcontract.

The subcontract also contained:

  • a liquidated damages clause requiring the Subcontractor to pay liquidated damages at the prescribed rate should it fail to complete the relevant parts of the Works by the relevant Completion Date or Milestone Date.
  • dispute resolution provisions requiring, in the usual way, for notified disputes to be subject to discussions and dispute resolution measures, failing which the dispute was to be determined by binding arbitration.
  • a proviso that neither party was precluded from applying to a court to seek urgent relief including interlocutory or conservatory measures.

During the project, CPB submitted a number of Extension of Time claims, some of which were rejected by JKC and the balance of which were accepted only in part.

CPB issued a Notice of Dispute in respect of the EOT claims, and those disputes remained unresolved (the EOT Disputes).

In February 2017, JKC asserted that completion dates had not been achieved and CPB was liable to pay liquidated damages.  CPD disputed JKC’s entitlement to liquidated damages and sought an undertaking from JKC that it would not pursue payment of the liquidated damages by calling on the performance bonds.

JKC refused to provide that undertaking.

In March 2017, CPB issued a further Notice of Dispute under the Subcontract disputing JKC’s entitlement to call on the performance bonds in reliance on its demand for payment of liquidated damages (the Bond Dispute Notice).

Shortly thereafter, CPB commenced proceedings seeking an injunction restraining JKC from demanding or receiving any payment pursuant to the performance bonds until:

  1. JKC complied with the dispute resolution process required by the subcontract in respect of the Bond Dispute Notice; or
  2. after a determination of the validity and extent of the EOT Disputes.

The Trial Judge refused to grant the injunction.

CPB appealed the decision of the Trial Judge on various grounds including:

  1. The Trial Judge made an error in failing to grant an injunction to restrain the contractor from calling on the performance bonds while the Bond Dispute was subject to the contractual dispute resolution process (Ground 1).
  2. That on a proper reading of the provisions of clause 35.3(a); an amount is “payable” under that clause only if, objectively and indisputably, in the events that have happened, the Subcontractor has a contractual obligation to pay that amount (Ground 2).

Ground 1 – Effect of the Notice of Dispute

CPB argued that if JKC could have recourse to the performance bond after the Bond Dispute had arisen, this would:

  1. defeat the dispute resolution process under the Subcontract; and
  2. deny the Subcontractor a right it had under the contract to avail itself of that process.

The Subcontractor also argued that the Contractor was under an implied duty to do all things necessary to enable the Subcontractor to have the benefit of the dispute resolution process.

The Court of Appeal:

  • rejected these arguments;
  • held that the Contractor had a contractual right to call on the performance bonds and neither the implied duty to cooperate (ie to allow the Subcontractor to avail itself of the dispute resolution process) nor any specific provision of the contract fettered that right; and
  • held that the fact a party had invoked the contractual dispute resolution process in respect of a dispute, did not require the status quo to be preserved pending resolution of the dispute.

Ground 1 was dismissed.

Ground 2 – what does “payable” mean?

The Court of Appeal considered the meaning of “payable” and looked at the purpose and effect of the performance bonds.

In particular, the Court took notice of the requirement that the financial institution was to pay the contractor on the first demand, without:

  • notice to the Subcontractor; and
  • reservation or condition, including notwithstanding any contest or dispute by the Subcontractor.

The Court rejected CPB’s argument that an amount was only “payable” once determined either by agreement between the parties or by arbitration, as such a construction would render clause 35.3(b) redundant.

The Court said that the inclusion of the words “on demand” in clause 35.3(a) worked against that proposition as an agreement to pay “on demand” an amount that is agreed or determined to be payable by an arbitration makes little sense.

A demand for payment was to be made directly to the financial institution without notice to the Subcontractor, the court observed that the purpose of the performance bonds was:

  • not only to protect the contractor from insolvency of the Subcontractor;
  • but also to permit the contractor to recover sums payable without delay, including any delays associated with the dispute resolution process.

That is, the Court determined that the objective purpose of the performance bonds included a risk allocation measure to put the contractor in funds whilst any dispute with the Subcontractor is resolved.

What did the court decide?

The Court held that:

  1. The term did not require sums claimed to be payable on an objective and indisputable basis.
  2. The Contractor was entitled to have recourse to the performance bonds for an amount that was payable, if at any time the contractor had an honest claim (ie a bona fide claim) for the amount claimed, in all the circumstances.
  3. The fact the Subcontractor may dispute its liability in relation to the amount claimed did not affect the contractor’s ability to call upon the bonds.

What to take away

  1. The decision affirms and develops the established law in this area that absent any contract term to the contrary, contractors should not be precluded from having recourse to performance bonds unless the demand is fraudulent or unconscionable
  2. When agreeing to the provision of performance bonds the parties should be specific as to when a call may be made on that bond.
  3. If the parties intend for the performance bond to be used solely in circumstances of insolvency, then the terms of the contract should specify as much.
  4. Similarly, if the parties intend for the performance bond to be called upon only in respect of undisputed claims, the contract should make such provision clear.
  5. If however the performance bond is intended to operate as a risk allocation measure in favour of the contractor, so as to place the contractor in funds during any dispute resolution period, then the Subcontractor should be aware that absent any fraudulent or unconscionable claim, Courts will be extremely reluctant to intervene to preclude the contractor making a claim on the performance bonds, even where the Subcontractor can show there is a genuine dispute as to the amount claimed.

The subcontractor should accordingly make appropriate provision in its budgets and risk profile for that contingency.

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