Can a bank guarantee defeat the intent of Australian building and construction industry security of payment legislation?

I suggest this decision is going to stimulate some spirited discussion, both in Australia and overseas:

Last week, the Federal Court of Australia took matters a step further than previous decisions by holding that a head contractor who holds security from the sub-contractor (in this case, bank guarantees), may call on that security to recover funds which it has been ordered to pay over by an adjudicator under security of payment legislation. 

The NSW Court of Appeal has previously held that a head contractor is entitled to retain pre-existing security pending final determination of the disputes between the parties, even though an adjudication has been made.¹ This decision goes further, saying that the head contractor is entitled to call on such security immediately after an adjudication has been made.

I point out some implications for industry below, but I would urge caution: In my respectful view, this issue is likely to receive further judicial attention in the near future and it is difficult to predict the final outcome.

Fabtech Australia Pty Ltd v Laing O’Rourke Australia Construction Pty Ltd [2015] FCA 1371 (4 December 2015; Besanko J)  http://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/single/2015/2015fca1371

Background – the purpose of security of payment legislation

Readers involved in the construction industry in Australia will no doubt be familiar with the various Building and Construction Industry Security of Payment Acts.  Their general scheme in each State is to require that where a head contractor disputes a payment claim by a sub-contractor, an Adjudicator may make an Award, which is an interim order for payment of the claim.  The purpose of the Award is to ensure that sub-contractors are not left waiting for their money until the conclusion of litigation or arbitration.  It is entirely possible for the final result of the litigation or arbitration to require repayment of some or all of the awarded monies back to the head contractor.

The Queensland Court of Appeal has described the purpose of the legislation this way:

“It is evidently the intention of [the Queensland security of payment legislation] … that the process of adjudication established under that Act should provide a speedy and effective means of ensuring cash flow to builders from the parties with whom they contract, where those parties operate in a commercial, as opposed to a domestic, context. This intention reflects an appreciation on the part of the legislature that an assured cash flow is essential to the commercial survival of builders, and that if a payment the subject of an adjudication is withheld pending the final resolution of the builder’s entitlement to the payment, the builder may be ruined”.²

Background – brief facts

Under terms of a Sub-Contract Agreement (SCA) concerning the construction of a water treatment plant and associated infrastructure at Wandoan in Queensland, the plaintiff Fabtech Australia Pty Ltd (the Sub-Contractor) agreed to provide bank guarantees to Laing O’Rourke Australia Construction Pty Ltd (the Head Contractor).  The terms of the SCA came within the Building and Construction Industry Payments Act 2004 (Qld) (the Act) which provides for payment claims by a sub-contractor to be adjudicated and paid immediately, pending final determination of any arbitrated or litigated dispute between the contractor and the sub-contractor. 

On 13 April 2015, the Sub-Contractor served a payment claim on the Head Contractor under the Act.  The Contractor disputed this with a payment schedule.  The claim went to adjudication, and on 16 September 2015 the Adjudicator awarded the Sub-Contractor an amount in excess of 4 million AUD plus interest, and 75% of the Adjudicator’s costs.

On 25 September 2015 the Head Contractor commenced proceedings in the Supreme Court of Queensland for a declaration that the Adjudicator’s decision was void.  However, on 16 October 2015 the Head Contractor discontinued these proceedings, and paid the money owing to the Sub-Contractor under the Adjudicator’s award.  Then, on 27 October 2015 the Head Contractor wrote to the Sub-Contractor outlining various claims against it for about 3.7 million AUD for “overpayments” (which apparently meant amounts which the Adjudicator had awarded to the Sub-Contractor in error) as well as for misleading or deceptive conduct, and liquidated damages.  The Head Contractor also gave 24 hours’ notice of its intention to call on the bank guarantees.  The bank guarantees covered an amount of just over 1 million AUD.

The Sub-Contractor sought an interlocutory injunction restraining the Contractor from calling on the bank guarantees.  The matter came before Besanko J in the Federal Court of Australia who, at the first substantive hearing, refused to issue the injunction.

Unsurprisingly, one of the main planks in the Sub-Contractor’s argument was that the use of the bank guarantees in this way breached section 99 of the Act, which voids any agreement or arrangement between parties which “purports to … change the effect of a provision of this Act; or … may reasonably be construed as an attempt to deter a person from taking action under this Act”.

The Sub-Contractor did not dispute that the Contractor is entitled under the Act to pursue the claims through the process of the court or in an arbitration. However, it contended that that is a very different thing from making a claim on a bank guarantee almost immediately after payment had been made pursuant to an adjudicator’s decision.

Besanko J referred to the decision of the Victorian Court of Appeal in Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd³ as authority that a commercial bargain between parties to distribute risk of non-payment by means of bank guarantees must be given effect. However, with respect, that case did not involve security of payment legislation with its characteristic provision striking down arrangements or understandings that are inconsistent with the purposes of the legislation.    

Implications for the building and construction industry

• Where possible, head contractors should seek to protect their position by taking bank guarantees from sub-contractors which are unconditional (i.e. do not require them to be “acting reasonably” when calling on the guarantees).  Conversely, sub-contractors should avoid giving such guarantees.  However, the relative bargaining power of the parties is likely to be the real determinant of whether such guarantees are given, and on what terms.
• The previous findings by courts concerning the purpose of security of payment legislation (e.g. as set out in the quote from the Queensland Court of Appeal above) is potentially inconsistent with the result in this case, so both head contractors and sub-contractors should prepare for further litigation and uncertainty on the issue.
• There is also the issue of legislative change.  No doubt this decision will lead to increased lobbying by representatives of building sub-contractors for provisions in legislation giving an Adjudicator power to release security such as a bank guarantee – see for example, the enquiry submission by the Australian Institute of Building last year: http://aib.org.au/wp-content/uploads/2014/11/AIB-Submission-to-the-DP-into-Payment-Dispute-Resolution-into-the-Qld-BC-Industry-FINAL.pdf.

Keypoint Law is able to advise on all aspects of commercial dispute resolution in Australia.