30 March, 2012
Legal News & Analysis – Asia Pacific – Australia – Construction & Real Estate
A recent Federal Court decision is a timely reminder that a court is unlikely to restrain a beneficiary of an unconditional undertaking provided as security under a contract from making a bona fide call on it, except where the contract's words, and the undertaking itself, clearly limit when such a call can be made.
How does it affect you?
- In the absence of clear words to the contrary in the contract's terms, and in the undertaking itself, an unconditional undertaking operates as a risk allocation device as to which party is to be 'out of pocket' pending the resolution of a dispute (rather than only to secure payment in the event of an undisputed claim to damages).
- A beneficiary of an unconditional undertaking is entitled to make a bona fide call upon the undertaking in respect of a claim for breach of contract, even if the party that provided the undertaking disputes that claim.
- If the party providing an unconditional undertaking intends for it to be a form of security for default in respect of an undisputed claim to damages only, the contract and undertaking must clearly express this intention.
The legal context
As a general rule, a beneficiary of an unconditional undertaking is entitled to convert the security into cash, except where they are acting fraudulently, unconscionably, or are in breach of any term of the contract that fetters their right to call on the security.1
The facts
Redline Contracting Pty Ltd entered into a contract with MCC Mining (Western Australia) Pty Ltd to construct and install three pipelines as part of the Sino Iron Project in Western Australia.
Clause 5 of the contract provided:
5.1 Provision
Security shall be provided in accordance with Item 13 or 14. All delivered security, other than cash or retention moneys, shall be transferred in escrow.
5.2 Recourse
Security shall be subject to recourse by a party who remains unpaid after the time for payment where at least 5 days have elapsed since that party notified the other party of an intention to have recourse.
Redline provided security to MCC Mining, under clause 5, by putting up four undertakings to pay unconditionally, up to a prescribed maximum amount, the sum that MCC Mining required.
A series of disputes arose between Redline and MCC Mining, culminating in the termination of the contract before Redline achieved practical completion of the works.
MCC Mining sent Redline notices of intention to call on a portion of the total amount under the undertakings that Redline provided, in relation to a claim for two liquidated sums.
The Federal Court dismissed Redline's application for an injunction to restrain MCC Mining from calling upon the unconditional undertakings,2 and those amounts were paid to MCC Mining.
MCC Mining subsequently sent Redline a notice of demand stating its intention to have immediate recourse to the full (remaining) amount provided under the undertakings in respect of claims for unliquidated damages it had allegedly suffered due to Redline's alleged breach of the contract, and MCC Mining's termination of the contract pursuant to that alleged breach.
Redline applied for an interlocutory injunction, seeking to restrain MCC Mining from calling upon the full amount of the unconditional undertakings.
The decision
In the Federal Court, Justice Siopis considered whether there was a serious question to be tried by a trial court that:
- clause 5.2 of the contract contained an implied negative stipulation preventing MCC Mining from calling on the undertakings; or
- MCC Mining's attempts to call on the undertakings were unconscionable conduct, in contravention of section 51AA of the Trade Practices Act 1974 (Cth) (now s20 of the Australia Consumer Law, contained at Schedule 2 to the Competition and Consumer Act 2010 (Cth).
Issue 1: Did clause 5.2 of the contract contain an implied negative stipulation precluding the call on the security?
Justice Siopis held that Redline had failed to demonstrate a sufficient likelihood of success at trial for its submission that clause 5.2 of the contract contained an implied negative stipulation precluding MCC Mining's call on the undertakings, to justify the grant of an interlocutory injunction.3
His Honour rejected Redline's submission that MCC Mining was not entitled to have recourse to the security under clause 5.2 of the contract for its claims for unliquidated damages, because the words 'time for payment', in the context of clause 5.2 of the contract, were to be construed as referring to the payment of a sum that is 'due and payable'. His Honour said that MCC Mining's recourse to the security was not expressed to be conditional (under the terms of the contract or the undertakings) upon an undisputed amount being due and payable by Redline. It was sufficient that MCC Mining held a bona fide belief that it had such a claim.4 Accordingly, as more than five days had passed since the time for payment specified in MCC Mining's notice to Redline of its intention to have immediate recourse to the full amount of the undertakings, Justice Siopis found it was likely that the trial court would find that the conditions specified for recourse to the security under clause 5.2 of the contract had been satisfied.5
Issue 2: Was MCC Mining's attempt to call on the security unconscionable conduct?
Justice Siopis held that Redline had failed to demonstrate a sufficient likelihood of success at trial for its submission that MCC Mining's attempt to have resort to the security was unconscionable conduct, in contravention of s51AA of the Trade Practices Act, to justify the grant of an interlocutory injunction.6
In reaching this decision, his Honour cited the Full Court of the Federal Court's finding in Clough Engineering7 that the commercial purpose of unconditional bank undertakings (as being equivalent to cash) meant that there was little, if any, scope for the application of equitable doctrines of unconscionable conduct to restrain the exercise by a party of its legal rights under such guarantees.8 Justice Siopsis also noted that it was open to Redline, during the preparation of the contract, to protect itself from the effects of earlier decisions such as Clough Engineering by expressly and unequivocally limiting the circumstances in which the unconditional undertakings could be called upon in the contract.9
Accordingly, his Honour dismissed Redline's application.10
Comment
The reasons for Justice Siopis's decision serve as a reminder to parties providing unconditional undertakings as security under a contract that if the undertaking is intended to be provided only as a measure of protection against insolvency in respect of an undisputed claim to damages for breach of contract (as opposed to the broader purpose of acting as a risk allocation device as to who is to be 'out of pocket' pending resolution of a dispute as to the parties' respective liabilities), the words of the contract, and the undertaking itself, must be clearly drafted to express that more limited purpose.
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