You get what you give - Protecting security under contracts

Mar 2020 | Construction & Engineering

The recent decision of Icon Co (NSW) Pty Ltd v Australia Avenue Developments Pty Ltd [2020] NSWSC 178 relating to the high profile Opal Towers construction is a wake up call to contractors of the need to be very careful when agreeing to any terms or conditions that amend the standard provisions regarding recourse to security. In short, the Courts will give effect to the ordinary and natural meaning of the words in such clauses and if they give wider rights to call on security, then the contractor will be unlikely to prevent such recourse.

Icon Co (NSW) Pty Ltd v Australia Avenue Developments Pty Ltd serves as a salutary reminder to all contractors that there are five key points which are crucial for contractors to consider when drafting and negotiating recourse to security clauses within their contracts:

  1. Reasonable notice periods;
  2. Certainty as to the ‘debt’ or other claims which gives right to a party to have recourse;
  3. Whether recourse can extend to claims beyond the actual works;
  4. What other clauses of the contract give rise to a right to have recourse; and
  5. Whether recourse can extend to claims under other contracts with the same party.

Background

Icon Co (NSW) Pty Ltd (Icon) acted as the builder and Australia Avenue Developments Pty Ltd (Australia Avenue) as the principal, in a design and construction contract (Contract) to orchestrate works for a high-rise residential and commercial development property known as ‘Opal Towers’.

Under the Contract, Icon was to provide security, being an unconditional and irrevocable bank guarantee in the sum of $3.9 million in exchange for the proper performance of its obligations to Australia Avenue (Bank Guarantee).

Australia Avenue sought to call upon the Bank Guarantee under the Contract due to it claiming that two security recourse events had occurred as a result of damage suffered (specifically, cracking) to various levels of the property. This damage required residents to be evacuated and resulted in Icon spending significant amounts on repairs and other issues.

Relevantly, the recourse clause under the contract provided that Australia Avenue could have recourse to any security as follows:

  1. where Australia Avenue is entitled to exercise a right under the Contract in respect of the security;
  2. where Icon has failed to comply with a material obligation under the Contract;
  3. where there is a debt payable by Icon to Australia Avenue; or
  4. subject to cl 37.4, to meet any genuine bona fide claims that Australia Avenue may have against Icon arising out of or in connection with the termination of the Contract.1(emphasis added)

Clause 37.4 was very broad in nature, and provided that any debt due from Icon to Australia Avenue or moneys claimed by Australia Avenue from Icon under or in connection with the Contract or the work under contract may be deducted by Australia Avenue from any moneys which may otherwise become payable to the Contractor by the Principal and any security held by the Principal.2

The ‘moneys claimed’ were assessed by Australia Avenue as exceeding $6.795 million, generalised as follows:

  1. costs of defending a class action to which Australia Avenue had been joined;
  2. damages for breach of Contract with respect to the defects under the work under contract;
  3. damages for losses suffered by Australia Avenue due to the defects in the Opal Towers and the subsequent loss of sales; and
  4. all additional costs involving the administering the Contract.

Stevenson J interpreted that the words ‘any debt due’ in the context in which they were used alongside ‘moneys claimed’ were intended to have two different meanings, whereby:

  1. any debt due’ would be a result of Icon actually being in default; and
  2. moneys claimed’ would mean that Australia Avenue could make a ‘genuine and bona fide’ claim for the moneys that is genuine, not fraudulent and not ‘specious fanciful or untenable’.3

Stevenson J provided that cl 37.4 should be read in accordance with its terms, and that is that there is a distinction between the words and accordingly, Australia Avenue is ‘entitled’ to deduct from any money otherwise payable by it to Icon ‘moneys claimed’ by it under or in connection with the Contract. Australia Avenue documented the moneys claimed in a letter to Icon on 4 February 2020, in which the moneys claimed fit the criteria of cls 5.2 and 37.4 whereby they were claimed under and in connection with the Contract.

When reading both cls 5.2 and 37.4 together, Stevenson J agreed with counsel for Australia Avenue when they stated that the Contract ‘clearly provided for a right of access to the security for any claim by the principal from the contractor, which is either under or in connection with the contract or the works, or arising out of or in connection with the termination of a contract'.4

Stevenson J also considered a second basis for recourse to security for failing to comply with a 'material obligation'. In short, Stevenson J found that despite the issue of a certificate of practical completion, that Icon failed to comply with a material obligation under the contract because as at the date of practical completion, the ‘Works’ were not fit for use and occupation; the Opal Tower residents were evacuated a few months later due to defects that would have been present at the date of practical completion.

Icon’s application for an injunction to restrain recourse to the security was dismissed.

Takeaways

The decision in this case, confirms that courts will read contracts on face value, interpreting clauses (in this instance, recourse to security clauses) on the ordinary and natural meaning of the words within the clause. If those words are very broad, then they will be given the broad meaning.

The recourse clause here allowed Australian Avenue to have recourse to security with greatly expanded rights than it otherwise would have had under unamended Australian Standard conditions. A number of the grounds for recourse would in the eyes of most contractors be beyond what they would usually consider as a basis for calls on security relating to the works, for example the costs of being joined as a defendant to a class action and loss of sales on the project. Unfortunately because of the very broad terms of the contract, the Court considered that there were grounds for recourse, even on these broad and arguably indirect claims.

The case highlights a number of issues which contractors should consider when drafting and negotiating the terms and conditions of any clause within their contracts which entitles a party to have recourse to the contractor’s security.

1. Notice

Although in this case, the principal was required to give Icon notice before calling on security, in many contracts this requirement is deleted or severely reduced.  

Reasonable notice gives a contractor an opportunity to understand or enquire about the issue and then do something to resolve it. At the very least it gives an opportunity to consider whether the Contractor can offer a cash bond (particularly where the call is for only part of the security values).

The impact on credit rating, relationships with financial institutions providing the security and industry reputation cannot be underestimated when a bank guarantee or insurance bond is called.

For this reason, contractors should always seek to have prior notice and if possible an explanation of the basis on which the recourse is being sought.  

2. Certainty as to the ‘debt’ or other claims

As soon as parties move away from a clearly defined liability such as for unpaid amounts or even debts due and payable, then the scope of potential recourse can be significantly expanded. In this case, Australia Avenue was entitled to recourse to security to meet 'any genuine bona fide claims' that Australia Avenue may have against Icon arising out of or in connection with the termination of the Contract. Although this give some parameters, it is still very broad and allows claims for amounts that are not actually due but are contingent and still largely undefined. Many, security clauses go even further and allow for amounts 'claimable' or amounts that 'may be claimed' which allows recourse for what are in effect future claims that may not be clearly defined or quantifiable.

Contractors should where possible, limit claims for amounts that have been incurred by the principal or are actually due or if this expanded then parameters should be put around the nature of the claim. For example such claims should not only be bona fide but also reasonable and documented so that recourse cannot be for 'pie in the sky’ undefined claims.

3. Can recourse can extend to claims beyond the actual works

In this case the contract entitled Australia Avenue to have recourse to security or claims 'arising out of or in connection with the termination of the Contract'. The contract did not limit the entitlement to recourse to debts or liabilities directly under the contract or directly arising out of the carrying out of the Works. The fact that the Contract included the phrase 'arising out of or in connection with' allowed the situations where Australian Avenue could call on security to be significantly broadened.

Contractors should ensure that, where possible, they limit the entitlement to claims for security to be those which are a direct consequence of the work under the contract.

4. Be aware of the nature and extent of clauses of the contract that give rise to a right to have recourse

The wording of the recourse clause will dictate the breadth of the nature of what may give rise to recourse but individual clauses will then determine when the individual debts or claims arise.

In this instance, the recourse clause called upon the ‘moneys claimed’ in clause 37.4 and could be any moneys claimed “under or in connection with the Contract”. This is very broad and once it was established that the relevant claims were ones in connection with the contract then the recourse entitlement under clause 5 was enlivened.

Where recourse is limited to unpaid amounts or debts due and payable, then the parameters are narrower but if wording in individual clauses expands this then the rights of recourse are expanded.

The key clauses to review are those allowing cost recovery such set-off, defects liability, liquidated damages and delay and take out. However these may not be the only relevant clauses and any clause that may allow cost recovery (even if not clearly stated as a debt) may be significant. Often these clauses are ancillary to the main works, such as liabilities in relation to sales agreements or agreements for lease, liabilities to owners of neighbouring properties or to local authorities or subsequent owners or operators. The liabilities under these provisions can be significantly greater than just construction or defects related issues.

Of significance here will also be consideration of limitations or liability, exclusions of consequential loss and insurance coverage. If there are general limits to liability then this is likely to limit rights of recourse where those limits have been met or exceeded.

Although it may seem obvious, when considering the right to have recourse to security it is fundamental that the whole of the contract is reviewed to ascertain and manage circumstances which may give rise to a call on security and to what extent.

5. Are claims for recourse to security are limited to the particular contract

Although not specifically an issue in Icon, it is not uncommon for the wording of a contract to state that a party is entitled to call upon security for a debt or claim 'arising out of this agreement or any other agreement between the parties'. Where the parties have more than one project together this can produce a risk of calls on security, unrelated to or disproportionate to the actual project for which the security was provided.

Summary

Contractors will be bound by the terms of the contract allowing recourse to security and it is the present view of the courts that such clauses will be interpreted on their clear and broad meaning.

Contractors should where possible:

  • ensure that there is reasonable notice prior to recourse;
  • that recourse is limited to clearly defined liabilities, if possible amounts actually due and payable but at a minimum, amounts that are reasonable, bona fide and able to be documented; and
  • avoid wording that expands liability beyond what is directly arising from the works under the contract for which the security is given, and in particular does not extend rights to recourse fro liabilities under other contracts.

Lastly contractors must understand the liabilities under the whole of the contract so that as necessary, limitations can be put in place or protocols adopted to minimise risk of liability and then a call on security.

....

1 [2020] NSWSC 178,18.
2 Ibid 21.
3 Ibid 27.
4 Ibid 51.

This article may provide CPD/CLE/CIP points through your relevant industry organisation.

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