Australia: Are PC1 security regimes and contracts which adopt those regimes, really unconditional?

Last Updated: 26 December 2013
Article by Grant Ahearn and Danielle Strain

Introduction

Developed by the Property Council of Australia, PC-1(1998) (PC1) contracts are still used by commercial principals in Australia, and as a basis for particular Department of Defence Contracts. The current Australian Department of Defence - Head Contract and Managing Contractor Contract contain almost identical terms in relation to security as PC1.

The recent decision of Master Mossop of the Supreme Court of the Australian Capital Territory in Walton Construction Pty Ltd v Pines Living Pty Ltd [2013] ACTSC 237 (Walton Construction), calls into question the generally accepted PC1 security regime.

Implications

The Walton Construction decision could have a significant impact for those in the industry using PC1 or contracts with security regimes based on it, as the ability to call on bank guarantees appears to be significantly more restricted.

The Walton Construction decision was that, despite the absence of a negative stipulation or contractual limitation or fetter on the Principal's right to call on the security under the contract, the Principal was nevertheless restrained from calling on bank guarantees provided by the Contractor. As the parties were found to be involved in a genuine dispute, and the terms of the Contract did not expressly provide for the risk allocation of the security to be for the benefit of the Principal until the dispute was resolved, the Principal was not entitled to have recourse to the security.

Next steps

If the reasoning in Walton Construction is accepted and not overturned on appeal, then where a genuine dispute (which has not yet been resolved in accordance with the dispute resolution process under the contract) is said to exist, and the Principal has no express right to call on the security, the Principal will likely be restrained from calling on the bank guarantee, even where that guarantee is expressed to be unconditional, particularly where it is experiencing financial difficulties.

To avoid this outcome it is recommended to include a provision making it clear which party bears the cash flow risk in relation to the security, pending the hearing and determination of an unresolved dispute.

An appeal against Master Mossop's decision was filed on 10 December 2013.

Case note: Walton Construction Pty Ltd v Pines Living Pty Ltd [2013] ACTSC 237

The Contractor (Walton) and Principal (Pines) entered into a construction contract for a retirement village redevelopment. The contract took the form of an amended PC1 (Contract). Walton provided two bank guarantees each to the value of $190,000 as security for each of the two separate stages of the project. Each of the bank guarantees was expressed as being unconditional, in that there were no conditions to be met before they could be called on by Pines.

Consistent with the unamended PC1, the Contract contained express terms regarding the provision of security and when the security was to be returned to Walton, but contained no express statement as to when Pines was entitled to call on the security.

Various disputes arose in relation to the project, including as to payment under the Security of Payment legislation, defective work and liquidated damages. Correspondence went back and forth between the two parties about these issues, as well as Pines' right to call on the bank guarantees.

On 25 September 2013, Walton successfully applied to the Court for urgent interlocutory relief, to restrain Pines from calling on the bank guarantees. Shortly after this, Pines terminated the Contract after becoming aware that administrators had been appointed to Walton. Walton then issued two notices of dispute under the Contract, setting out those matters in dispute between the parties and enlivening the dispute resolution process, which was by way of arbitration.

The day after the notices were served, the Court considered whether to grant an injunction restraining Pines from calling on the bank guarantees. At the hearing it was accepted as a matter of evidence that Pines was also experiencing financial difficulties.

Decision

The broad terms of the PC1 security regime are considered to have been drafted in light of the decision in Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443 (Wood Hall). Master Mossop considered the application of the generally accepted principle from Wood Hall and determined that no such general principle existed.

Prior to Walton Construction it was generally accepted that Wood Hall stood as the authority for the proposition that where a bank guarantee contains an express unconditional promise to pay, the Court will only restrain the surety from paying on demand where there are exceptional circumstances such as fraud.1 Master Mossop very narrowly construed the ratio in Wood Hall, taking the view that since the facts in that case were specific (and as such the issues were "less generally applicable"), the case should only be taken as relevant or applicable to circumstances where a Principal intends to convert a bank guarantee into retention monies.

Master Mossop held that a term could not be implied into the Contract that dealt with the risk allocation of the security during the resolution of a dispute. Therefore, as no term could be implied, based on the express terms of the Contract, Pines did not have an entitlement to call on the security for an arguable claim for damages made in good faith. Consequently Master Mossop held that Walton was entitled to an injunction restraining Pines from calling on the security.

Although Master Mossop based his reasoning on an interpretation of the terms of the Contract, it appeared relevant to his reasoning that Pines was also experiencing financial difficulties. This may be a distinguishing feature on the issue of whether damages are likely to be an adequate remedy and possibly, the balance of convenience point. Master Mossop commented that if the bank guarantees were to be called upon, and it was later found that Pines was not entitled to those funds, it would be very difficult for Walton to recover those funds.2

Footnotes

1Robert Hunt, Enforcing Security Bonds, Guarantees and Injunctions (2001) 17 BCL 395, 397. Hunt cites Hortico (Australia) Pty Ltd v Energy Equipment (Australia) Pty Ltd [1985] 1 NSWLR 545 as an example of this position.

2[65].

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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