Traditionally, security has been provided in construction contracts as a means of securing the performance of a contract. As projects become more competitive, the role of security has widened. Today, security is used to not only secure performance of the works – but to also secure the principal’s risk of the project going wrong.
Security comes in many shapes and sizes, but the two most common in Australia are cash retention (where an amount is deducted from each progress payment) and bank guarantees (where a third party financial institution provides a guarantee that is ‘as good as cash’).
As the risk in construction contracts has shifted more and more towards the contractor – so have the number of disputes where contractors have attempted to recover the security. To date, it has been relatively uncontroversial that the adjudication process can be used to recover cash retention.
Since Fabtech Australia Pty Ltd v Laing O’Rourke Australia Pty Ltd [2015] FCA 1371, it has been common practice for principals to use broad contractual powers to have recourse to bank guarantees to set off an unfavourable adjudication decision.
What has been less clear, is whether the adjudication process can be used to recover the value of a security – once it has been converted to cash.
Providing some much needed clarity, the recent NSW decision of Grocon (Belgrave St) Developer Pty Ltd v Construction Profile Pty Ltd [2020] NSWSC 409 (Grocon v Construction Profile) has decided that a payment claim which predominately seeks reimbursement for the value of a bank guarantee is void. This decision confirms the position that a claim for the value of security is not a claim for “construction work” and, therefore, excluded from adjudication.
Background
Grocon engaged Construction Profile (CP) to construct the Telstra Exchange residential development in Manly, NSW. In response to a payment claim served by CP, Grocon served a payment schedule deducting $1.65 million on account of liquidated damages for delay in reaching practical completion.
CP applied for adjudication under the Building and Construction Industry Security of Payment Act 1999 (NSW) (the NSW Act), which resulted in a determination in favour of CP to the tune of $1.25 million. The adjudicator found that CP was entitled to extensions of time and, on that basis, rejected Grocon’s claim for liquidated damages.
Immediately after the adjudication determination, Grocon called on CP’s two bank guarantees (of approx. $1 million in value) in satisfaction of Grocon’s claim for liquidated damages.
In an attempt to seek reimbursement of the converted bank guarantees, CP issued a second payment claim for the value of the bank guarantees.
Pre-emptive injunction application
After receiving the payment claim, Grocon sought a declaration from the NSW Supreme Court that the payment claim was void and an injunction restraining CP from seeking an adjudication determination under the NSW Act.
Grocon argued that the payment claim was invalid because the reimbursement of the monies called under the bank guarantees did not fall within the definition of “construction work” or “related goods or services” under the NSW Act.
In its defence CP argued (amongst other things):
- it was inappropriate for the Court to make pre-emptive orders because the question of whether the claim is for “construction work” or “related goods or services” is a determination to be made by the appointed adjudicator;
- the claim was a proper claim for “construction work” because it included the value of the whole of the work undertaken, less amounts CP had been paid.
Decision
In response to CP’s arguments, Justice Ball held that:
- while issues regarding jurisdiction typically are dealt with by a Court following a determination by an adjudicator “there is no reason why in an appropriate case the question of jurisdiction should not be determined in advance of an application under the [NSW] Act”;
- CP’s claim was not for “construction work” or “related goods and services” supplied because it was, in effect, a “claim for credit” in respect of the value of the cashed bank guarantees. His Honour considered that the fact that the payment claim was for the whole of the work done less the amount paid did not alter the character of the two amounts in question.
In light of the above, the Court found that the payment claim was not valid because the amounts claimed were not for construction work. The Court highlighted that the security under the contract in question acted as a risk allocation device, rather than a means of securing performance.
In other words, the purpose of the security was to address which party should be ‘out of pocket’ while a dispute under the contract is being determined.
What is the practical effect of this decision?
This decision serves as a timely reminder about the purpose of security under a contract. Unfortunately, most contractors think that security is only provided to secure performance. In recent years, security has more commonly been used as a risk allocation tool – meaning that the principal gets to hold onto the cash until a dispute is finally resolved through the court or arbitration process.
While security of payment legislation is a vital tool for contractors in recovering unpaid amounts, it does not allow adjudicators to resolve all disputes in one go.
Instead, the contract remains king and is a contractor’s best means of protecting its security. When negotiating contracts, contractors should insist that:
- the principal’s right to have recourse to security is limited only to amounts which have been quantified and are ‘due’ under the contract (rather than amounts which are ‘claimed’ to be due, or amounts which the principal ‘might’ incur); and
- before recourse to any security, a principal MUST give reasonable notice (e.g., 5 business days) of its intention to do so. This will allow the contractor sufficient time to obtain an injunction if the principal is unfairly trying to convert the contractor’s security.
For principals, this decision serves as a win – confirming that it is not necessary to wait for a lengthy and expensive adjudication process to finalise before applying for a decision to be set aside.
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