Want to convert security for LDs? Make sure your conversion clause is wide enough

Last  week,  the  Queensland Court  of Appeal held that a head contractor was not entitled to have recourse to bank guarantees provided by a subcontractor for liquidated damages (LDs) in the absence of a valid certificate from the superintendent certifying the LDs were due and payable to the head contractor.¹


In 2011, Forge Group Power Pty Ltd (Forge) was engaged by Diamantina Power Station Pty Ltd (DPS) to undertake the design, engineering, construction  and  commissioning  of the Diamantina Power Station in Mt Isa. Forge subsequently engaged RCR O’Donnell Griffin Pty Ltd (RCR) as an electrical subcontractor.

Under the subcontract, RCR provided two unconditional bank guarantees to Forge, totaling approximately $5 million.

By clause 5.2 of the Subcontract, Forge was entitled to have recourse to the guarantees where it remained “unpaid after the time for payment”.

Further, clause 34.7 of the Subcontract provided   that   “the  Superintendent shall certify” LDs due and payable to Forge if RCR failed to reach practical completion by the date for practical completion.

During the course of the works, Forge became insolvent, and was ordered to be wound up in March 2014.

In April 2014, DPS, Forge and RCR entered into a Deed of Novation (Deed), pursuant to which the Subcontract was discharged and RCR entered a new contract with DPS for performance of the remainder of the Subcontract works.  The  receiver  of  Forge appointed a superintendent, as the previous superintendent had resigned several months prior and had not yet been replaced.

Within an hour of being appointed, the superintendent certified LDs in the amount of approximately $2.5 million.

Forge’s receivers then demanded payment of the LDs, and informed RCR that it intended to:

  1. convert the guarantees to cash security; and
  2. have   recourse   to   the   cash security if its demand for payment of the LDs was not met.

RCR commenced proceedings in the Supreme Court of Queensland seeking to restrain Forge from having recourse to the guarantees.²



Forge argued that pursuant to clause 5.2 of the Subcontract, it was entitled to have recourse to security on a bona fide (genuine)  claim.  RCR  disagreed, arguing that Forge’s right of recourse was dependent upon the existence of a debt due to it.

The  leading  judgment was  given  by Philip McMurdo JA, with whom Applegarth J agreed. His Honour held that the language of clause 5.2 permitted Forge to have recourse to the guarantees only where, as a matter of objective fact (rather than subjective belief), there was an outstanding debt owed to it by RCR. His Honour said:

[T]he precondition to recourse to the security was the fact of money being unpaid to [Forge]. Clause 5.2 was not in terms which referred to a belief, or grounds for a belief, that money remained unpaid

His Honour held that the superintendent had not been validly appointed, and that the superintendent’s certification of liquidated damages was therefore invalid. This aspect of the Court’s decision turned on the specific wording and provisions of the Deed.

Importantly, His Honour rejected Forge’s argument that clause 34.7 of the Subcontract created an entitlement to LDs, even in the absence of a certificate issued by the superintendent. His Honour confirmed that LDs become a debt due only upon certification by the superintendent.

Ultimately, the Court held that Forge was not entitled to have recourse to the guarantees to satisfy its claim for LDs.


What this means for you

The decision of  the  Court of  Appeal highlights the  importance  of  careful contract drafting and administration.

In this case, due to the lack of a valid certificate, Forge was unable to convert RCR’s security to recover LDs, even though it was not disputed that RCR had failed to achieve practical completion on time.

Contracting parties should be aware that it will be difficult to prevent recourse to security when the entitlement to do so depends on subjective belief of a  genuine claim, rather than the objective fact of a debt due.

With respect to the conversion of security for, and setting off, LDs, participants in the construction industry should keep in mind that:

  1. under most standard contracts, there is no right to set-off LDs until they have been certified by the superintendent. Specific drafting is required to set-off LDs prior to the superintendent’s certification of the same;
  2. there is no right to set-off LDs unless a contractual provision expressly permits one party to set-off amounts due to it against amounts due to the other party;⁴
  3. unless a valid certificate was issued prior to termination, there is no right to set off or convert security after termination of the contract unless those clauses are specifically stated to survive termination;
  4. prior to having recourse to security, the notice requirements under section 67J of the Queensland Building and Construction Commission Act 1991 (Qld) must be complied with unless the contract has been terminated.


1 RCR O’Donnell Griffin Pty Ltd v Forge Group Power Pty Ltd (Receivers and Managers Appointed) (in liq) [2016] QCA 214.

2 RCR O’Donell Griffin Pty Ltd ACN 003 90093 v Forge Group Power Pty Ltd and Ors [2015] QSC 186.

3 At [95].

4 J Hutchinson Pty Ltd v Glavcom Pty Ltd [2016] NSWSC 126, [57].


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