Contractors face uphill battle restraining security calls

In brief

The Supreme Court of Western Australia has dismissed a subcontractor's application for an interlocutory injunction restraining a call on a bank guarantee. Partners Nick Rudge and Jeremy Quan-Sing and Lawyer Evan Lacey discuss the decision and its implications.

The facts

In February 2014, Samsung C&T Corporation (Samsung) and Laing O'Rourke Australia Construction Pty Ltd (LORAC) entered into a subcontract under which LORAC agreed to carry out landside port construction work (the Subcontract). Under the Subcontract, LORAC was obliged to provide performance security in an amount equal to 10 per cent of the value of the Subcontract. It did so by way of two bank guarantees.

In February 2015, Samsung terminated the Subcontract for convenience. Following termination, Samsung and LORAC entered into an 'Interim Deed', which provided that the bank guarantees would be returned and replaced by a single security in substantially the same form in the amount of $7.5 million (the Replacement Security).

In September 2015, Samsung merged with Cheil Industries Inc (Cheil). Following the merger, the company formerly named 'Samsung C&T Corporation' was dissolved and Cheil was renamed 'Samsung C&T Corporation'. The 'new' Samsung company retained Cheil's company registration number, which was distinct from that of the 'old' Samsung company.

In January 2016, with the parties in dispute, Samsung gave notice of its intention to call on the Replacement Security. LORAC applied for an injunction restraining Samsung from doing so.

Application for injunction

In applying for the injunction, LORAC argued that there was a serious question to be tried that:

• Samsung was not the beneficiary of the Replacement Security, and therefore not entitled to make a call.
  LORAC argued that the Replacement Security was issued for the benefit of 'old' Samsung rather than 'new' Samsung, and, thus, 'new' Samsung was not entitled to make a call.
• The conditions of the Replacement Security that must be satisfied before payment can be made had not been satisfied.
  The Replacement Security provided that the bank was obliged to make payment upon receiving a written demand signed by 'the Contractor'. LORAC argued that the definition of 'Contractor' in the Replacement Security could only refer to 'old' Samsung, and, therefore, any demand made by 'new' Samsung would not comply with the terms of the Replacement Security.
• The Replacement Security can only be realised if Samsung considers, acting bona fide, that it is entitled to recover from LORAC the secured amount.
  Such a condition on the realisation of the Replacement Security was not evident on the face of the Interim Deed, although it was express in Clause 5.2 of the General Conditions of Subcontract, which dealt with the conversion and use of security. LORAC argued that the condition survived termination of the Subcontract and now formed part of the Interim Deed. LORAC argued further that, as a matter of fact, the condition had not been satisfied.

In arguing that the balance of convenience favoured the grant of an injunction, LORAC highlighted the fact that its Australian business operations were on the market for sale and that it would suffer reputational damage if it became known that Samsung had made a call on the bank guarantee. LORAC also argued that it may be unable to enforce any award or judgment for the return of the Replacement Security given that Samsung had few assets in Australia.

The decision

Justice Tottle dismissed the application, holding that LORAC had failed to establish that there was a serious question to be tried or that the balance of convenience favoured the grant of an injunction.

Serious question to be tried

In relation to LORAC's argument that 'new' Samsung was not the beneficiary of the Replacement Security and therefore not entitled to make a demand, Justice Tottle held that the succession by 'new' Samsung to the rights and liabilities of 'old' Samsung (including the right to call upon the Replacement Security) was a question as to the status of 'new' Samsung to be determined according to the law of the Republic of Korea. Having regard to various provisions of the Korean Commercial Code, including Article 235 which provided (in relation to a partnership of companies) that 'a surviving company or a company newly incorporated in consequence of a merger shall succeed to the rights and obligations of the company which disappeared', Justice Tottle concluded that 'new' Samsung was the beneficiary of the Replacement Security.

In addressing LORAC's argument that the conditions of the Replacement Security had not been satisfied as 'new' Samsung did not meet the definition of 'Contractor' in the Replacement Security, his Honour construed the Replacement Security in accordance with the ordinary principles of construction, holding that it was both sensible and commercial to construe the term 'Contractor' in the Replacement Security as including 'new' Samsung. Therefore, Justice Tottle rejected LORAC's argument that this condition of the Replacement Security had not been complied with.

Finally, his Honour accepted LORAC's argument that it was a condition of the Replacement Security that Samsung consider, acting bona fide, that it was entitled to recover the secured amount from LORAC. While such a condition was not express in the Interim Deed, his Honour concluded that:

• the clear commercial intent of those provisions of the Interim Deed dealing with security was to give Samsung the same benefit as conferred by Clause 5.2 of the General Conditions of Subcontract; and
• nothing in the text of the Interim Deed indicated an intention to depart from the approach to security set out in the General Conditions of Subcontract.

Justice Tottle was not convinced, however, that LORAC had established to the requisite degree of certainty that Samsung had not acted bona fide in considering that it was entitled to recover the amount secured by the Replacement Security. His Honour held that while an application for an interlocutory injunction requires the court to undertake a provisional assessment of whether there is a 'serious question to be tried', a provisional conclusion as to a lack of bona fides can only be made on the basis of 'persuasive evidence':

A party that tries to establish, within the context of, and subject to the procedural limitations of, an interlocutory application, that its opponent acted without bona fides faces significant forensic difficulties. In assessing the allegation of a breach of bona fides, a court will look for undisputed facts and facts not surrounded by controversy from which to draw inferences. In this case, many of the matters relied upon by LORAC are so bound up in the controversies involved in the underlying dispute that it is difficult to draw the inference of a lack of bona fides for which LORAC contends.

 

LORAC submitted that an inference of a lack of bona fides on the part of Samsung could be drawn from a number of factors, including a substantial downward revision in Samsung's assessments of the amount payable to LORAC under the Subcontract between February and November 2015.  In response, Samsung's Project Control Director gave affidavit evidence explaining the method by which payments to LORAC had been calculated and how this method, in Samsung's view, had led to LORAC being overpaid. Justice Tottle stated that while Samsung may ultimately be required to pay LORAC more than it currently considers LORAC to be entitled to, his Honour was satisfied that Samsung's explanation of the downward revision indicated that it had acted in good faith. 

While a contracting party may seek to gain a degree of comfort by including such a bona fides condition on access to a performance bond, the decision sets a high evidentiary bar and indicates that it will be very difficult to establish bad faith on the part of the party making a call at the interlocutory stage. The bar will be particularly high where, as in this case, the purpose of the performance bond is to allocate the risk of being 'out of pocket' pending resolution of the underlying dispute and the granting of an injunction would effectively deprive the party making a call from the benefit it contracted for – the right to realise the bond at short notice.

Balance of convenience

Justice Tottle rejected each of LORAC's submissions with respect to the balance of convenience.

While not doubting that LORAC would suffer reputational harm as a result of a call on the Replacement Security, his Honour stated that potential buyers of LORAC's Australian operations would view the matter as part and parcel of the 'commercially aggressive world of international construction contracting'.

In the context of the LORAC sale and the associated increase in scrutiny of LORAC's commercial dealings, it is difficult to imagine that an argument relating to reputational damage could be put any more strongly than it was in this case. Its rejection by Justice Tottle indicates that reputational damage caused by a call on a performance security is unlikely to be given weight in considering whether the balance of convenience favours the grant of an injunction.

In relation to LORAC's claim that it may not be able to enforce a judgment or award ordering Samsung to return the Replacement Security, Justice Tottle was satisfied that Samsung was an international company with a history of profit making and that it was highly unlikely that it would be unable to satisfy any such judgment or award.