Australia: Calling on a bank guarantee following termination of contract: Lucas v Armour

In brief - Right to call on guarantee accrued prior to termination of contract

In Lucas Drilling Pty Limited v Armour Energy Limited [2013] QCA 111, the Queensland Court of Appeal affirmed that on a proper construction of the contract, a party was entitled to call on the guarantee, even following termination of the contract, as the right to call on the guarantee accrued prior to termination.

Security under the contract between drilling company and energy company

Lucas Drilling Pty Limited entered into a contract with Armour Energy Limited pursuant to which Lucas agreed to provide oil and gas drilling services to Armour.

Clause 7 of the contract relevantly provided that the undisputed portion of an invoice was payable by Armour within 14 days of issue by Lucas. Any dispute of any item invoiced must be notified by Armour to Lucas within 14 days, otherwise it will be deemed to accept the invoice.

Clause 19.2 of the contract provided that in the event Armour has not paid a payment that it is obligated to pay under the contract and Lucas has provided seven days' written notice that it intends to make a demand under the performance bond, then Lucas may make a demand on the performance bond and apply it against any amount of a valid invoice which is undisputed by Armour.

Clause 19.3 of the contract provided that Lucas must, subject to any rights it may have in relation to the performance bond, return the performance bond to Armour within three days after the termination of the contract.

Pursuant to the contract, Armour procured a bank guarantee in favour of Lucas.

Invoices from Lucas unpaid and contract terminated by Armour

On 27 July 2012 and 13 August 2012, Lucas submitted two invoices to Armour which were not paid and were undisputed.

On 29 August 2012, Armour gave notice of termination of the contract. Later that same day, Lucas sent Armour a "Notice of Intention" pursuant to clause 19.2, providing notice that it intended to make a demand under the performance bond in respect of the unpaid invoices.

On 7 September 2012, Armour sought an interlocutory injunction to restrain Lucas from calling on the performance bond. The primary judge granted Armour the interlocutory relief sought.

Accrued right to recourse to security prior to termination

Lucas appealed the decision. The issue before the Court of Appeal was whether the primary judge erred in the exercise of the discretion to grant such interlocutory relief. In determining this, the Court of Appeal examined the proper construction of clauses 19.2 and 19.3.

The Court of Appeal considered the Full Federal Court's decision in Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd (2008) 249 ALR 458.

Clough set out that a court will not interfere with a party's right to call on a bank guarantee unless there is fraud, unconscionability or an unqualified promise to pay. The case also emphasised that the primary focus will always be the proper construction of the contract.

Southern Cross Constructions v Bucasia

The Court of Appeal also considered the decision of the Supreme Court of NSW in Southern Cross Constructions (NSW) Pty Limited (Administrators Appointed) v Bucasia Pty Limited [2012] NSWSC 1419.

Both Lucas v Armour and Southern Cross turned on the issue whether, on the proper construction of the contract, a party is entitled to issue a notice of intention to have recourse to security after termination of the contract. Southern Cross held that:

  • where a contract is terminated, the parties do not lose rights already unconditionally acquired.
  • where one party to a contract terminates for breach of contract, accrued rights are preserved.
  • upon a proper construction of the contract, the giving of the notice was not a condition precedent to the accrual of the right. It was merely the manner in which the right was to be exercised.

Lucas not required to return performance bond to Armour

Applying Southern Cross, the Court of Appeal held that the giving of the notice under clause 19.2 was not a condition precedent to the accrual of the right to have recourse to security, but was merely the manner in which the right was to be exercised.

Thus, it did not matter that Lucas did not give notice of its intention to have recourse to the security until after termination. The issue was whether Lucas had accrued the right to have recourse to the security prior to termination of the contract.

In this case, both parties agreed that both invoices were undisputed. Thus, Lucas accrued rights in relation to the performance bond when Armour failed to pay the invoices, prior to the termination of the contract.

Hence, the termination by Armour did not preclude Lucas giving the notice of its intention to make a demand under the performance bond after termination of the contract. Accordingly, Lucas was not required to return the performance bond pursuant to clause 19.3.

Karen Lo James Neal
Energy and mining law
CBP Lawyers

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