It is common for parties in contract negotiations to insert a requirement for a party to "act reasonably" in exercising its rights under a contract. The qualifier is often a compromise to lessen the potential for an otherwise harsh position. While this is often an appropriate compromise, the recent Victorian Supreme Court decision in Lend Lease Services Pty Ltd v Sugar Australia Pty Ltd, demonstrates the dangers of inserting the qualifier into an unconditional bank guarantee regime.
The case arose out of a contract to upgrade a refined sugar station. The parties went into dispute and Sugar Australia (Sugar), the principal of the project, attempted to call on the bank guarantees that Lend Lease, the contractor, provided under the contract. By the time of the proceedings, Lend Lease had terminated the contract.
The proceedings involved an application by Lend Lease for an interlocutory injunction to restrain Sugar from calling on the bank guarantees.
Importantly, this case involved an interlocutory injunction, not a final determination of the matter. As a result, the proceedings are directed to determining whether the test for granting an interlocutory injunction has been met, rather than finally determining whether Sugar was entitled to succeed in its claim for damages and have recourse to the bank guarantee.
The test for an interlocutory injunction involves whether:
- there is a serious question to be tried – that is, there must be a sufficient likelihood of success to justify the preservation of the status quo until trial
- the party seeking the injunction is in a position that, if no injunction is granted but they succeed in their final claim, they will have suffered irreparable harm and damages will not be an adequate remedy, and
- the balance of convenience favours the grant of the injunction.
Assuming this test is met, the court has discretion to grant the injunction.
Interlocutory injunctions and unconditional securities: the general rule
Bank guarantees are included in contracts for two main purposes:
- provide security to the holder by allowing recourse against a third party bank, rather than having to recover directly against the party, and
- allocate the risk of which party should be out of pocket, pending resolution of any dispute that may arise.
It is a matter of contractual construction whether the security provisions are designed to meet one or both of these objectives.
In the case of injunctions against a party calling on a performance guarantee, generally a court will not step in to prevent the issuer of a performance guarantee from performing its unconditional obligation to make payment, unless one of the recognised exceptions apply.
- if the party calling on the performance guarantee has acted fraudulently
- if the party calling on the performance guarantee has acted unconscionably in contravention of the Trade Practices Act 1974 (Cth) or the Competition and Consumer Act 2010 (Cth), and
- where the contract in question provides for negative stipulations on the calling on the performance guarantee and the negative stipulations are met.
In general, it's the last exception that's most commonly relevant in commercial disputes, and is resolved through the application of general construction principles to the contract in question.
Contract in question
The clause in question was an amended version of the General Conditions of Contract AS 4910–2002's bank guarantee clause, and stated:
Any security provided by the Contractor in accordance with the Contract shall be available to the Principal whenever the Principal may claim (acting reasonably) to be entitled to:
- the payment of moneys or an indemnity by the Contractor under or in consequence of or in connection with the Contract;
- reimbursement of any moneys paid to others under or in connection with the Contract; or
- other moneys payable by the Contractor to the Principal (whether by way of set-off or otherwise).
The inserted term, "acting reasonably", was not defined.
Sugar argued that "acting reasonably" involved a solely subjective element focussing on its motive for making the claim for payment. As a result, Sugar claimed it was only required to demonstrate that it has a genuine arguable claim for an amount equal to, or in excess of, the amount of security.
Lend Lease argued that Sugar was not "acting reasonably" in seeking recourse to the bank guarantees because:
- Lend Lease contended that it had no indebtedness to Sugar
- Lend Lease's claims against Sugar far exceeded Sugar's claims against Lend Lease, and
- Lend Lease had the benefit of a liability cap under the contract.
The Court held that the matter turned on the proper construction of the words "acting reasonably" found in the clause. In particular, whether these words are confined to a subjective analysis, or import the concept of an objective assessment. As a result, this was held to constitute a serious issue to be tried.
In granting the interlocutory injunction, the Court held:
- if no injunction was granted but the claims of Lend Lease are ultimately vindicated, it will, in all likelihood, suffer the irreparable harm for which damages will not be an adequate remedy due to reputational damage and questions over the solvency of Sugar, and
- the balance of convenience strongly favours the grant of the injunction to preserve the status quo pending the resolution of the disputes.
Implications for agencies
This case highlights that wording to water down the strength of obligations can introduce uncertainty. While this may be an appropriate compromise for some obligations, where the obligation in question relies on certainty to meet the purpose it was designed for inserting vague qualifiers should be avoided.
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.