Building And Construction Update

• Enforcing bank guarantees under construction contracts

• The double-edged sword of proportionate liability – when should principals 'contract out' of the Civil Liability Act?

Enforcing bank guarantees under construction contracts

Most construction contracts (particularly those which govern large-scale projects) require contractors to provide unconditional bank guarantees to secure and guarantee their due and proper performance under the contract. However, bank guarantees for construction projects cannot be regarded as ironclad security or 'as good as cash'.

In recent times, contractors have been able to prevent principals from obtaining access to the funds secured by the guarantee by way of obtaining an injunction through the Court. Accordingly, it is essential for principals to ensure that:

• the form and the provisions of the bank guarantee; and
• the provisions of the contract dealing with recourse to the bank guarantee

adequately protect their interests and enable them to call on the bank guarantee without having to get involved in lengthy and expensive legal battles.

Ordinarily, the provisions of the unconditional bank guarantee will state that the financial institution (on behalf of the contractor) will unconditionally pay on demand, any amount demanded from time to time by the principal, up to a maximum aggregate of the amount of the bank guarantee. That is, the financial institution must not question the principal's entitlement to the bank guarantee under the construction contract and must simply hand over the cash demanded by the principal. The bank guarantee will usually remain active until the entire amount guaranteed has been paid or is no longer needed, and the original is handed back to the financial institution.

Some forms of bank guarantee place certain conditions on the principal before any money is handed over, including requiring the principal to provide a statutory declaration stating the reasons for its entitlement to the guarantee under the relevant contract. Some bank guarantees also contain a 'drop dead' expiry date. It is not uncommon for some bank guarantees to expire on a date which constitutes the end of the Defects Liability Period under the contract.

Principals should be wary of these forms of bank guarantee and not accept them, as a general rule. They have the potential to cause substantial hardship, and, in some cases, disentitle principals from ever having recourse to it. For instance, if the bank guarantee expires on the last day of the Defects Liability Period and the Final Certificate (usually issued 14 or 28 days after the expiry of the Defects Liability Period) certifies that an amount is owing to the principal, the principal may be left high and dry if the contractor fails to pay the amount certified.

Most contracts permit the principal to call on the bank guarantee in circumstances where a debt has become due and payable under the contract, and the contractor has failed to pay that amount within the required time. A debt becomes due and payable if it has been properly crystallised and certified in accordance with the contract.

That is, a mere assertion or claim by the principal that it is entitled to liquidated damages, or a claim for rectification of defects or money expended or likely to be expended as a result of work taken out of the hands of the contractor, is not enough to entitle the principal to call on the bank guarantee.

Therefore, it is essential for principals to ensure that either the contract permits them to call on the guarantee without having to actually incur or crystallise the debt; or the contract is administered properly so that all debts are crystallised as soon as possible.
by Ranjan Rajagopal

Part 4 of the Civil Liability Act (NSW) provides defendants to actions for 'apportionable claims' the right to identify 'concurrent wrongdoers' and thereby reduce their risk in an adverse judgment. Liability for judgments is apportioned between 'concurrent wrongdoers' at a rate reflective of individual responsibility.

A significant percentage of actions commenced by, or in relation to construction projects fall within the definition of an 'apportionable claim', which is a claim for economic loss or damage to property, in an action for damages under contract, tort or otherwise, arising from a failure to take reasonable care, or arising from a breach of section 42 of the Fair Trading Act 1987. A claim for personal injury is not an 'apportionable claim'.

A 'concurrent wrongdoer' is any party liable for a percentage of the loss, who could be joined as a defendant in the proceedings under Part 4 of the Act.

The scheme provides several benefits to principals under construction contracts. Firstly, it may enable a principal to ventilate claims against multiple parties in one action. Secondly, it may enable recovery of damages in excess of the construction contract 'liability cap' if the contract between the principal and the contractor includes such a cap.

If a defendant intends to invoke the proportionate liability scheme, it has a duty to give written notice to the plaintiff of the identity of any concurrent wrongdoer and the court may give leave to join an alleged concurrent wrongdoer. For example, in circumstances where a claim is for defective work, the contractor may identify a subcontractor as a concurrent wrongdoer, and the court may give leave to join the subcontractor in the proceedings. As such, the plaintiff/principal may seek recovery against the subcontractor within a claim against the contractor. Also, if the contractor is unable to meet an adverse judgment, the principal may still be able to recover the percentage of the judgment apportioned against the subcontractor.

Similarly, if the total loss claimed is greater than any liability cap contractually negotiated between the principal and contractor, proportionate liability will enable the principal/plaintiff to recover from the contractor the percentage of damage apportioned against the contractor, to the limit of the liability cap, and recover from the joined defendants further damages in the percentages determined by the court. The net consequence may be an award of damages in excess of the liability cap established between the principal and the contractor.

Naturally, if the scheme is not excluded from the contract between the principal and the contractor, the principal will also enjoy the benefits if an action is commenced by the contractor, and a concurrent wrongdoer could be identified. Such circumstances are, however far less frequent.

The scheme also poses a substantial risk to principals, in that it can either result in more complex and expensive multi-party proceedings or, if the concurrent wrongdoers are not joined in the proceedings, it can leave a principal/plaintiff with a right to recover only the percentage of the damage apportioned to the one defendant. Such is the 'double-edged sword' of proportionate liability legislation.

If concurrent wrongdoers are joined and judgment is apportioned to parties other than the contractor, the principal will have to recover sums from multiple parties creating inefficiencies and increased costs in enforcing the judgment, in addition to achieving the judgment. Also in terms of recovery, the contractor is likely to have provided security to the principal under the contract, which may be accessed as a consequence of the judgment however the concurrent wrongdoers may not have provided any security, and the principal/plaintiff will be required to pursue traditional enforcement mechanisms.

Part 4 of the NSW Act (Part 4) creates rights and liabilities with significant consequences in construction litigation. In New South Wales and Western Australia, the legislation is drafted to provide the capacity to contract out of the proportionate liability regime. Victoria, Queensland, the Northern Territory and the Australian Capital Territory all have similar proportionate liability regimes, but the legislation in those states does not provide the option to contract out.

A determination of the appropriateness of Part 4 should be made when drafting the contract for a project. For the sake of certainty, if it is determined that Part 4 will create inefficiencies in the resolution of disputes under the contract and possibly create further risks for the principal, a clause should be drafted specifically excluding the operation of Part 4 from the contract.

Considering the consequences in litigation of proportionate liability, principals and contractors are encouraged to seek specialist advice as to the risks for individual parties and projects under proportionate liability and to assist in determining whether it is appropriate or not to contract out of Part 4 in specific circumstances.
by Will Marshall

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.