Molino Cahill July 2015

2015 CHANGE AND CONTINUITY This July 2015 edition of our brochure comes at a time of significant change for many of our clients. Mining construction has come off the boil and our clients are looking for opportunities in growth sectors, including road, rail, pipelines and health care infrastructure. Established players are adjusting the way they do business in the face of strong competition from international players who are seeking to win tenders to build a long term Australian presence. The mix of our work reflects the changing mix of projects in the Australian marketplace.

We are currently acting for Australian and international clients on a wide range of projects across the country. Some of these projects are highlighted on page 6 in our Project Snapshot.

Notwithstanding changes in the project mix, some things never change. In this edition, we examine the ongoing challenge presented by back-toback contracting. We also focus on applications to block calls on bank guarantees, and the enforceability of settlement deals involving future claims.

Finally, Tony Molino has again been named the Best Lawyers’ Melbourne Construction/Infrastructure ‘Lawyer of the Year’. Only a single lawyer in each practice area in each region is honoured as the ‘Lawyer of the Year’.

This recognition is based on peer-review assessments and reflects the high level of respect Tony has earned among other leading lawyers for his experience, ability, professionalism and integrity.

In addition, Tony Molino, Meghan Cahill and Penny Swain have again been named in Best Lawyers of Australia in the practice areas of Alternative Dispute Resolution and Construction/ Infrastructure Law. Alastair Oxbrough has again been named in the practice area of Construction/Infrastructure Law. We are extremely grateful to our peers for this recognition.

We hope you find this edition interesting and useful.

July 2015

Discussed inside: Back to Back Contracting

3-5

Project Snapshot

6-7

Calling Bank Guarantees Can it harm my reputation?

8-13

Settlement of Unknown and Future Claims

14-15

2

Head contractors have a legitimate reason to want to hold security until the defects liability period under the head contract has expired. However subcontractors may not be well placed to manage the risk that the defects liability period could drift out indefinitely.

3

BACK TO BACK CONTRACTING With back to back arrangements it is common to find that the subcontract links certain entitlements to completion under the head contract. In particular, there is often a link between achieving completion upstream and the expiry of the defects liability period downstream.

This can have a knock-on effect on the date for return of security and the duration of the subcontractor’s obligation to maintain certain kinds of insurance cover.

The decision in Wright v Lend Lease Building Pty Ltd; Intercon Engineering Pty Ltd v Lend Lease Building Pty Ltd [2014] NSWCA 463 involved an arrangement where the subcontractors’ right to call for release of retention monies was linked to the achievement of completion under the head contract.

The Court of Appeal recognised that the commercial purpose of such arrangements is to ensure that the head contractor will not be required to release bank guarantees or retention money before the defects liability period under the head contract has expired.

The outcome of that decision favoured the head contractor, leaving the subcontractors out of pocket pending completion upstream.

Head contractors should not assume that the outcome on this particular issue will always favour the head contractor.

There are a number of reasons why the outcome could be different the next time this question comes before a court: • The precise words in the head contract and subcontract will be critical to the outcome.

• The words in the contract are not the only relevant consideration. If there is evidence that the failure to achieve completion is the result of default on the part of the head contractor, for example, this evidence may open up a line of argument that was not available in this case.

• As between the head contractor and principal, there is nothing to prevent the head contractor from negotiating amendments to the upstream dates but, as between the head contractor and subcontractor, there may be limits on the head contractor’s ability to push negotiated changes down to the subcontractor via tied obligations, particularly if there is a change to the fundamental basis of the underlying contract that causes significant prejudice to the subcontractor.

4

Contracts

Subcontractors’ Submissions

Court of Appeal Findings

In Wright, Lend Lease entered into a head contract with the Commonwealth to carry out building works for the Mulwala Redevelopment Project (Head Contract).

In 2009 Intercon and the Wrights (together, the Subcontractors) entered into four subcontracts with Lend Lease for work on the project (Subcontracts).

The Subcontractors put forward a variety of overlapping arguments, seeking to persuade the Court that on a proper construction of the Subcontracts, the Defects Liability Period under the Subcontracts:

The Court rejected the notion that a date in a contract could not be defined by reference to a date that would only become certain when relevant events had “played themselves out”. The Court accepted Lend Lease’s submission that parties have the contractual freedom to agree to a date in a contract by reference to a future event in respect of which a date is not known, citing Austra Tanks Pty Ltd v Running [1982] 2 NSWLR 840.

The Subcontracts were in identical terms, except for differences in the dates, scopes and prices. Under the Subcontracts: • Lend Lease was entitled to hold retention money; • the Subcontractors were entitled to the release of the retention money in two tranches, with the second tranche being released on the expiry of the Defects Liability Period (as defined); and • the Defects Liability Period commenced on the Date of Substantial Completion and expired “24 months after the Date of Final Acceptance (as defined under the Head Contract)”.

The Subcontractors completed the works under the Subcontracts and sought the release of the second tranche of retention monies held by Lend Lease. Lend Lease refused, arguing that Final Acceptance under the Head Contract had not been achieved.

• should not be tied to the Date of Final Acceptance under the Head Contract; and • expired 24 months after the Date of Substantial Completion under the Subcontracts. ne argument was that defining the O expiry of the Defects Liability Period by reference to the Date of Final Acceptance under the Head Contract, which date was not known and indeed may never occur, was inconsistent with the requirement under the Subcontracts for a finite Defects Liability Period. nother argument was that the words A “after the Date of Final Acceptance (as defined under the Head Contract)” should be omitted to avoid commercial absurdity and inconsistency. The only remaining words would be “24 months”, meaning that the Defects Liability Period would expire 24 months after the Date of Substantial Completion under the Subcontract.

I t was also argued that the Court must ascertain the expiry of the Defects Liability Period. The Subcontractors submitted that this should be done by reference to the Head Contract in its form as at the date of entry into the Subcontracts, and without reference to a number of amending deeds entered into

by Lend Lease and the Commonwealth which appear to have included a significant extension to the Date for Final Acceptance. It would also involve nominally replacing the words of the Subcontracts so that the expiry date of the Defects Liability Period would be based on the Date for Final Acceptance, rather than the Date of Final Acceptance, under the Head Contract.

Likewise, Beazley P, with whom the other Judges agreed, rejected the submission that the words “after the Date of Final Acceptance (as defined under the Head Contract)” should be omitted to avoid commercial absurdity and inconsistency.

Beazley P observed that “[a]lthough the [Subcontractors] might not have foreseen this consequence at the time of entering into the contract, that is not the relevant test to apply. Rather… it is the objective intention of the parties that is relevant in determining the proper construction of a contract”.

Beazley P agreed that there was merit in the argument that the Subcontracts should be construed by reference to the Head Contract in its form as at the date of entry into the Subcontracts.

Nevertheless, the Subcontractors’ construction of the Defects Liability Period was rejected because it required the Court to draw an inference that the Date of Final Acceptance was the same as the Date for Final Acceptance, when there was no factual evidence to support such a finding.

In a separate judgment, Emmett JA agreed with the reasons of the President. Emmett JA observed that the Subcontractors had not adduced evidence to the effect that the failure to achieve Final Acceptance under the Head Contract was the result of default on the part of Lend Lease. While noting that no suggestion to that effect had been made by the Subcontractors, Emmett JA indicated that submissions of this nature may have been considered if such evidence was available.

5

Parties have the contractual freedom to agree on a contract date which is linked to future events, even though the date can only be ascertained once these events have “played themselves out”.

This highlights, as mentioned earlier, that the words in the contract are not the only relevant consideration. It is possible that default by the head contractor may untie the link between the obligations upstream and downstream.

Practical Considerations There is no doubt that a head contractor has a legitimate reason to be concerned about an arrangement where it is required to release bank guarantees or retention money before the Defects Liability Period under the head contract has expired.

Equally, subcontractors and suppliers may not be well placed to manage the risk that the Defects Liability Period will drift out for an indefinite period for reasons that have nothing to do with their own contract, particularly where they do not have the commercial leverage to flow this risk down to their own subcontractors and sub-suppliers.

At tender stage, subcontractors and suppliers who are concerned about this risk should consider whether to propose that the Defects Liability Period should be subject to a ‘latest’ date of expiry, which is (say) two years from completion of their work. Alternatively, it may be possible to negotiate that (say) 90% of the security should be returned by an agreed date, with the balance returned once completion is achieved under the head contract.

6

WESTERN AUSTRALIA • Roy Hill Port and Mine • Solomon Mine • Perth Children’s Hospital

PROJECT SNAPSHOT This map shows some of the Australian projects where we have had recent involvement.

We work on large scale projects across Australia in the infrastructure, construction, energy, technology, defence and resource sectors.

We act for Australian and international clients from the private sector in relation to all aspects of these projects, including for principals, contractors, subcontractors, engineers, superintendents, consultants, suppliers, insurers and investors.

We’re currently advising on all stages of projects, from requests to tender through to project delivery and dispute resolution. This includes providing advice and assistance on individual issues and contracts, through to preparing full tender packages and conducting largescale arbitration and court proceedings.

Right now, we’re involved in Supreme Court and Federal Court proceedings in various States, involving issues ranging from professional negligence claims to claims about defective equipment.

We’re currently helping Australian and international principals, consultants, contractors and suppliers with claims on a wide range of projects, including claims involving delay, variations, performance issues, bank guarantees, fitness for purpose, defects and Security of Payment claims and responses. We’re also advising superintendents on a number of resource and infrastructure projects which are at the construction stage.

Our recent advisory work includes providing advice to clients in Australia, the United States and Europe in relation to various contracts and tenders, including joint venture agreements, teaming agreements, engineering consultancy agreements, supply contracts, defence tenders and long term service agreements, including water technology services and aeronautical services.

Often our work is behind the scenes, particularly when we’re asked to assist bid teams or to provide advice on claims administration.

If you would like any further information on our capabilities, please contact one of our Directors.

7

NORTHERN TERRITORY • Ranger Uranium Mine • Ichthys

QUEENSLAND • Airport Link • Lady Cilento Children’s Hospital

SOUTH AUSTRALIA • Port Pirie Smelter Redevelopment • New Royal Adelaide Hospital

NEW SOUTH WALES

• Rail Project

• West Connex Stage 1 – M4 • North West Rail Link • Water technology project • Eastern Gas Pipeline

VICTORIA • Wonthaggi Desalination Plant • Melbourne Airport • Ravenhall Prison • East West Link • Bendigo Hospital • Longtom Gas Field

TASMANIA • National Broadband Network Rollout

8

Contractors are concerned that calls on bank guarantees are taken into account during tender evaluation, potentially undermining their ability to win tenders.

9

9

CALLING BANK GUARANTEES – CAN IT HARM MY REPUTATION? A bootstraps argument is a circular argument. Like the fictional tale of Baron Munchausen who pulled himself out of a swamp by pulling on his own pig tail, there is a fundamental problem in the logic.

There have been a number of recent cases where contractors have successfully established that the balance of convenience favours granting an injunction to block principals from calling on unconditional bank guarantees.

It has been suggested that an argument based on reputational harm is a bootstraps argument. Arguably, any call on security involves at least some risk of reputational harm. The question is whether reputational harm should be considered when justifying injunctive relief.

In light of the recent decision of the Victorian Court of Appeal in Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98 (Sugar Australia), this article considers how courts have dealt with the issue of reputational harm.

Status of Bank Guarantees Unconditional bank guarantees are the most common form of security provided by contractors and suppliers.

From the principal’s point of view, there is a general expectation that a bank guarantee is ‘as good as cash’. One of the principal’s commercial objectives is to

lock in the right to immediate and reliable access to funds, without the need to wait for the determination of any dispute. The bank guarantee is intended to provide the principal with immediate access to funds to reduce the risk that it will be left out of pocket in the event of default by the contractor or supplier. Consequently, if the bank guarantee is seen as anything less than cash, then the practical value of the security to the principal is significantly undermined.

Generally, the terms of the underlying contract will dictate how beneficiaries may call on the bank guarantee. When an unconditional bank guarantee is called, the bank must not involve itself with the underlying reason or contractual entitlement for the call; rather the bank must simply pay the requested amount.

Upon catching wind of such demand, contractors often seek an injunction to restrain the principal calling upon the guarantee. To be successful, the contractor must satisfy the court that: • there is a serious question to be tried; • the contractor is likely to suffer injury for which damages will not be an adequate remedy (if an injunction is not granted); and • the balance of convenience favours the granting of an injunction.

In recent years, it is this last point that has seen a rise in applications by contractors invoking reputational harm.

10

Having established there is a serious question to be tried and damages are an inadequate remedy, some contractors have sought to prove that the balance of convenience favours the contractor, claiming the calling of the bank guarantee will expose them to reputational damage.

11

Seeking Injunctions Restraining the Call of Bank Guarantees Having satisfied the court of the first and second requirements listed above, contractors have sought to prove the balance of convenience favours the granting of an injunction on the basis that calling the guarantee will expose the contractor to reputational damage in the industry.

Historically, contractors seeking an injunction have ‘painted’ their case with regard to the financial impact the calling of the bank guarantee may have on its reputation. More recently however, in addition to claims of financial harm, contractors have argued that allowing the call of the bank guarantee may potentially impact on: • the contractor being able to obtain bank guarantees on similar terms and costs in the future; • the contractor’s good will with clients; • the contractor’s ability to negotiate future contracts; and • the contractor being competitive in tenders.

In particular, contractors have pointed to the fact that the number of times security has been called forms an integral part of their reputation within the industry. This is especially so as prospective clients often treat this issue as part of the selection criteria for tender evaluation.

Since the decisions of Barclay v Mowlem, Abigroup Contractors Pty Ltd v Peninsula Balmain Pty Ltd, Walter Construction Group Ltd v Secretary Department of Infrastructure, and Reed Construction Services Pty Ltd v Khen Seng (Australia) Pty Ltd, which together lay the groundwork for contractors to claim reputational harm in relation to the calling of bank guarantees or the like, the judiciary appears to have placed increasing weight on such propositions.

The recent decision of the Victorian Court of Appeal in Sugar Australia however, highlights that reputational harm should have no bearing on the matter, unless the contractor has first established that there is a serious question to be tried and damages are not an adequate remedy.

Sugar Australia involved an appeal from the decision of the Victorian Supreme Court granting an interlocutory injunction restraining recourse to two bank guarantees, worth more than $4 million, provided by way of performance bonds

by Lend Lease to Sugar Australia under a building contract.

In the Court of Appeal, the outcome turned on the recourse clause, which stated as follows: 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: i. t he payment of monies or an indemnity by the Contractor under or in consequence of or in connection with the Contract; or ii. r eimbursement of any monies paid to others under or in connection with the Contract; or iii. o ther monies payable by the Contractor to the Principal (whether by way of set off or otherwise).

Recourse to security shall only be subject to the Principal having given the Contractor five days’ notice of its intention to have recourse to the security for the purpose of allowing the Contractor to replace the security with cash where it has been issued in a form other than cash. Where the Principal has recourse to security in accordance with clause 37.3, the Contractor shall provide replacement security in accordance with clause 37.3.

The Court of Appeal allowed the appeal on the basis that Vickery J failed to resolve the construction of this clause which was a necessary prerequisite to determining whether Lend Lease had established that there was a serious question to be tried. As noted by Osborne and Fergusson JJA, the dual purpose of the bank guarantee was to allocate risk pending the final determination of the parties’ rights and to provide Sugar Australia with security. Consequently, their Honours held that the recourse clause, …fundamentally alters the context in which the Court must exercise its discretion by changing the complexion of the status quo and raising the prospect of substantial injustice if the purpose of the provision is defeated. That is, the status quo in such circumstances becomes what the parties have agreed as to which of them should bear the financial risk pending final determination…

Kaye JA, with whom Osborne and Ferguson JJA concurred, also found that Vickery J ought to have determined the correct construction of the recourse clause, in order to determine whether Lend Lease had demonstrated that there was a serious question to be tried as to the application of that clause to the circumstances of the case. Whilst finding there was no serious question to be tried in relation to certain rectification claims outlined in the recourse notice, Kaye JA did find there was a serious question to be tried in respect of the other items mentioned in the recourse notice.

In determining whether the balance of convenience favoured granting an injunction in respect of those claims which satisfied the serious question requirement, his Honour made a number of observations concerning Lend Lease’s claim that it would suffer reputational harm if the bank guarantees were called. In particular, Kaye JA expressed reservations as to the assertions that the existence of the dispute in this case would have any substantial adverse impact on Lend Lease’s reputation in the marketplace, noting that the claims of reputational harm were “substantially assertions”. In other words, a party wishing to rely on reputational harm needs to provide evidence in support, rather than a mere assertion that harm may occur.

Additionally, Kaye JA held that by agreeing to the recourse clause at the time of entering into the contract, Lend Lease assumed the risk that a call may be made upon the security. Furthermore, his Honour noted “that it is notorious that disputes are commonly part and parcel of building contracts”. Consequently, Kaye JA considered claims about reputational harm were not valid considerations for determining where the balance of convenience lay in this particular case.

12

Similar views in relation to reputational harm were expressed by Kenneth Martin J, in Central Petroleum Ltd v Century Energy Services Pty Ltd (Central Petroleum). Although accepting that there may well be instances where the cold calling of a performance guarantee may cause reputational damage to the exposed party, his Honour did not see the present case of the same ilk.

In particular, in Central Petroleum, the contractor was in a strong financial position and was able remove itself from the potential threat of the undertaking being called by making a payment of a modest sum to the principal.

Consequently, Kenneth Martin J held that the contractor’s argument in relation to its damaged business reputation was “a paradigm case of a party ‘bootstrapping’ towards its own asserted prejudice to achieve its end game of injunctive relief”.

Similarly, although in dissent, Young JA’s judgment in Lucas Stuart Pty Ltd v Hemmes Hermitage Pty Ltd (Lucas) also expressed doubts about the weight to be attributed to a claim of reputational harm: …it is difficult to pay much credence to a statement [claiming reputational damage] by a person against whom it is alleged that the building which it and its subcontractors constructed has over a thousand defects and is not watertight would suffer in its reputation any more if in addition to those facts being known…it was known that its performance guarantee had been called up in a manner which it disputed.

In contrast to the above decisions, in New South Wales in the decision of Lucas Stuart Pty Ltd v Hemmes Hermitage Pty Ltd (Lucas) the Supreme Court of Appeal was prepared to accept that the calling of bank guarantees had the potential to cause reputational harm in that case. In Lucas, the principal argued that as the guarantees had been called (in part), any damage to the contractor’s reputation had already occurred and therefore the balance of convenience did not favour the granting of an injunction. The Court rejected this argument and accepted evidence to the effect that further calls on the bank guarantees had the potential to increase the reputational harm already suffered and accordingly, granted an injunction.

Conclusion Irrespective of whether reputational harm may arise, the party seeking to restrain the call of a bank guarantee must first establish that there is a serious question to be tried and that damages will not provide an adequate remedy. Unless and until these are established, the balance of convenience does not arise for consideration.

The cases demonstrate that reputational harm is one factor which may be taken into account when the courts determine the balance of convenience. The applicant needs to be able to point to hard evidence that the call of the bank guarantee will adversely impact the estimation in which the business is held in the market place.

Mere assertion is not sufficient. In those cases where the contractor has agreed that the principal can call on the guarantee pending dispute resolution, reputational harm is not a valid consideration because the contractor has assumed the risk that a call may be made upon the security.

13

The Judge found the contractor’s argument about reputational damage was a paradigm case of a party ‘bootstrapping’ to achieve an end game of injunctive relief.

14

14

SETTLEMENT OF UNKNOWN AND FUTURE CLAIMS

Releases in settlement agreements are often drafted in language which appears to cast a very wide net, releasing liability for unknown and future claims, in addition to the claims which are in dispute.

Is a Release of Unknown and Future Claims Enforceable?

Yes. In principle, there is nothing to prevent a party from entering into a binding agreement to release unknown and future claims, provided clear language is used to make the intention plain. Turning that proposition on its head, unless the language is crystal clear the courts will not conclude that a party intended to surrender rights that it did not know about and could not have known about.

Where the words in the release clause are general, there is a risk the court may read down the words. This practice dates from an ancient case which held “the general words of a release should be restrained by the particular occasion�: Knight v Cole (1690) 3 Lev 273; 83 ER 686.

It is common for the recitals of a settlement deed to provide brief details of the dispute that the parties have resolved to settle. The purpose of the recitals is to outline the nature and objectives of the agreement. The recitals in a settlement deed become the centre of attention if a dispute arises about the scope of the release. The majority in the High Court in Grant v John Grant & Sons Pty Ltd (1954) 91 CLR 112 (Grant) held that prima facie the release should be read as confined to the matters forming the subject matter of the disputes which the deed recites.

For this reason, the recitals need careful consideration when the deed is being prepared. If the recitals specifically refer to the resolution of a dispute about delay on a power station project, query whether the release clause would be read as applicable to latent defects discovered in the power station after settlement, even if the release is drafted in general terms and refers to unknown claims. The answer to this question will depend on the natural and ordinary meaning of the words in the release, read in light of the settlement deed as a whole (including definitions of terms used in the release, such as Claims), giving due weight to the context in which the clause appears and the nature and object of the agreement.

Is Non-disclosure Relevant?

Yes. The majority in the High Court in Grant observed that failure in a duty of disclosure, or misrepresentation, may in some cases go to the validity of the whole settlement agreement. In that situation, there may be legal grounds to do more than simply confine the general words of the release, and a court could instead set aside the contract and return the parties to their original position, prior to settlement.

Non-disclosure that involves unconscionable conduct may also give rise to the right to seek equitable remedies. The majority in Grant held that equity permits an investigation of the circumstances, including the actual intention of the parties, in order to determine whether enforcement of the general words of a release would be against conscience.

15 4

Unless the language is crystal clear, the courts will not conclude a party intended to surrender rights it did not know about.

1

Level 22, 181 William Street, Melbourne, VIC 3000, Australia

Telephone +61 3 9606 3200 Facsimile +61 3 9606 3222

www.molinocahill.com.au

Tony Molino Director MolinoCahill Lawyers T +61 3 9606 3210 tmolino@molinocahill.com.au

Meghan Cahill Director MolinoCahill Lawyers T +61 3 9606 3299 mcahill@molinocahill.com.au

Penny Swain Director MolinoCahill Lawyers T +61 3 9606 3209 pswain@molinocahill.com.au

Alastair Oxbrough Director MolinoCahill Lawyers T +61 3 9606 3215 aoxbrough@molinocahill.com.au

Brigid Lloyd Director MolinoCahill Lawyers T +61 3 9606 3202 blloyd@molinocahill.com.au