Supreme Court of Victoria implies term: Contractor can make unconditional payment in lieu of security
In L.U.Simon Builders Pty Ltd v Cardigan Commercial Pty Ltd (No 2), the Supreme Court of Victoria implied a contract term, allowing the Contractor to pay the Principal cash in lieu of performance bond.
Background
The dispute arose from a design and construct contract under which the contractor (L.U. Simon) had provided two performance bonds as security, for the purpose of ensuring due and proper performance of the contract. The contractor sought return of the second of the two performance bonds, upon the contractor, unconditionally paying the amount of the performance bond to the principal (Cardigan) in cash. As is typical, the performance bond in dispute was to be returned to the contractor following the 12-month defects correction period.
The defects correction period had commenced when the proceedings began. The principal objected to the order sought by the contractor on the basis that there were numerous defects requiring rectification and it was always intended under the contract that the Contractor performed those works, with the risk of potential call on the security hanging over its head if it fails to perform.
The contractor had previously sought to restrain the principal from having recourse to the security in an earlier proceeding. The principal extended a previous undertaking that it would not have recourse to the security at the conclusion of the earlier hearing. Shortly before the undertaking was due to expire, the contractor offered to pay the principal the full value of the disputed bond in exchange for its return. The principal refused that offer. The contractor then commenced this proceeding.
The contractor sought an order allowing it to pay the principal the value of the security unconditionally, following which the principal must return the performance bond.
Decision
Delany J found that:
- the contractor's proposal to exchange the performance bond for cash did not fall within the contract's substitution of security regime; and
- the contract contained an implied term that "the Contractor may pay out the Security at the Contractor’s discretion by paying to the Principal the amount of the Security in cash, less any part or parts that previously have been paid, following which the Principal is to release the Bank Guarantee/s to the Contractor and the Contractor shall have no obligation to provide replacement or other security."
Substitution of security regime was not applicable
The substitution of security regime was contained in clause 5.3 and allowed the contractor to request permission to substitute the form of security. The principal had absolute discretion to accept such requests.
The principal initially contended that the contractor's proposal to pay cash to discharge the performance bond was a substitution and therefore fell within clause 5.3. Whereas, the contractor argued that clause 5.3 was not applicable as it was not seeking to 'substitute' the performance bond, but was instead seeking to pay cash to the principal to put it in the same position it would be in if the bond was cashed.
During the course of the hearing, the parties reached a common position that the contractor's proposal did not fall within clause 5.3.
Implied term
Delany J found the implied term was permissible, with applicable appellate authority tracing back to the established requirements for the implication of terms in BP Refinery. Delany J held :
First, the implied term was necessary to ensure the contract's commercial efficacy and was consistent with its express terms. Delany J emphasised the approved form of unconditional undertaking annexed to the contract, which allowed the issuing financial institution to at any time pay the principal a sum equal to the value of the security less amounts previously paid, following which the financial institution's liability immediately ceased. His Honour held it would be an odd result for the contractor to not also be able to pay out the security sum where both circumstances would have the same contractual consequence.
Second, the implied term was reasonable and equitable. The implication of the term was consistent with the bank guarantee being 'as good as cash'.
Third, as is seen above, the implied term was capable of clear expression. Its text could also be formulated consistently with the contract's broader security provisions.
Fourth, the implied term was so obvious that it went without saying. It was also consistent with earlier appellate and Supreme Court authority that it remains open to the provider of a performance bond to pay the disputed amount to avoid any reputational damage that may result if recourse to the bond is had.
The requirements for the implied term were satisfied.
Takeaways
This decision highlights the need for parties to draft robust and comprehensive security regimes that address all potential factual scenarios.
From the principal's perspective, Delany J's decision to imply the term sought by the contractor reflects gaps in the contract's security regime. The implication of the term was permissible because the contract did not specify whether the contractor could pay out the bond's value in exchange for its return. Clear drafting to the contrary would likely have prevented this outcome.
Alternatively, Delany J's decision may be seen as surprising. The contract's security regime was reasonably comprehensive and in a relatively conventional form commonly seen in construction contracts. There is also body of Australian (and indeed Victorian) case law where implied terms were not needed to ensure the commercial efficacy of construction contracts.
Regardless of the view reached, the takeaway is clear: security regimes need to be comprehensively drafted and should expressly contemplate whether the contractor is permitted to pay out the value of security (whatever its form) in exchange for its return.
