Out-Law / Your Daily Need-To-Know

Australian court allows call on security despite ongoing arbitral proceedings

Out-Law Analysis | 29 Nov 2022 | 3:26 am | 3 min. read

The New South Wales (NSW) Supreme Court has refused to extend an injunction that prevented a company from calling on a contractor’s AU$467 million bank guarantee, despite the contractor facing financial troubles and potential insolvency.

In the case between Daewoo Shipbuilding & Marine Engineering Co Ltd and INPEX Operations Australia Pty Ltd, the Court was required to consider whether to extend an interim injunction preventing INPEX from calling on the bank guarantee until an arbitral tribunal determined the parties’ dispute. The Court refused to extend the interim injunction.

This decision highlights that a party will not be precluded from calling on a bank guarantee solely because arbitral proceedings are on foot and that the commercial purpose of a bank guarantee will be central to any decision concerning an injunction to restrain a call on the guarantee. Where the guarantee is designed to act as a risk allocation device, a party is less likely to be restrained from having recourse. The fact that a contractor is facing financial difficulties may not provide sufficient reasons to warrant a principal from being injuncted from having recourse to a bank guarantee.

It also highlights the importance of careful contract drafting. Parties seeking to restrain a call on, or have recourse to, a bank guarantee, should carefully consider the underlying contractual provisions to ensure they have a strong contractual basis for doing so.

The Court also noted there are generally two reasons why parties agree to provide a bank guarantee:

  • As a means of providing security: if there is a valid claim and there are difficulties associated with recovering from the defaulting party, the beneficiary may have recourse against the bank.
  • To allocate risk as to which party should pay for it itself until the dispute is resolved. Whether a bank guarantee is intended to allocate risk or merely act as security for performance is a question of contractual interpretation.

The case

Daewoo and INPEX signed a contract under which Daewoo was to engineer, procure, supply, construct and commission the floating production storage and offloading facility (FPSO). The contract also required, among other things, that Daewoo provide security in the form of a bank guarantee.

The FPSO was built and delivered by Daewoo. However, the parties fell into dispute, with INPEX asserting it had suffered loss and damage due to defects and delays in the delivery of the FPSO, in an amount greater than the value of the bank guarantee. INPEX subsequently requested that the dispute be referred to arbitration in accordance with the contract’s dispute resolution procedure.

Daewoo then applied to the NSW Supreme Court for an urgent injunction restraining INPEX from calling on the bank guarantee and seeking its return.

Daewoo said that it was facing financial difficulties and that it had recorded a $1.85 billion loss in 2021, and that any call on the bank guarantee could result in it being unable to meet its obligations under other contracts, which in turn could trigger defaults and calls on other bank guarantees.

Daewoo cited the impact of the Covid-19 on productivity and the sanctions imposed on Russia following the Russian-Ukrainian war as causes of its financial difficulties.

Daewoo argued that a call on the bank guarantee would cause a downgrade of Daewoo’s credit rating, which posed the risk of irreparable harm to Daewoo’s reputation and business, and that the balance of convenience favoured the injunction being extended.

INPEX argued that Daewoo’s financial difficulties supported its contention that the injunction ought not to be extended as there was a risk that Daewoo would be unable to obtain an extension of the guarantee, or satisfy any arbitral award made in favour of INPEX.

The Court preferred INPEX’s position on this issue and was ultimately unable to ignore the potentially adverse effects Daewoo’s financial difficulties could have on INPEX.

Justice Rees said that the bank guarantee was provided as a means of risk allocation as it provided for a ‘pay now, argue later’ regime. Her honour found that the commercial purpose of the contract was that INPEX would “get to hold the money” while the dispute between the parties was determined by an arbitral tribunal. On that basis, her honour concluded that Daewoo’s case was not strong enough to warrant an extension of the injunction restraining INPEX from making a call on the guarantee being granted.

Co-written by Jake Lengui of Pinsent Masons.

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