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Decoding design and construct contracts: Security (part 2)

11 July 2022

#Construction, Infrastructure & Projects

Published by:

Andrea Wilson

Decoding design and construct contracts: Security (part 2)

The AS4902 contract is one of the most popular standards used for design and construction projects. In the first instalment of this series, we explained what ‘contract sum’ is and the key considerations when finalising the price.

In this next article, we consider the ‘security’ clause and its effects.

The type of security under a contract, including its value and circumstances where a party can have recourse to that security, is often heavily negotiated because the ‘security’ acts as an important risk allocation device.

What is security?

Security is a monetary amount that is generally held under a contract by the principal to secure the contractor’s performance of its obligations, hence the name ‘security’.  

Security is defined in the AS4902 as being able to take multiple forms, with the most common being:

  1. cash
  2. retention money
  3. an approved unconditional undertaking or performance undertaking given by an approved financial institution or insurance company. This is usually done by way of a bank guarantee or insurance bond.

The type and value of security agreed will be included in Item 14(a) and 14(b), respectively, of Part A of the contract. Importantly, if Item 14(a) requires an unconditional bank guarantee, the inclusion of expiry dates could be in breach of your contract (see CCIG (Australia) Pty Ltd v Amicus Hospitality Group Pty Ltd [2019] QSC 232).

A retention security is a portion of the contractor’s progress payment held by the principal, up until the requisite value of the security is retained.  

The value of the security under Item 14(b) of the contract is generally five per cent of the contract sum. This is the default percentage value if Item 14(b) is left empty.

In Queensland, if the contract is with a principal or special purpose vehicle and is for building work as defined under the Queensland Building and Construction Commission Act 1991 (Qld) (QBCC Act), pursuant to section 67K, no more than five per cent of the contract sum can be held as security unless certain preconditions are met.

Recourse to security

Clause 5 of the AS4902 usually governs the circumstances where security must be returned or alternatively can be taken by the principal.

Clause 5.2 provides that if a party remains unpaid after a time for payment, with five days’ notice, it can have recourse to the security held. There are numerous ways in which a contractor may become liable to pay a principal money under a contract, including because of defective work, liquidated damages, or other set-offs.

In Queensland, section 67J of the QBCC Act requires the party seeking recourse to the security to give notice within 28 days of becoming aware of the right to have recourse, and that it intends to use the security to recoup some (or all) of its debt. When and how the 28 days begins to run, and how this section works, is the subject of much judicial consideration. As such, if you are considering having recourse to security, you should seek legal advice before doing so.[1]

Finally, contracts are often silent in relation to whether a contractor must replenish security after recourse or expiration of security. This is an important consideration when negotiating the contract.

Release

With respect to return of security, clause 5.4 of the standard AS4902 states that a party’s entitlement to security will be reduced by a percentage as stated in Item 14(f) of Part A to the contract, which is usually upon the issuing of the certificate of practical completion. The amount which the security is reduced by at this time is 50 per cent (unless there is a right of recourse).

Otherwise, and if no right of recourse arises in the interim, the remaining 50 per cent is to be released 14 days after the issuing of the final certificate under the contract.

Despite the above, we are seeing bespoke drafting introduced at clause 5.4 of the contract which creates further and more complex steps to the return of security, such as post practical completion requirements and execution of a deed of release. Each contract should be properly reviewed to ensure the party seeking the return of its security has adequately met the requisite criteria.

Bank guarantees

While we often see retention monies and cash held as security, the type of security with the most difficulties attached can be bank guarantees. This is for the following reasons:

  1. the bank guarantee itself may not be unconditional and may introduce further steps which must be satisfied prior to recourse being possible
  2. having a bank guarantee cashed can cause reputational damage for the contractor. Therefore in some instances if the bank guarantee is likely to be called on, contractors may offer to exchange the bank guarantee for the same value in cash
  3. getting bank guarantees can come with a cost that contractors aren’t always willing to (or can’t) absorb. This may end up being negotiated as part of the contract sum or an “establishment” cost
  4. if a demand is made on a bank guarantee, the only way to prevent it is to file an urgent injunction in the Supreme Court. These can be costly to run and defend, and can sometimes exceed the value of the bank guarantee in question. However, if there is a serious question as to whether the party is entitled to cash it, it can be worth considering whether an injunction is appropriate.

The above is only a brief look at some of the issues relevant to security. If you need any further advice on how to manage security being held or used, please contact us below or get in touch with our team here.

Authors: Jacqui Doyle & Andrea Wilson

  • Andrea Wilson is an Associate in our national Construction, Infrastructure & Projects group. This article was originally published in the July edition of Holding Redlich’s Junior In-House Monthly, which you can subscribe to here.

[1] For example, see the decisions of Saipem Australia Pty Ltd v GLNG Operations Pty Ltd [2014] QSC 310, Saipem Australia Pty Ltd v GLNG Operations Pty Ltd (No 2) [2016] 1 Qd R 254 and Saipem Australia Pty Ltd v GLNG Operations Pty Ltd [2017] QSC 294 where the operation of section 67J was considered in detail.

Disclaimer
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Andrea Wilson

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