Performance bonds – a glimmer of hope for contractors?

Overview

The recent decision in Hawkins Ltd v Elizabeth Properties Ltd [2024] NZHC 561 involved an application by a contractor for injunctive relief to restrain a principal from calling on its security. The case turned on the meaning of the Bond clause in the construction contract, which entitled the principal to make demand on the bank guarantee if it considered that the Contractor was in default of the contract (or an Insolvency Event had occurred).

In the result, the Court granted the contractor’s application. While the Court acknowledged the importance of performance bonds in commerce (“as the equivalent of cash in hand”) and the traditional difficulty of obtaining relief against a bank making payment or beneficiary making a call, the Court accepted issues could arise where the contract provided for conditions to the payment of the demand (for example, the production of an Engineer’s certificate stating its reasonable opinion that there is a breach of the contract).

Looking ahead, Hawkins provides a reminder of the Courts’ robust approach to upholding on-demand payment obligations (referring to McVeigh v CE of Corrections (2020) and Arrow (2019) amongst others). However, the possibility of obtaining an injunction at least in circumstances of bonds subject to conditions will provide encouragement to contractors to negotiate conditions such as those in Hawkins. To protect against reputational, and credit risks.  

Facts

In August 2019, Hawkins Limited (Hawkins) and Elizabeth Properties Ltd (EPL) entered an amended NZS3910:2013 standard form construction contract under which Hawkins was to construct the Elizabeth Street Development in Tauranga (the Contract).

After delays in the development, a dispute arose in relation to EPL’s right to liquidated damages under both the contract and a subsequent reset agreement for Hawkins late completion of the Contract. Hawkins issued a notice of adjudication under the Construction Contracts Act 2002 to determine its liability to pay the liquidated damages claimed.

After a series of unsuccessful settlement discussions and while the adjudication was still ongoing, EPL wrote to the Engineer to the Contract recording the sum that it considered due ($22.7 million). The Engineer made that deduction from one of Hawkins’ payment claims.

EPL then gave notice that Hawkins was in breach of contract by failing to pay the liquidated damages due and in order to remedy the breach it must make payment within 10 days, otherwise EPL would covert the Bond into cash and apply the proceeds to the liquidated damages owed.

EPL also requested the Engineer to certify that, in his opinion, Hawkins was in default under the contract by failing to pay the liquidated damages. The Engineer certified this.

Hawkins then applied to the High Court for an interim injunction to restrain EPL from calling on the Bond.

The Decision

The general principles governing applications for interim injunctions are well established. The court will usually adopt a two-stage approach. The court first considers whether there is “a serious question to be tried”. If that threshold is met, the court will then consider whether the “balance of convenience” favours granting or refusing relief. Ultimately, the Judge must stand back and consider where the overall justice lies.

Serious question to be tried

EPL submitted that in cases where the injunction seeks to restrain payment of a bond, a more stringent standard than “a serious question to be tried” applies – that is a “strong case”. The Court rejected this submission, preferring not to make an exception to the well-established law. The test applied was “whether there is a serious question to be tried that EPL is not entitled to call upon the Bond”.

The Court accepted that the contract is between sophisticated commercial parties and that a pre-condition in the special conditions of the contract to calling on a bond is that “the Principal considers that the Contractor is in breach” indicates a deliberate subjective requirement. The Bond also provides for the Engineer to state that, in the Engineer’s reasonable opinion (acting independently and impartially), the Contractor is in default.

The Court found that the combination of the contract terms identified and the actions of EPL and the Engineer in this case, gave rise to a serious question to be tried that EPL is not lawfully entitled to call upon the bond. The Judge made three key points which led to this conclusion:  

1.         The contract terms indicate an “objective overlay” given the need for the Engineer’s “reasonable” opinion and for the Principal to ensure that the Engineer fulfils all aspects of the roles and functions “reasonably”.

2.         This is not a case where the dispute only relates to whether the Contractor is responsible for delays. The dispute extends to whether liquidated damages are payable at all as a question of the proper construction of the contract and the reset agreement.

3.         The actions of EPL and the Engineer give rise to a serious question that the Engineer did not form a reasonable opinion and that EPL did not ensure that the Engineer acted reasonably.

Balance of convenience

As to the second inquiry – whether the “balance of convenience” favours granting relief, the Court found that it did.

The Court started by considering the adequacy of damages in the context of the dispute. The Court considered that while damages would ordinarily be an adequate remedy for the plaintiff which would weigh heavily against interim relief, the Court accepted Hawkins’ argument that calling on the bond would cause irreparable harm to its reputation.  The Court found that damages would therefore not be a sufficient remedy for Hawkins.

If the adjudicator determined EPL was entitled to payment of liquidated damages, any prejudice to EPL resulting from further delay pending disputes as to the amount owing can be addressed by limiting the term of interim relief to the date of the adjudicator’s determination.

The Court determined that the overall justice favoured restraining a call on the bond pending determination of the liquidated damages dispute.

Written by Sophie Barnao, Associate.