Security in building contracts is provided by the contractor as an assurance that it will meet its obligations under the contract. The security may be in the form of cash retention or a bank guarantee.
Release of security
Most standard-form building contracts include provisions for the release of the security to the contractor usually 50 per cent at practical completion and the remaining 50 per cent at the end of the defects-liability period.
Partial release of the security
ABIC contracts provide that the security shall be reduced by half (less any amount owing to the owner) upon the notice of practical completion.
In the case of cash retention, the owner draws upon the monies held in the trust account up to the value indicated in the architect's certificate and makes payment within the time limits shown in Schedule 1.
In the case of unconditional guarantees, one guarantee should be released by the owner within the time limits shown in Schedule 1.
Final release of security
The release of security on final certificate is described in Section C of ABIC 2018 contracts. If the security is cash retention, then the architect takes into consideration any balance in the preparation of the final certificate and the owner is obliged to pay within the time limits shown in Schedule 1.
If the security is an unconditional guarantee, then the owner is obliged to return the guarantee to the contractor (after drawing on any amounts owing under the contract) within the time limits shown in Schedule 1.
Amount of security
ABIC contracts provide that the security is a percentage of the contract price as nominated in Schedule 1. ABIC contracts define what the 'contract price' includes in Clause N1.1 and the number itself is inserted in the Introduction, where there is a warning that it may be subject to adjustment for a number of stated reasons. As the value of security is calculated on the 'contract price', which does not alter throughout the project, the security itself is effectively fixed in value. If there are substantial cost increases during the construction period, then the value of securities may fall below the percentage referred to in Schedule 1.
This situation is the same whether the security is in the form of cash retention or unconditional guarantees. In many instances this is not an issue, as the amount of security is somewhat notional in any case, and provided it is considered reasonable in dollar terms relative to the size of the project, the amount initially specified will suffice.
With projects where it is reasonable to expect significant cost increases (either because of duration, market conditions or a significant number of unknowns, such as in alterations or heritage conservation work); however, Special Conditions could be included to allow for the provision of additional security in the event that the 'contract price' substantially increases during the construction period.
Drawing on security
The case of Santos Limited v BNP Paribas [2018] QSC 105 heard in the Queensland Supreme Court reinforces the need for claimants on a bank guarantee to strictly follow the requirements of the bank guarantee when drawing on it. The Court held 'it is of critical importance that any financial institution pay only upon a complying demand' and that 'a complying demand must strictly comply with the requirements of the instrument for payment'. In this case the bank guarantee was in a standard form that included a pro forma demand letter to be signed by an ‘authorised signatory of Santos Limited’. The demand letter issued by Santos included an execution block that did not state the signatory was an ‘authorised signatory of Santos Limited’. The Court held BNP Paribas was entitled to reject the demand by Santos on the bank guarantee.
In ABIC contracts the owner's right of access to the security is covered in Section C where:
- a certificate issued by the architect in favour of the owner is not paid within the prescribed time;
- the contractor has not disputed the relevant certificate;
- the owner notifies the contractor and the architect in writing of the basis and amount of its entitlement; and
- the owner must first give to the security provider a written demand for payment stating the amount of its entitlement.
For many years, there was debate as to whether a bank guarantee operated in exactly the same way as cash retention as far as availability was concerned. A concern with unconditional guarantees is that the financial institution providing them can be unwilling to pay out on them when it appears that the contractor is on the verge of bankruptcy and will not be able to repay the guarantee. Financially healthy contractors may also attempt to prevent the institution from paying on the owner's demand. It is therefore very important that the guarantee should be in the form of an unconditional undertaking to pay upon the owner's demand. That is, the guarantee should make no mention of the circumstances that give rise to the owner's entitlement to receive the bank guarantee; only that the owner is entitled to it upon demand.
As ABIC contracts require the owner to notify both the architect and the contractor prior to issuing a written demand to the financial institution, it is important to ensure that the notice and demand are issued in such a way as to minimise the possibility of the financial institution or the contractor seeking injunctions to prevent the owner issuing its demand or the institution converting the guarantee into cash. In these circumstances, the owner's legal adviser should manage the serving of notices and demands.
Surety bond
A surety bond is a credit function (rather than insurance), where the issuer becomes involved in the claims-management process and assists in the operations of the contractor to expedite completion of the contract.
If a contractor experiences difficulty, the surety-bond issuer will assess the options and, if necessary, inject funds to get the contract finished without any default being called. In some cases, this will even occur without the client being aware of the problem.
In Australia, surety bonds are traditionally required in many industries, mainly construction and shipbuilding but also information technology, chemical and mineral products, fabricated metal products, transport and other equipment. They are provided mainly by the trading banks. The bulk of bonds appear to be sought by government and semi-government agencies at all levels.
Disclaimer
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