Calling on a Performance Security: As Good As Cash?

Commercial Law
Michael Whitten QC Headshot

Over the past several decades, performance securities have become a common and critical part of commercial dealings throughout Australia and around the world. While they feature across the panoply of transactions from sale of goods (domestic and international) to commercial leases, and surface in cases concerning the same, perhaps a disproportionate number of judicial decisions have been devoted to performance securities arising from construction contracts and disputes over recourse to them.

Consequently, this paper will reflect that balance, in its consideration of:

  1. reasons for security; 
  2. the essential nature of performance securities; 
  3. types of performance securities; 
  4. examples of contract provisions for security and recourse to it; 
  5. calling on a security; 
  6. injunctions to restrain the calling on a security; and 
  7. recent cases. 

Reasons for Security

Performance securities serve a number of purposes, including:

  1. to provide security to the beneficiary against default by the other party in the underlying contract (sometimes described as the “account” party); to secure an advance payment required under the underlying contract; 
  2. where the payment obligation arises without proof of default, to protect the beneficiary from carrying credit risk during the course of any dispute with the account party under the underlying contract; 
  3. in lieu of money that would otherwise be retained under the contract (e.g. cash retention in a construction contract). 

Fundamentally, performance securities are instruments of risk allocation.

The essential nature of performance securities

Reduced to its simplest definition, and bearing in mind the range of different types of security on equally different terms, a performance guarantee requires the issuer or ‘surety’ (usually a bank or insurer from whom the account party or ‘grantor’ has established the security) to pay the beneficiary up to a specified sum, on demand, or otherwise in accordance with its terms.

In order to effectively achieve any one or more of the above aims, most securities are  expressed to be irrevocable and unconditional, or, ‘as good as cash’.

That nature is reflected in what has become known as the “autonomy principle”. It means that a beneficiary is entitled to demand payment on the security (“calling it up” or “cashing” it), and the bank is obliged to meet that demand, regardless of whether or not the account party is in breach of the underlying contract.

The principle has been considered in many oft-cited and seminal decisions in this area of jurisprudence, such as Wood Hall Ltd v The Pipeline Authority (1979) 141 CLR 443; Olex Focas Pty Ltd v Skodaexport Co Ltd, [1997] ATPR (Digest) [46-163]; Reed Construction Services Pty Ltd v Kheng Seng (Australia) Pty Ltd (1999) 15 BCL 158; Bachmann Pty Ltd v BHP Power New Zealand Ltd [1999] 1 VR 420 and Fletcher Construction Australia Limited v Varnsdorf Pty Ltd [1998] 3 VR 812. More recently: Boral Formwork & Scaffolding Pty Ltd v Action Makers Ltd [2003] NSWSC 713 and Vos Construction & Joinery Qld Pty Ltd v Sanctuary Properties Pty Ltd & Anor [2007] QSC 332.

As will be explored further below, despite what is often pellucid language, many account parties have sought, through debates on the construction of the terms of the security or underlying contract provisions governing recourse to it, to impose qualifications on the entitlement of the beneficiary to call upon the guarantees, to introduce a would be to deprive them of the quality which gives them commercial currency.

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Michael Whitten QC Headshot

The Hon Michael Whitten KC practises in civil and commercial litigation. He is the former Lord Chief Justice of Tonga.

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