Bachmann Pty Ltd v BHP Power New Zealand Ltd

[1998] VSCA 40

SUPREME COURT OF VICTORIA

COURT OF APPEAL	Not Restricted
No. 5905 of 1998

BACHMANN PTY. LTD.

Appellant

v

BHP POWER NEW ZEALAND LTD.

Respondent

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JUDGES:	BROOKING, TADGELL and ORMISTON, JJ.A.
WHERE HELD:	MELBOURNE
DATE OF HEARING:	4, 5 and 6 August 1998
DATE OF JUDGMENT:	11 September 1998
MEDIA NEUTRAL CITATION:	[1998] VSCA 40

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BUILDING AND ENGINEERING CONTRACTS - Security for performance - Standby letter of credit - Underlying contract prohibiting conversion of security into money until purchaser entitled to exercise right under contract - Contract empowering purchaser to set off amounts due to it and have recourse to security if set off insufficient - Injunction sought to prevent recourse to letter of credit - Meaning of "entitled" - Bona fide claim by purchaser sufficient.

BANKING - Letters of credit - Autonomy principle - Standby credits.

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APPEARANCES:	Counsel	Solicitors
For the Appellant	Mr J.D. Elliott	Deacons Graham & James
For the Respondent	Mr A.K. Panna	BHP Group Legal

BROOKING, J. A.:

1. Again we find the contractor or supplier under a building or engineering contract trying to stop the owner demanding payment under a security given by a financial institution.

2. BHP Power New Zealand Ltd. - the contract calls it "the purchaser" and so shall I - made a contract with Bachmann Pty. Ltd. ("the supplier") for the purposes of the purchaser's steel kiln cogeneration project near Auckland. The contract was for the design, supply, manufacture and commissioning of boiler bypass dampers. The contract sum was the total of three amounts expressed in different currencies: NZ$646,583, AUD$342,943 and US$260,832. The contract documents comprise 231 pages and include articles of agreement dated 30 October 1995, general conditions of contract and special conditions of contract. The special conditions contain nothing now relevant. The general conditions are based on the standard form AS3556-1988, Australian Standard General Conditions of Contract for the Supply of Equipment. Those standard conditions have been modified for the purposes of the contract. Pages 21-24 of AS3556-1988 comprise an Annexure to the conditions which makes provision for a large number of matters which are, by the conditions, left to be dealt with in it. The contract modifies the standard conditions, not, as it were, directly, but indirectly, by inserting as part of the contract documents an Annexure which does not simply fill up the blank spaces in the standard form of Annexure but in addition departs from it in some respects. So the redrafted Annexure differs from the standard form by deleting the words "Purchaser shall provide security in the amount of ... (Clause 5.2)". It also makes an immaterial alteration to the part of the standard Annexure dealing with liquidated damages, fixing them as amounts per week instead of per day. In addition, the Annexure as redrafted omits the latter part of p.23 and the whole of p.24 of the standard form, in that it concludes with "The person to nominate the arbitrator (Clause 26)", specifying the President of the Institution of Engineers, Australia.

3. A consequence of the omission of p.24 of the standard form is that a reference to the provision of security by the supplier and purchaser respectively is left out.

4. The result of general condition 1 and the Annexure as redrafted and completed is that the contract is governed by and to be construed with reference to the law of New Zealand. Before us, both parties disclaimed any suggestion that the law of New Zealand differed from that of Australia in any relevant respect.

5. By the articles of agreement, they themselves and the notice of acceptance of the tender are, in the event of conflict between the terms and conditions contained in the contract documents, to be first in precedence. By the notice of acceptance of the tender, the contract is to incorporate a condition as follows:

"3.1	Security
Security shall be provided as required by Clause 5 of the General Conditions of Contract within 28 days from the date of this Notice.
The total amount of security shall be $NZ143,686 and shall be provided from the date of award. The security shall be reduced by an amount of 5% on achievement of key date number 1. The security shall be reduced by a further amount of 5% on issue of certificate of acceptance.
The Company require the security to be in the form of an unconditional irrevocable bank guarantee in the name of the Company. The wording of the guarantee shall be subject to approval by the Company."

1. The provisions of this condition concerning the form of the security conflict with clause 5.3 of the general conditions. But at no stage below was it suggested that any regard should be had to the condition about security introduced by the notice of acceptance: it seems simply to have been overlooked. Both parties invited us to ignore the notice of acceptance for the purposes of the appeal and I intend to act on that invitation.

2. Clause 1 of the general conditions provides that the clause and sub-clause headings shall not be used in the interpretation of the contract. Clause 5, dealing with security and retention moneys, is an important provision, and I can see no satisfactory alternative to setting it out in full (omitting the heading and sub- headings):

"5.1	Security and retention moneys are for the purpose of ensuring the due and proper performance of the Contract.
5.2 If it is provided in the Annexure that a party shall provide security then the party shall provide security in the amount stated in the Annexure and in accordance with this clause.
5.3 The security shall be in the form of cash, bonds or inscribed stock issued by the Australian Government or the Government of a State or Territory of Australia, interest bearing deposit in a trading bank carrying on business in Australia, an approved unconditional undertaking given by an approved financial institution or insurance company, or other form approved by the party having the benefit of the security.
The party having the benefit of the security shall have a discretion to approve or disapprove of the form of an unconditional undertaking and the financial institution or insurance company giving it or other form of security offered. The form of unconditional undertaking attached to these General Conditions is approved.
If the security is not transferable by delivery it shall be accompanied by an executed transfer. The costs and expenses (including all stamp duty or other taxes) of and incidental to the transfer and retransfer shall be borne by the party providing the security.
5.4 Security shall be lodged within 28 days of the Date of Acceptance of Tender. Failure to lodge security within that period shall be a substantial breach of the Contract within the meaning of Clause 25.
5.5 A party shall not convert into money security that does not consist of money until the party becomes entitled to exercise a right under the Contract in respect of the security. The party shall not be liable for any loss occasioned by conversion pursuant to the Contract.
*5.6	The Supplier shall be at liberty at any time to provide in lieu of retention moneys additional security in any of the forms permitted by Clause 5.3. To the extent that additional security is provided the Purchaser shall not deduct retention moneys and shall forthwith release retention moneys.
*5.7	Upon issue of the Certificate of Acceptance, the Purchaser's entitlement to security and retention moneys shall be reduced to the percentage thereof stated in the Annexure or, if no percentage is stated, by one-half.
The Purchaser shall release security and retention moneys in excess of the entitlement.
5.8 If the Purchaser has provided security, then when the Supplier has been paid all moneys due to the Supplier under the Contract or a Separable Portion, the Supplier shall account to the Purchaser for security lodged by the Purchaser in respect of the Contract, or the Separable Portion, as the case may be.
If the Supplier has provided security then the Purchaser shall release it when required by Clause 24.
5.9
Alternative 1
The party holding retention moneys or cash security shall own any interest earned on the retention moneys or security.
Alternative 2
A party holding security which is in cash or is converted to cash or retention moneys shall forthwith deposit them in an interest bearing account in a bank. That party shall nominate the bank and the type of account. The account must be in the joint names of the Purchaser and the Supplier and must be one from which moneys can only be drawn with the signatures of two persons, one appointed by each of the Purchaser and the Supplier. The moneys shall be held in trust until the Purchaser or the Supplier is entitled to receive them.
Upon the Purchaser or the Supplier becoming entitled to receive any moneys, including interest in the account, the other party shall have the appointee sign the document necessary to withdraw the money and shall give the document to the other party."

1. A note at the outset of the general conditions explains that clauses prefixed by an asterisk can be omitted without making consequential amendments.

2. The redrafted Annexure contains the following:

"Supplier shall provide security in	Performance Security - 10% of
the amount of:	Contract Sum"
(Clause 5.2)

It makes applicable the first of the alternatives set out in clause 5.9. That part of the redrafted Annexure which deals with "Time for Payment Claims (Clause 22.1a)" begins with the words, "25% of the Contract Sum as an Advance Payment upon receipt of a Performance Security".

1. General condition 5 in several places contemplates that security may be provided by either party to the contract. The result of the way in which the Annexure was in fact redrafted and completed was, however, that only the seller had to provide security.

2. By clause 5.5 a party shall not convert into money security that does not consist of money until it becomes entitled to exercise a right under the contract in respect of the security. The only provision of the contract to which we were referred entitling the purchaser to exercise a right in respect of the security is clause 22.4 of the general conditions:

   "The Purchaser may deduct from moneys otherwise due to the Supplier any moneys due from the Supplier to the Purchaser and if those moneys are insufficient, the Purchaser can have recourse to the security under the Contract."

3. Clause 5.3 requires the security to take the form of cash or one of a number of other specified forms, there being in addition a dragnet ("or other form approved by the party having the benefit of the security"). Clause 5.5, containing the qualified prohibition on conversion, speaks, not of conversion into cash of security that does not consist of cash, but of conversion into money of security that does not consist of money. But I think that "money" in clause 5.5 bears the same meaning as "cash" in clause 5.3; the contrary has not been contended by either party before us. That the expressions mean the same is suggested by clause 5.9. This clause contemplates that the Annexure will determine whether the applicable provision is Alternative 1 or Alternative 2. The Annexure as redrafted and completed selects Alternative 1. Although Alternative 2 does not form an operative part of the contract, regard may be had to it in considering the scope and effect of sub-clauses of clause 5. The full terms of clause 5.9 show the alternative schemes available to the parties and the view which is taken of the effect of one alternative may be affected by the terms of the other. It has not been suggested that we may not have regard to the terms of Alternative 2, notwithstanding that the parties have chosen to reject it in making their contract. Alternative 1 speaks of "cash security" and in my opinion this is a shorthand expression used by the drafter of clause 5.9 in place of the longer expression used in Alternative 2, "security which is in cash or is converted to cash". The two expressions have the same meaning. Clause 5.9 supports the view that the reference to conversion into "money" and to a security that does not consist of "money" in clause 5.5 has the same effect as a reference to conversion to "cash" and to security that does not consist of "cash".

4. Clause 5.3 of the general conditions gives approval to the form of unconditional undertaking by a financial institution or insurance company which is set out at the end of the general conditions. The approved form is as follows:

   "At the request of .......................................................... ('the Supplier') and
   in consideration of ............................................. ('the Purchaser')

   accepting this undertaking in respect of the contract for

........................................................ ('the Financial Institution')

unconditionally undertakes to pay on demand any sum or sums which may from time to time be demanded by the Purchaser to a maximum aggregate sum of $ (.................)

The undertaking is to continue until notification has been received from the Purchaser that the sum is no longer required by the Purchaser or until this undertaking is returned to the Financial Institution or until payment to the Purchaser by the Financial Institution of the whole of the sum or such part as the Purchaser may require.

Should the Financial Institution be notified in writing, purporting to be signed for and on behalf of the Purchaser that the Purchaser desires payment to be made of the whole or any part or parts of the sum, it is unconditionally agreed that the Financial Institution will make the payment or payments to the Purchaser forthwith without reference to the Supplier and notwithstanding any notice given by the Supplier not to pay same.

Provided always that the Financial Institution may at any time without
being required so to do pay to the Purchaser the sum of
$ (....................................................................................) less any
amount or amounts it may previously have paid under this
undertaking or such lesser sum as may be required and specified by
the Purchaser and thereupon the liability of the Financial Institution

hereunder shall immediately cease.

DATED at this day of 19 ".

1. In fact security was given in the present case by the supplier by causing its bank to establish two irrevocable letters of credit in favour of the purchaser. I am presently rather disposed to think that these credits do not fall within the words in clause 5.3 "an approved unconditional undertaking given by an approved financial institution or insurance company", since they are not unconditional, in that they require production of a statement from the beneficiary that the supplier has failed to comply with the underlying contract. On this view, to answer the description in clause 5.3 the credits would have to be what has been called in the United States "suicide credits", that is, credits payable against a draft without any supporting document. But the matter is not free from doubt. Compare the question whether a credit calling for the beneficiary's own certificate of non-performance is properly described as "clean": Dolan, Law of Letters of Credit, Revised Ed., para. 1.07[2] and Glossary, S.V. "clean credit". Note also the discussion of what bonds may properly be described as "conditional" in Penn, Shea & Arora, Law and Practice of International Banking, pp.268-71. Zohrab, "Standby Letters of Credit: Autonomy", (1996) N.Z.L.J. 417 at pp.418-9 appears to regard as "unconditional" a performance bond which requires the beneficiary's written statement that the account party failed to perform. Contrast Debattista, "Performance Bonds and Letters of Credit: a Cracked Mirror Image", (1997) J.B.L. 289 at p.293. It is certainly arguable that the imposition of a requirement which it lies entirely within the power of the beneficiary to satisfy does not make the undertaking "conditional". If the present credits are not "unconditional undertakings" they must each be regarded as an "other form [of security] approved by the party having the benefit of the security" within the meaning of clause 5.3.

2. I have mentioned that general condition 5.2, taken in conjunction with the Annexure, required the provision of "performance security" in an amount equivalent to 10% of the contract sum. The total contract sum expressed in New Zealand dollars was $1,436,855. Security was in fact provided by means of two irrevocable letters of credit issued by the Westpac bank, each for 5% of the contract sum, that is, NZ$71,842.75. The first of these credits is no longer current and this case is only about the second. It was established by telecommunication on 20 March 1996; the document constituting this communication appears to be the operative credit instrument. I must say it seems to me in some respects unusual - I shall append a copy of it to my reasons. The letter of credit appears to have been issued by a Victorian branch of the Westpac Bank. It is addressed to the Wellington branch of the same bank "for all New Zealand branches", and the addressee (or addressees) might be thought to be the beneficiary (or beneficiaries). It seems to contemplate that a New Zealand branch of the bank will issue a performance bond in favour of the purchaser and that the credit will serve to reimburse that branch for any amount it is called on to pay under the performance bond. There is no suggestion that any such bond was ever issued, and all parties - the bank, the supplier and the purchaser - have at all times treated the letter of credit as issued in favour of the purchaser. Accordingly, nothing more need be said about this matter (which was not mentioned in argument).

3. As originally established, the credit undertook to honour a sight draft presented prior to 30 June 1998 for an amount not exceeding NZ$71,842.75. The draft was to be accompanied by a statement purporting to be signed by two authorised officers of the beneficiary to the effect that the supplier had failed to comply with the terms and conditions of the contract dated 30 October 1995. The credit incorporated "UCP for Documentary Credits (1994 Revision)", which should be taken as a reference to the Uniform Customs and Practice for Documentary Credits (1993 Revision) of the International Chamber of Commerce, which became effective on 1 January 1994. There is no 1994 Revision. On 5 February 1997 the credit was amended by telecommunication with the concurrence of the supplier and the purchaser by substituting for the words "prior to 30.06.98" the words "valid until the defects period for the dampers has expired, as evidenced by the issue of the final certificate by BHP, as per Clause 24 of the general conditions of contract". By clause 20 of the general conditions, read in conjunction with the redrafted Annexure, the defects liability period was 24 months from the actual delivery date of the equipment. We were told by counsel that, some doubt having arisen about the actual delivery date, the credit was further amended by the bank at the request of the parties so as to reinstate a fixed expiration date (which date counsel could not recall), this evidently having been done at some time in May 1998. There may well be some confusion about this, but nothing turns on the point. On 1 June 1998 the credit was again amended, with the concurrence of purchaser and supplier, so as to make it expire on 31 August 1998. This was done at a time when an application to the Court of Appeal for leave to appeal was pending in circumstances which I shall mention in due course.

4. Article 3a of the Uniform Customs and Practice states the well-known principle of autonomy or independence:

   "Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the Credit. Consequently, the undertaking of a bank to pay, accept and pay Draft(s) or negotiate and/or to fulfil any other obligation under the Credit, is not subject to claims or defences by the Applicant resulting from his relationships with the Issuing Bank or the Beneficiary."

1. Similarly, Article 4 is a reminder of the closely related principle that in credit operations "all parties concerned deal with documents, and not with goods, services and/or other performances to which the documents may relate."

2. By May 1997 a dispute existed between purchaser and supplier as a result of the failure of the dampers. In September 1997 the purchaser claimed more than $2.4 million (evidently in New Zealand currency) from the supplier as the cost of rectification to date. The supplier denied liability and alleged that a sum of money - much less than $2.4 million - was due to it from the purchaser. The contract provides for the resolution of disputes by arbitration, and the purchaser has invoked the arbitration clause, but as yet no arbitrator has been appointed.

3. By letter of 9 April 1998 to the Westpac bank (a letter describing itself as a sight draft and not accompanied by any statement that the supplier had failed to comply with the underlying contract), the purchaser sought payment under the letter of credit. Not surprisingly, no payment was made. On 15 April the supplier's solicitors wrote to the purchaser alleging that the letter of credit was no longer valid - a contention that was not put in the lower court and has now been in terms abandoned. The letter of 15 April went on to assert in the alternative that clause 5.5 of the general conditions of contract disabled the purchaser from seeking payment from the bank under the credit. On or about 17 April the purchaser presented to the bank a sight draft bearing that date together with a beneficiary's statement that the supplier had failed to comply with the terms and conditions of the underlying contract. The draft has not yet been honoured.

4. On 28 April his Honour Judge Dyett granted the supplier an interim injunction restraining the purchaser until 4.15 p.m. on 1 May or further order from demanding or receiving any payment under the credit. On 30 April the supplier filed an originating motion in the County Court claiming an injunction unlimited in point of time. On 1 May his Honour Judge Barnett continued the interim injunction until 4.15 p.m. on 8 May. On the latter date his Honour dismissed the plaintiff's application for an injunction. On 11 May the same judge stayed his order of 8 May until 4.15 p.m. on 29 May, a stay which was evidently regarded as causing the injunction that had been granted until 4.15 p.m. on 8 May to continue to operate until 29 May. On 3 June the Court of Appeal granted the plaintiff leave to appeal, if needed, against the order of Judge Barnett made on 8 May, the order, that is, which dismissed the plaintiff's application for an injunction. This is the appeal that is now before us. On 3 June the Court of Appeal took an undertaking from the defendant not to demand or receive payment under the credit pending the determination of the appeal or further order. We were told by counsel that at the suggestion of the Court of Appeal the parties arranged for the bank to amend the expiry date of the credit to 31 August 1998, but again there seems to have been some confusion, since this amendment appears to have been made on 1 June, at a time when the application for leave to appeal was pending. The amendment which extended the expiry date to 31 August was arranged by the parties in the hope that the appeal would be disposed of some little time before that substituted date, but we ourselves have taken the precaution of asking the parties to arrange a further extension (until 30 September 1998), and this has been done.

5. I have mentioned that the injunction sought in the originating motion was unlimited in point of time. Counsel for the supplier (as I shall continue to call the appellant plaintiff) submitted that, if we allowed the appeal, we should grant an injunction restraining the purchaser from demanding or receiving payment under the credit "until after the determination of the dispute presently the subject of arbitration proceedings between the appellant and the respondent, or further order".

6. The reasons of his Honour Judge Barnett are brief and may be set out in full:

   "I am asked to extend the temporary injunction granted by His Honour Judge Dyett which was returnable on the 1st May 1998. The injunction granted by His Honour Judge Dyett and extended by me restrained the respondent BHP Power NZ from accessing the security represented by way of a letter of credit provided by the Westpac Bank dated the 20th March 1996 and amended on the 5th February 1997.

   In my view the contractual arrangements that exist between the parties would entitle the respondent to access those funds by the filing of a statement signed by two authorized officers of the beneficiary (respondent) to the effect that the contractor (applicant) has failed to comply with the terms and conditions of the contract. I am told the respondents have recently filed such a statement, that being the case, then the respondents have a right to call on the Bank for payment of the funds in accordance with the terms of the Westpac letter of credit. It may be a court has a power to restrain the respondent from accessing those funds if the plaintiff could establish some form of fraud, mala fides, or establish the respondent's behaviour was unconscionable in the circumstances. In this case none of those things can be established. At the most the plaintiff can point to is the existence of a dispute as to the suitability of the goods supplied. The respondent's right to the funds is not dependant or fettered pending the resolution of that dispute. See Fletcher Constructions Australia Ltd. v. Vansdorf Pty. Ltd. Court of Appeal 24/11/97.

   Accordingly I would discharge the injunction."

7. These reasons are, if I may say so, the sort of reasons one might expect to find in a case in which there was no express provision in the building or engineering contract underlying the letter of credit which prohibited the owner from converting the security into cash except in certain circumstances. There is no mention in the reasons of clause 5.5 of the general conditions, or of the decision in Pearson Bridge (N.S.W.) Pty. Ltd. v. State Rail Authority of New South Wales [1982] 1 Aust. Const. L.R. 81. It is accepted that reliance was placed below on clause 5.5 and on the Pearson Bridge case. The matter may have been dealt with in a busy practice court, but it is not possible to feel confident that his Honour gave proper consideration to the argument based on clause 5.5 which lies - and lay - at the bottom of the supplier's case.

8. I mentioned at the outset that it was becoming more common for the contractor or supplier under a building or engineering contract to seek an injunction against the owner to prevent the calling up of a security. So far as I am aware, of the cases which have come before the courts in this country the present may be said to be novel in one respect and unusual in another. It is novel in the sense that the present case raises for the first time the effect of an express, albeit qualified, contractual prohibition (in the underlying contract) on the conversion of a security into cash. The novelty resides in the circumstance that the present contract contains an express, but qualified, prohibition on conversion of a security into cash -express in the sense that it is in form a negative stipulation ("a party shall not convert ... until the party becomes entitled"). In some of the other cases a court has had to consider whether a provision of the contract in form enabling the owner to convert to cash, or have recourse to, a security in a certain event did on its proper construction prohibit the owner from doing so except in that event.

9. The present case, while not novel in a further respect, is unusual in that the security actually provided under the contract was by way of standby letter of credit, the name used to distinguish between letters of credit performing the traditional function of providing payment to the seller of goods when he performs his part of the contract of sale by delivering documents of title to the bank, and letters of credit performing the function of providing security against the danger that a party to a contract will fail to perform it. International trade is facilitated by traditional credits, which provide a mechanism for performance of contracts of sale. Standby credits are a safeguard which comes into play where there is a suggestion that contracts (whose subject-matter can vary widely) have been broken: Jack, Documentary Credits, 2nd ed., para.2.39; Dolan, Law of Letters of Credit, Revised Ed., para.1.04; Benjamin's Sale of Goods, 5th ed., paras.23-032 and 23-217 to 23-219.

10. So far as I know, there are only two other Australian cases of an application for an injunction to prevent the enforcement of a security given under a building or engineering contract where the security consists of a standby letter of credit. The first case is Austal Ships Pty. Ltd. v. National Australia Bank Ltd. (Supreme Court of Western Australia, Templeman, J., unreported, 13 February 1997), where under a ship-building contract a letter of credit was established by the builder's bank for the benefit of the purchaser's financier, who had provided the deposit. The second case is Fletcher Construction Australia Ltd. v. Varnsdorf Pty. Ltd. (Court of Appeal, unreported, 24 November 1997). Leaving to one side what I have described as unusual features of the letter of credit in the present case, the irrevocable standby letters of credit in Fletcher resembled that issued in this case, in that they required the presentation of a sight draft accompanied by a statement on behalf of the beneficiary about the position under the underlying contract. The letters of credit in Fletcher required not a mere statement but a statutory declaration. The declarant was required to state that the amount claimed represented an amount or amounts remaining unpaid to the beneficiary. The credits differed from the credit in the present case by expressly providing that the bank must make payment to the beneficiary on production of the sight draft and statutory declaration without reference to the contractor or any other party. Like the present credit, the Fletcher credits incorporated the Uniform Customs and Practice for Documentary Credits of the International Chamber of Commerce, but, because those credits were established before 1 January 1994, it was the 1983 Revision that was incorporated, not the 1993 one. (I note that in Fletcher Charles, J.A. regarded each letter of credit as answering the description "unconditional undertaking" by a financial institution to pay in favour of the owner notwithstanding that the draft had to be accompanied by a statement on behalf of the beneficiary.)

11. It is plain that clause 5.5 of the general conditions of the contract before us is an express, albeit qualified, contractual prohibition on the conversion of a security into cash. It is also plain that it is competent to the holder of a security provided by the other contracting party to promise as part of the contract under which the security is provided - the underlying contract - not to do some act in relation to the security except in a certain event. Such a contractual promise is efficacious, not in the sense, when the security is constituted by the obligation of a third person, that the third person can rely by way of defence as against the security-holder on a term of the underlying contract, to which he was not a party, but in the sense that relief can be afforded to the person who procured the security in an action brought against the security-holder on the promise contained in the underlying contract. No principle or rule of law would deny that a promise forming part of the underlying contract is in this sense efficacious, and the cases recognise this:

• Wood Hall Ltd. v. Pipeline Authority (1979) 141 C.L.R. 443 at 452-4 per
Gibbs, J. (with whom Mason, J. agreed) and at 459 per Stephen, J.;

• the Pearson Bridge case;

• Washington Constructions Company Pty. Ltd. v. Westpac Banking

Corporation (1983) Qd.R. 179;

• Hortico (Australia) Pty. Ltd. v. Energy Equipment Co. (Australia) Pty.

Ltd. (1985) 1 N.S.W.L.R. 545 at 554;

• Tenore Pty. Ltd. v. Roleystone Pty. Ltd. (unreported, Supreme Court of
New South Wales, Giles, J. 14 September 1990, at p.31);

• J.H. Evins Industries (N.T.) Pty. Ltd. v. Diano Nominees Pty. Ltd.

(unreported, Supreme Court of the Northern Territory, Kearney, J.,

30 January 1989);

• Hughes Bros. Pty. Ltd. v. Telede Pty. Ltd. (1989) 7 Building and

Construction Law 210;

•	Barclay Mowlem Construction Ltd. v. Simon Engineering (Australia) Pty.
Ltd. (1991) 23 N.S.W.L.R. 451 at 457;
•	Malaysia Hotel (Aust.) Pty. Ltd. v. Sabemo Pty. Ltd. (1993) 11 Building and Construction Law 50;

• the Fletcher Construction case.

1. I do not overlook the critical distinction between the effect of the underlying contract as between the parties to it and its effect (if any) as between the holder of the security and the third person whose obligation constitutes the security. One can for brevity speak of a contractual qualification upon the owner's powers in relation to the security where the underlying agreement between the owner and the contractor or supplier contains a term which restricts the exercise of those powers in some way.

2. In the present case the supplier, in trying to stop the purchaser demanding payment under the letter of credit, did not try to make any case of fraud on the purchaser's part: it relied solely on the contractual qualification upon the purchaser's powers constituted by clause 5.5 of the general conditions. The present case appears to be novel so far as this country is concerned, in that it is clear, and is conceded, that clause 5.5 does constitute a contractual qualification on the purchaser's powers in relation to the security. In all the other Australian cases of which I am aware, the initial question was whether the underlying contract, on its proper construction, did contain a qualification on the owner's powers as regards the security. In particular, the question arose in other cases whether a stipulation not negative in form was negative in substance, in that it laid down the only circumstances in which something might be done. See:

   • the Pearson Bridge case;

   • Selvas Pty. Ltd. v. Hansen & Yuncken (S.A.) Pty. Ltd. (1987) 6 Aust. Const.

   L.R. 36;

   • the Barclay Mowlem case;

• J.H. Evins Industries (N.T.) Pty. Ltd. v. Diano Nominees Pty. Ltd.;

• Hughes Bros. Pty. Ltd. v. Telede Pty. Ltd.;

• the Fletcher Construction case.

But the present stipulation is negative in form; there is undoubtedly a contractual qualification on the purchaser's powers in relation to the security; the only question is that of the content of the qualification. This is the point of this appeal. It will be recalled that by clause 5.5 a party shall not convert into money security that does not consist of money until it becomes entitled to exercise a right under the contract in respect of the security and that it is common ground that clause 22.4 is the only provision of the contract conferring on the purchaser a right in respect of the security once the security has been provided. The issue between purchaser and supplier concerns the words in clause 5.5 "becomes entitled to exercise a right". The purchaser says they require only that it shall have made a bona fide claim to be entitled to exercise a right under the contract in respect of the security. The supplier says they require something more than this.

1. Notwithstanding the able argument of Mr Elliott on the supplier's behalf, I have not found it easy to determine just what, in his submission, that something is. In the course of his written outline of argument and his oral submissions Mr Elliott invited adoption of a number of different views of the effect of clause 5.5. This is not surprising, having regard to the words used in the clause, "until the party becomes entitled to exercise a right ...". One of the submissions was that a party does not become entitled to exercise a right when a serious dispute is extant. This submission does not in terms tell us when a party does become entitled to exercise a right, unless by implication the submission is that a party becomes entitled to exercise a right where it asserts that right and no serious dispute is extant about whether the entitlement exists. Another submission made by Mr Elliott was that a party "becomes entitled to exercise a right" where the existence of that entitlement has been authoritatively determined. He made no precise submission in this regard about the distinction between arbitrations and curial proceedings or about the point at which, having regard to the possibility of one or more appeals, a determination should be regarded as authoritative. In formulating, in the course of his reply, the order which he submitted should have been made below he sought the grant of an injunction "until after the determination of the dispute presently the subject of arbitration proceedings between the appellant and the respondent, or further order". This submission itself, by implication, takes up a position with regard to the meaning of "becomes entitled to exercise a right", but it leaves open the meaning of "determination".

2. At another stage Mr Elliott submitted that a provision indistinguishable from the present clause 5.5 had been authoritatively construed in Pearson Bridge, that persons in the building and engineering industry should be taken to have acted on that decision and that this Court should construe clause 5.5 of the present contract as the corresponding provision was construed by Yeldham, J. in Pearson Bridge. The contract in question in that case - my impression is that it was the standard form NPWC2 rather than NPWC3 - contained, in general condition 5, a provision the same in some respects as that contained in the standard form with which we are concerned, AS3556-1988. Clause 5.5 of the Pearson Bridge contract ran:

   "If the Principal becomes entitled to exercise all or any of his rights under the Contract in respect of the security the Principal may convert into money the security that does not consist of money. The Principal shall not be liable for any loss occasioned by such a conversion."

3. One of the main questions in dispute there was whether clause 5.5, not being negative in form, was nevertheless a negative stipulation. Yeldham, J. decided that it was. The judgment does not disclose what rival contentions, if any, were put forward by the parties if it was accepted, contrary to the principal's contention, that the clause did impose a qualification on the principal's right to convert the security into money. The principal's case was that it had cancelled the contract in consequence of the contractor's failure to show cause after a notice given to it in consequence of its own default. In the litigation the principal asserted that it had cancelled the contract by reason of breaches committed by the contractor. The cancellation, and the breaches, were put in issue by the plaintiff contractor. The injunction granted by Yeldham, J. was one pending the resolution of the action or further order. The meaning of "entitled to exercise all or any of his rights under the Contract in respect of the security" is not in terms discussed in his Honour's reasons, but a passage at p.86 of the report suggests to me that his Honour considered that the event required was that the contractor should be in default and that in consequence the principal should have suffered damage, although it is possible that what his Honour meant was that there should have been a judicial determination of such a default and such damage.

4. This distinction is important in considering the effect of the provision in question in this case and the one considered in Pearson Bridge. For if "becomes entitled" looks only to the effect of events which have occurred in the light of relevant provisions of the contract and any relevant rules or principles of law, so that, once the "necessary" events have occurred, the entitlement exists, notwithstanding that it has not been recognised in any decision of a court or arbitrator, then the practical difficulty arises that in most cases, as a result of a dispute about the facts and possibly about the effect of other provisions of the contract and even about the general law, one side will be asserting and the other will be denying that in the events that have happened entitlement does exist.

1. Clause 5 of NPWC3 was considered by the Supreme Court of the Northern Territory in J.H. Evins (N.T.) Pty. Ltd. v. Diano Nominees Pty. Ltd. (unreported, Kearney, J., 30 January 1989). The view taken in Pearson Bridge was adopted, it being held that the principal was not entitled to convert the security into money unless there was a debt due to it by virtue of the contract and there was an insufficiency of the non-security moneys. Kearney, J. seems to have regarded what he called "the arbitrator's final decision on the claims", not as the event which was directly made relevant and necessary by the contract, but as that which would serve to establish whether the event made necessary had in fact occurred.

2. There is another decision in which passing reference is made to the matter of entitlement for the purposes of a clause resembling the one in Pearson Bridge. That case is ADI Ltd. v. State Electricity Commission of Victoria, an unreported decision given by Byrne, J. on 6 June 1997, which was affirmed by the Court of Appeal on 12 August 1997. It concerned two securities, one a performance security and the other a retention security which was provided to the principal in place of the deduction of retention money. Byrne, J. granted an interlocutory injunction restraining the owner from making any demand under the performance security. He declined to grant a similar injunction in respect of the retention security and the appeal from his decision related only to that refusal. And so the Court of Appeal was in no way concerned with the performance security, which was described in the contract as the security deposit. Clause 14.3 dealt, not with the retention security, but with the performance security:

   "If the Commission becomes entitled to exercise all or any of its rights under the Contract in respect of the Security Deposit, the Commission may convert into money or otherwise take the benefit of such part of the Security Deposit that is in a form other than money, such conversion being at the cost of the Contractor, and the nett money proceeds after such conversion shall be the sum which may be taken into account under subcl 39.3, subcl 39.6, subcl 42.1 or subcl 42.7. The Commission shall not be under any duty of care nor be liable to the Contractor or any other person for any loss, actions, suits or demands, or costs or expenses occasioned by such a conversion or taking of benefit."

3. His Honour thought it clear from the opening words of the clause that the Commission's right to convert into money the bonds that had been given depended upon its having an entitlement under the contract in respect of the security deposit. The reasons for judgment might be thought to suggest that this point, if not conceded by the Commission, was at all events not the subject of any real argument. Be that as it may, his Honour plainly took the view that, notwithstanding that clause 14.3 was cast in positive terms, it contained in substance a negative stipulation. With this point we are not presently concerned. The question is whether anything said by his Honour bore on the meaning of "becomes entitled to exercise ...". As to this, the judge said only:

   "This entitlement might arise in a limited number of circumstances which are to be found in cl 39.3.2; cl 39.6.1; cl 42.1.1(e) and cl 42.7.1. It was not suggested that any such entitlement now exists. Accordingly, I conclude that there is a serious issue to be tried as to whether it is lawful under the building contract for the SECV to call upon the grantors to pay under the bonds held as Security Deposit."

4. In view of the concession made in that case that no entitlement existed the decision of Byrne, J. cannot be regarded as expressing any opinion on the meaning of "entitled". I should add that it is not possible to ascertain from the judgment the basis on which the concession was made.

5. The contract in question in Hughes Bros. Pty. Ltd. v. Telede Pty. Ltd. (1989) 7 Building and Construction Law 210 was the standard form JCC-A 1985. By general condition 10.25:

   "Any security provided by the Builder in terms of this Agreement shall be available to the Proprietor whenever the Proprietor may be entitled to the payment of moneys by the Builder under or in consequence of this Agreement or whenever the Proprietor may be entitled to reimbursement of any moneys paid to others under this Agreement, in all such cases as if the security were a sum of money due or to become due to the Builder by the Proprietor."

6. Cole, J. thought that the words "Builder" and "Proprietor", where last appearing, had been transposed, but an explanation of their use in the clause as drawn is suggested in an editorial note at p.210 of the report. Despite Hughes the Joint Contracts Committee - a body well aware of the course of judicial decision - remains impenitent. Clause 10.25 of JCC-C 1994 preserves the order of the words, strongly suggesting that the authors of the form were not guilty of unintentional transposition.

7. His Honour considered the meaning of the phrase "may be entitled". He thought that what was necessary was a claimed entitlement that was not specious or fanciful; "may be entitled" could not be read as "is entitled". I entertain a respectful suspicion, however, that "may be entitled" was used in the form as an almost archaic way of saying "is entitled". Unfortunately I do not have at my disposal a copy of JCC-A 1985. But JCC-C 1994 (which is unlikely to have introduced near-archaisms not to be found in the 1985 standard form) contains examples of a similar usage. A quick look at only the first four general conditions has yielded a number of examples of the subjunctive used where nowadays the indicative would be employed:

• "such other copies ... as may be required from time to time" (cl. 2.05.03);

• "as the Architect may require" (cl. 2.06);

• "any survey or ... information which may be necessary" (cl. 3.01.02);

• "all facilities ... as may be reasonably necessary" (cl. 3.06);

• "which he may require" (cl. 3.09);

• "any discount that may be allowed" (cl. 4.06);

• "so far as the same may concern" (cl. 4.07.02);

• "to which the nominated sub-contractor may become entitled" (cl. 4.07.05,

words especially to be noted);

• "upon which the Builder ... may be entitled to rely" (cl. 4.08.02, again

important words).

1. The archaic flavour is enhanced by the use of expressions like "as shall be determined" (cl. 1.02.07), "unless he shall first have ascertained" (cl. 4.04), "as the case shall require" (cl. 4.05) and "shall fail to pay" (cl. 4.07.07). These are further instances of the subjunctive used to express what most of us would express by the indicative mood.

2. If JCC-A 1985 contained the other examples of the use of "may" I have drawn from the 1994 form, I should have thought, with respect, that the words in clause 10.25, "whenever the Proprietor may be entitled", were but an example of the use of the subjunctive "may be" in place of the indicative "is". The contingency expressed by the clause introduced by the words "whenever the Proprietor may be entitled" is the contingency of "entitlement": clause 10.25 recognises that this is an event that may or may not occur. The words "whenever ... may be" are an old-fashioned way of expressing the contingency. But the contingent nature of the event - the arising of "entitlement" - is not to be confused with the introduction of doubt about what will constitute the event. The clause does not mean "whenever it is possible that the Proprietor is entitled". It means "whenever the Proprietor is entitled". But of course to say this is not to say that "entitled" necessarily bears some such meaning as "entitled when the law is applied to the facts", or "entitled by virtue of a determination": "entitled" must still be defined.

3. In Queensland Byrne, J. found it unnecessary to decide whether general condition 10.25 of JCC-A 1985 should be given the meaning assigned to it by Cole, J. in Hughes Bros.: Mitsui Kensetsu Corporation Australia Pty. Ltd. v. State of South Australia (unreported, 9 August 1990). The possibility that "may be entitled" was merely the subjunctive was not in terms discussed. Byrne, J. seems to have regarded as the view of clause 10.25 competing with that taken in Hughes Bros. the opinion that the clause required that the proprietor establish "(in litigation or arbitration) an actual entitlement to payment of the moneys".

4. I mention as a matter of interest the decision of Master Burley of the Supreme Court of South Australia in Selvas Pty. Ltd. v. Hansen & Yuncken (S.A.) Pty. Ltd. (1987) 6 Aust. Const. Law R. 36. There a clause in terms permissive was held to contain a negative stipulation, following Pearson Bridge. It was as follows:

   "Any security provided by the sub-contractor in terms of this contract shall be available to the contractor upon default of the sub-contractor or whenever the contractor may be otherwise entitled to the payment of moneys by the sub-contractor under or in consequence of this contract or whenever the contractor may be entitled to reimbursement of any moneys paid to the other under this contract, in all such cases as if the security were a sum of money due or to become due to the sub-contractor by the contractor."

   An interlocutory injunction was sought restraining the sub-contractor from making a call on a bank under the security. The contractor contended that there had been "default of the sub-contractor" within the meaning of the clause; it was not suggested that either of the other events mentioned in the clause (entitlement otherwise to payment and entitlement to reimbursement) had occurred. The sub- contractor denied that there had been default on its part. My impression, reading the Master's reasons, is that he took the view that the words in the clause "upon default of the sub-contractor" simply raised a question of fact, or question of mixed fact and law, namely, in the events which had happened and having regard to the terms of the sub-contract had there been default on the part of the sub-contractor? The fact that there was "a real dispute, both factual and legal, between the parties" as to whether there had been default meant that there was a serious question to be tried (p.40).

5. Then there is the decision of Rolfe, J. in Barclay Mowlen Construction Ltd. v. Simon Engineering (Australia) Pty. Ltd. (1991) 23 N.S.W.L.R. 451 concerning general condition 5.6 of the standard form AS2124-1981:

   "If the Principal becomes entitled to exercise all or any of his rights under the Contract in respect of the security the Principal may convert into money the security that does not consist of money. The Principal shall not be liable for any loss occasioned by such a conversion."

6. In that case it was common ground that on the facts disclosed by the material before the judge it could not be said that the principal had become entitled to exercise a right within the meaning of this condition. See pp.453 and 457. This decision contains no discussion of the meaning of "becomes entitled". It is concerned with whether clause 5.6 constituted a negative stipulation and with other questions not presently relevant.

7. Clause 5.5 of the standard form AS2124-1986 is in the same terms as clause 5.5 of AS3556-1988. The former provision is treated as requiring that there be a debt in Davenport, Flowchart Analysis AS2124-1986, p.20.

8. The decision of the Court of Appeal mentioned earlier in these reasons in relation to standby letters of credit as a form of security (Fletcher Construction Australia Ltd. v. Varnsdorf Pty. Ltd.) bears on the meaning of "becomes entitled to exercise a right" in clause 5.5 of the present contract. I shall come back to this decision. One question which arises is whether use can be made, in construing clause 5.5, of the fact that the particular form of security which the parties caused to be employed was a standby letter of credit. I have earlier expressed the tentative view that the letter of credit fell within clause 5.3, dealing with the form of security, not as "an approved unconditional undertaking given by an approved financial institution or insurance company" (since it is not unconditional, requiring as it does the production of a statement by purported officers of the beneficiary), but as an "other form approved by the party having the benefit of the security". There is much learning on the "autonomy" of credits, quite apart from the articles of the Uniform Customs and Practice to which I have drawn attention. See Dolan, Law of Letters of Credit, Revised Ed., para. 2.09; Jack, Documentary Credits, 2nd ed., paras.1.40-1.42; Benjamin's Sale of Goods, 5th ed., paras.23-120 et seq.; Tyree, Banking Law in Australia, 3rd ed., paras.14.27 et seq.; Zohrab, "Standby Letters of Credit: Autonomy" and "Standby Letters of Credit: Fortex", (1996) N.Z.L.J. 417 and 392. If the present contract had provided simply that the security should take the form of a standby letter of credit, or perhaps even if the parties had, by an agreement made at the same time as the engineering contract, agreed that the security should take that form, it could have been argued that the very nature of the security for which the parties had provided could be used in the construction of clause 5.5. But the agreement or arrangement pursuant to which the letter of credit was furnished was made after the engineering contract had been entered into. Compare in this regard what was said by Callaway, J.A. in the Fletcher Construction Case at p.33 of his judgment. But we are, as Callaway, J.A. observed, entitled to have regard, in construing clause 5.5, to the fact that clause 5.3 contemplates an unconditional undertaking. Fletcher Construction was a stronger case than the present in this regard, in that the only form of security permitted by the contract there was an unconditional undertaking to pay in favour of the owner in a form, and given by a financial institution, approved by it. In the present case, the unconditional undertaking is only one of the particular forms of security recognised by clause 5.3, although the contract does go on to approve a particular form of unconditional undertaking. That form is one whereby the institution "unconditionally undertakes to pay on demand", without reference to the supplier and notwithstanding any notice not to pay given by it.

9. It is noteworthy that in the 11th edition of Hudson's Building and Engineering Contracts Mr I.N. Duncan Wallace Q.C. says this:

   "However, insofar as a construction contract may make clear provision for the furnishing of an unconditional guarantee as security for due performance, the normal interpretation ... will be that, in response to the stipulated demand, an unqualified transfer of the sums in question is intended, provided only that there is a bona fide dispute or claim on the secured party's part, and any further investigation of its merits or extent is not usually intended by the contract. In this regard the Pearson Bridge case supra, does not seem entirely convincing."

   In Fletcher Construction Callaway, J.A., at p.39, spoke of the doubt attending the line of cases that began with Pearson Bridge.

10. In the United States standby credits have been in common use for the last 30 years as a result of the banks' lack of power, by reason of Federal and State banking laws, to issue guarantees: Penn, Shea & Arora, Law and Practice of International Banking, p.287. While the courts of that country have been criticised for occasional lapses (Dolan, Law of Letters of Credit, para. 3.07[4]), the view which commands general acceptance is that standby credits are intended by the buyer and supplier - or other parties to the underlying contract - to require the supplier to stand out of the amount of the credit in favour of the buyer pending resolution of the underlying dispute. For example, in Mellon Bank N.A. v. General Electric Credit Corporation 724 F. Supp. 360, (1989) at 365 this was said:

    "Although GECC states the principle accurately, it does not apply it correctly in this case. The independence principle, and the above- quoted portion of the Letter of Credit [recognising that principle], speak only to the bank's obligation to honor the sight draft in the first instance. They do not preclude subsequent investigation and efforts at recovery. Pubali Bank v. City National Bank, 676 F.2d 1326 (9th Cir. 1982), appeal after remand, 777 F.2d 1340 (1985).

    The purpose of the independence principle, and of the similar provision in Mellon's Letter of Credit, is to provide the beneficiary with an unfettered, immediate remedy upon occurrence of the triggering event on a standby letter of credit. The purpose is not to prevent any subsequent challenge to the validity of the beneficiary's claim, but to ensure that 'contractual disputes wend their way towards resolution with money in the beneficiary's pocket rather than in the pocket of the contracting party'. Itek Corp. v. First National Bank of Boston, 730 F.2d. 19, 24 (1st Cir. 1984); C.K.B. & Associates v. Moore McCormick Petroleum, 734 S.W. 2d 653, 655 (Tex. 1987)."

11. Similarly, in the Fletcher Construction case Charles, J.A. and Callaway, J.A. spoke of the allocation of the risk in the sense of showing which party was to be out of pocket pending resolution of a dispute.

12. In the present case the matters of conversion of and recourse to the security are dealt with by two general conditions, which should if possible be construed so as to work in harmony. Clause 5.5 prohibits conversion into money until the purchaser becomes entitled to exercise a right under the contract in respect of the security. Clause 22.4 entitles the purchaser to deduct from moneys otherwise due to the supplier any moneys due from the supplier to the purchaser and, if those moneys are insufficient, entitles the purchaser to have recourse to the security. Like clause 3.13(b) in Fletcher, it confers a right of recourse against the security to obtain the balance if the exercise of the right of set-off which it also confers leaves a balance outstanding in favour of the purchaser. It would, as Charles, J.A. said in Fletcher, be strange if the clauses concerned in that case and this - clause 3.13(b) and clause 22.4 - conferred the practical right of recourse only where moneys were "due" from the supplier to the purchaser in some such sense as actually or indisputably due. I would treat clauses 5.5 and 22.4 of the present contract, read in conjunction, as entitling the purchaser, as between itself and the supplier, to have recourse to the security where according to a bona fide claim made by the purchaser moneys are due to it from the supplier which exceed any moneys due from it to the supplier.

13. The fact that one of the forms of security recognised by clause 5.3, when regard is had to the approved undertaking which is attached, is cast in the now familiar form of an unconditional promise to pay on demand without reference to the supplier and notwithstanding any notice by it not to pay supports the view that the parties contemplated that it was the supplier who should be out of pocket pending the resolution of any dispute.

14. The letter of credit, which has been twice extended in point of time as a result of the pendency of litigation, will now expire on 30 September 1990. But for the two extensions (to 31 August and 30 September), it would have expired already. It is manifest that there is no prospect that an arbitrator will make an award resolving the disputes until much more time has elapsed. Letters of credit invariably stipulate an expiry date; compare Article 44 of the Uniform Customs and Practice (1993), which requires that they do so. While a letter of credit would fall within clause 5.3 of the present contract only if its form was acceptable to the purchaser, no bank would have issued one without an expiry date. On the view of clause 5.5 put forward by the supplier, the purchaser must accept from the outset that its security will almost certainly implode long before recourse becomes permissible, so that it loses not only the benefit of cash in hand while the dispute drags on but also the entire benefit of the letter of credit as a security. Counsel for the supplier accepts that if his argument is accepted the security has now become worthless.

1. The appeal should not succeed.

TADGELL, J. A.:

1. For the reasons prepared by Brooking, J.A., which I have had the benefit of perusing in draft, I agree that this appeal should fail.

ORMISTON, J. A.:

1. I have had the great benefit of reading the judgment of Brooking, J.A. in draft form. It canvasses all the relevant matters so comprehensively that it is only necessary for me to say that I agree in his conclusions and in his reasons for reaching them.