Focus on what words say: WA Court of Appeal confirms parental company guarantees ‘not as good as cash’

The Western Australian Court of Appeal has dismissed an appeal[1] by JKC Australia LNG Pty Ltd (JKC) from a decision of the Chief Justice that particular parent company guarantees (PCGs), given to it by CH2M Hill Companies Ltd, UGL Pty Ltd, and General Electric Company (Parents) to secure the performance of a consortium of subsidiaries comprising JKC’s subcontractor, are not ’as good as cash’. 

The background to the first instance decision was set out in detail in a previously published Corrs Insight. In short, JKC called on the PCGs in circumstances where liability arising from the termination of the subcontract between JKC and the subcontractor remained unresolved and the subject of an international arbitration.

JKC argued at first instance that the PCGs should be understood to operate as ‘on demand’ instruments which created a ‘pay now, argue later’ obligation on the Parents. The result being that any monetary call on the PCGs, subject to JKC forming a reasonable opinion that the subcontractor had failed to perform an obligation or discharge a liability under the subcontract, must be paid in full regardless of whether the subcontractor had a good defence, set-off or counterclaim available. 

At first instance, Quinlan CJ found that the PCGs guaranteed the performance of the subcontractor’s obligations during the currency of the subcontract, but that they did not create a ‘pay now, argue later’ obligation akin to an ‘on demand’ bank guarantee. 

In responding to JKC’s call, his Honour found that the Parents could rely on any defence, set-off or counterclaim that was available to the subcontractor in response to the subject matter of the call. This meant that any contested call by JKC on the PCGs would need to wait until actual liability had been determined in the arbitration. 

The appeal 

JKC appealed Quinlan CJ’s decision on three grounds, claiming that His Honour erred in holding that:

• the PCGs did not require each Parent to meet a liability, identified in a call by JKC, upon the formation of a reasonable opinion that the subcontractor failed to discharge a liability under the subcontract (Ground 1);
  
  
• Clause 3 of the PCGs was concerned exclusively with the obligations to physically perform works and did not address any type of payment obligation (Ground 2); and
  
  
• Each Parent’s obligation under clause 3 of the PCGs ceased to operate after termination of the subcontract (Ground 3).

The Court of Appeal unanimously dismissed the appeal, with separate judgments from President Buss and Justice of Appeal Vaughan, and Justice of Appeal Beech. The Court found, similarly to Quinlan CJ at first instance, that while the PCG’s guaranteed the performance of obligations under the subcontract (subject to the satisfaction of a number of criteria), they were not ‘on demand’ instruments which created an obligation to ‘pay money now, argue later’ without regard to any defence, set-off or counterclaim that might be asserted. 

Understanding commercial contracts

In dismissing the appeal, the majority (Buss P, Vaughan JA) spent some time distilling the proper approach to the interpretation of commercial contracts and the judgment helpfully summarises the principles of contractual construction. 

The key takeaway is the Courts’ caution against starting the process of contractual construction from an assumption as to the purpose of an instrument, and searching for support for that construction in the text of the instrument.  

The majority criticised JKC’s approach to the interpretation of the PCGs on that basis, which it described as ’mere bootstrapping’. Approaching the task in this way meant that JKC failed to interpret the PCG’s as a whole by reference to their text, context and purpose.  

Construction of performance bonds and guarantees

The majority also confirmed the first instance judgment that there exist no separate rules for the interpretation of performance bonds. The normal principles of contractual construction apply to all instruments, reinforcing the Australian Courts’ unwillingness to make presumptions about particular instruments when construing them.   

What constitutes a ’reasonable opinion’ 

Clause 3 of the PCGs required the formation by JKC of a ’reasonable opinion’ (wording common in guarantees) before it could make a call.  

The majority held the assessment as to whether JKC’s opinion, that the subcontractor had failed to perform an obligation or discharge a liability under the subcontract, was reasonable, was to be assessed objectively based on the information and facts known, or which ought reasonably to have been known at the time.  

The majority held that the possible availability of a defence, set-off or counterclaim ought to be taken into account in objectively forming the required reasonable opinion. In that way, the requirement for a reasonable opinion in clause 3 was compatible with clause 9.2 of the PCGs, which allowed the Parents, in response to any call by JKC, to rely on any defence, set off or counterclaim available to the subcontractor.

Comment

This decision reinforces the importance of taking the correct approach to construing commercial instruments. Approaching the task in a piecemeal fashion or in a manner that strains the language of the instrument when considered as a whole must be avoided. As must approaching the construction with an assumption as to how the instrument operates, and searching for support for that construction in the text of the instrument.

This decision also emphases that the assessment as to the reasonableness of an opinion is an objective test which must consider the information and facts known or which reasonably ought to have been known at the time.