Major Projects & Construction 5 Minute Fix 107: escalation risk, unconditional undertakings, building legislation and standards

Commercial principles on escalation risk for infrastructure projects – a view from NSW

On 1 September 2022, the NSW Government released a set of "commercial principles on escalation risk for infrastructure projects". The release of these commercial principles is indicative of governments needing to respond to the rapid and substantial price increases experienced across the construction industry generally, and the end of a relatively extended period of stable prices and low background inflation.

The recommendations accompanying the commercial principles relate primarily to the structure and management of procurement processes, as opposed to setting out a prescriptive guideline on risk allocation and contractual terms. However, where price escalation risk on a specific input is demonstrated to pose a material risk, the guideline recommends that agencies consider applying a "rise and fall" pricing mechanism in respect of that input.

Agencies are recommended to introduce as many of the measures, outlined in the principles, as is practicable in the circumstances (including to projects in advanced stages of procurement) to account for movements in input prices. Noting that this approach is more likely to be successful where there is still a competitive process underway with more than one bidder.

There are some notable exceptions to the application of the commercial principles, including public private partnerships and unsolicited proposals. Further, the principles do not recommend any change in approach to projects already in delivery, as at 31 August 2022.

Unsuccessful attempts to restrain recourse to bank guarantees

Two recent cases illustrate a judicial preference for giving effect to the commercial purpose of a performance undertaking and the “contractual bargain of the parties”.

In Daewoo Shipbuilding & Marine Engineering Co Ltd v INPEX Operations Australia Pty Ltd [2022] NSWSC 1125, the NSW Supreme Court declined to extend an interim injunction against calls on a $467 million bank guarantee, finding that the bank guarantee was intended to operate as a “risk allocation” mechanism. To restrain recourse in that circumstance would, the Court held, defeat the commercial purpose of the bank guarantee, as it provided a “pay now, argue later” regime. The Court determined that it was “exercisable ‘at any time’ and was not expressed to be conditional upon an admission of liability or an arbitral determination”.

Notably, the Court declined to provide the injunctive relief sought despite the considerable financial difficulties being experienced by Daewoo because of the pandemic and international sanctions imposed on Russia after its invasion of Ukraine, stating:

“When agreeing to give a bank guarantee a decade ago, Daewoo could not have foreseen a global pandemic, let alone both a pandemic and a war. But that does not detract from INPEX’s entitlement to be protected by the bank guarantee from Daewoo’s troubles in the event of a dispute…”.

In another recent decision, the Court of Appeal in Perkins (WA) Pty Ltd v Weston [No 2] [2022] WASCA 111 held that the principal’s rights in respect of a performance bond did not cease on the (disputed) termination of the relevant contract and that, contrary to the contractor’s submission, there was “no basis for the implication of a term to that effect”. This flowed, the Court of Appeal said, from “the express purpose of the security - to secure 'the due and proper performance of' [the contractor’s] obligations.”

Uncertainty in commercial contracts revisited

The NSW District Court recently considered whether a commercial contract was void for uncertainty, in the matter of Go For Your Life Pty Ltd v Charas Constructions Pty Ltd [2022] NSWDC 328. This case is a useful example of the sorts of issues that will not suffice in challenging the validity of a contract on the grounds of uncertainty.

In this case the defendant (Charas) resisted paying certain invoices claimed by the plaintiff (Go For Your Life) on the basis the agreement between them was too uncertain to be valid.

That argument relied on four claims:

1. payments that had already been made by Charas were made to an entity other than Go For Your Life;
2. the agreement pre-dated the incorporation of Charas;
3. while Charas was described as a trustee in one part of the agreement, there was no evidence that it had ever had that role; and
4. the ACN for Charas was incorrectly stated.

On the question of uncertainty, Taylor DCJ revisited the “traditional doctrine” that “courts should be astute to adopt a construction which will preserve the validity of the contract” (Meehan v Jones (1982) 149 CLR 571, 589 (Mason J)) and then stated that courts should “uphold the reasonable expectations of parties who believed that they had made an effective contract and avoid the reproach of being the destroyer of bargains” [20].

Taylor DCJ held that the agreement was not void, largely on the basis that its construction was to be approached on the basis that the parties intended to produce a commercial result, and because the agreement was in writing, had been signed and was almost fully performed. Specifically, the incorrect rendition of an ACN did not displace the clear intention that Charas was the contracting party.

Restoring confidence in the NSW construction industry

On 30 August 2022, the NSW Government announced that it would be seeking community input on:

• proposed changes to building sector legislation; and
• more compliant and fire-safe buildings.

The “have your say” public consultations are geared towards seeking public feedback to restore confidence in the construction industry.

The consultation period is open until 25 November 2022.

NSW Government tables response to the “Further Inquiry into the Regulation of Building Standards”

On 25 August 2022 the NSW Government tabled its response to the recommendations in the Public Accountability Committee’s “Further inquiry into the regulation of building standards”.

The Inquiry contained 20 recommendations on the efficacy and adequacy of the government’s regulation of building standards in respect of:

• the cost, effectiveness and safety concerns arising from the use of flammable cladding; and
• private certification of and engineering reports for construction projects.

The NSW Government’s responses outline key actions that have been taken or will be taken in the future to transform the NSW residential construction sector. These include (but are not limited to):

• legislative reforms;
• consulting with stakeholders on future reforms;
• empowering the building regulator with greater compliance and enforcement powers;
• addressing illegal phoenixing activity in the building and construction industry;
• developing an insurance product and addressing the availability and affordability of professional indemnity insurance;
• improving the regulation of certifiers; and
• taking action on flammable cladding (including through Project Remediate, the NSW Cladding Taskforce and the Cladding Product Safety Panel).