WA Supreme Court confirms insurance bonds are as good as cash

In the case, Primero was contracted by Coburn Resources to design and construct a mineral sands project in the Gascoyne region of Western Australia and the two entered into an EPC contract, with Primero Resources providing four insurance bonds to Coburn as security. 

Coburn returned two of the bonds to Primero. Disputes surrounding defects and delays on the project arose and, in fear of Coburn calling on Primero’s security, Primero commenced legal proceedings, seeking declarations in relation to the proper construction of the contract and an injunction to stop Coburn from calling on the two remaining bonds that remained as security. 

The central issue for the court to consider was the proper interpretation of clause 5.2(b) of the EPC contract which enabled Primero to have recourse to Coburn’s security if Coburn was in breach of any material obligation of the contract.

Primero argued that Coburn could only have recourse to the security if it agreed that it was in breach of a material obligation under the contract or if it had been determined by the court to be in breach of a material obligation.

Coburn argued that a proper interpretation of clause 5.2(b) permitted it to have recourse to the security if Coburn honestly believed that a contractor is in breach of a material obligation under the contract and that an honest belief in the existence of a dispute, not that a dispute has been determined, was the only requirement.

In agreeing with Coburn’s submission and rejecting Primero’s, the court emphasised that the power to have recourse to the security must be exercised honestly and for proper purposes and that this construction was consistent with the clause. The court found that the object of the relevant clause is to permit the bond holder to call upon it before any dispute is determined and 'allocate risk'. 

Nicole Whitby, a construction expert at Pinsent Masons, said: “The WA Supreme Court has confirmed the importance and role of security on construction projects as a risk allocation device,” she said. 

“Our news headlines continue to be dominated by subcontractor and contractor insolvencies and the financial pressures of delivering major projects,” she said. 

“Security and the bond holder’s ability to have recourse to it will continue to be hotly contested in this environment. It remains difficult for bond providers to restrain a call.” 

Australia’s construction sector has continued seeing a surge in insolvencies, with news last week of two companies entering administration around the country. Security, whether bank guarantees, insurance bonds or retention, remains a critical risk allocation and mitigation device on major projects.