Supreme Court New South Wales Medium Neutral Citation: EGL Management Services v Northern SEQ Distributor-Retailer Authority [2011] NSWSC 1234 Hearing dates: 28/09/2011 Decision date: 02 November 2011 Before: McDougall J Decision: Summons dismissed with costs. Catchwords: CONTRACT - security for performance of obligations under contract - whether conversion of security into cash then deposited into bank account amounted to appropriation - whether security intended to serve function of risk allocation - meaning of words 'to account' in contract. Cases Cited: Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd [2008] FCAFC 136 Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812 Lucas Stuart Pty LTd v Hemmes Hermitage Pty LTd [2010] NSWCA 283 Texts Cited: Australian Oxford Dictionary, 2nd Edition, 2004 Category: Principal judgment Parties: EGL Management Services Pty Ltd (ABN 27 062 716 572) Northern SEQ Distributor - Retailer Authority trading as Unitywater (ABN 89 791 717 472) Representation: Counsel: M Christie SC / LDR Shipway (Plaintiff) MG Rudge SC / EB Cowpe (First Defendant) Solicitors: Zraika Partners (Plaintiff) Corrs Chambers Westgarth (Defendant) File Number(s): 2011/249736 Judgment 1On 17 December 1999, the plaintiff (EGL) contracted with Redcliffe City Council (the Council) to design and construct upgrades to, and to maintain and operate, a waste water treatment plant. The defendant (Unitywater) is the statutory successor of the Council. EGL and Unitywater are in dispute as to the construction and effect of provisions in the contract relating to "Security" (performance guarantees) provided by EGL. 2The issue for decision is whether, on the proper construction of the contract and in the events that have happened, Unitywater's obligation to "account" to EGL for security given by EGL requires Unitywater to return that Security (or the cash into which it has been converted), or whether Unitywater is entitled to retain it. Factual background 3The Council owned and operated a waste water treatment plant. It wished to upgrade that plant, and to secure its proper maintenance and operation over a period of years. Accordingly, it entered into the contract with EGL. The initial term of the contract runs until 2016, unless it is terminated in accordance with its terms before then. There is a provision for renewal after 2016. 4Under the contract, EGL is required to maintain the plant at its own expense, subject to an entitlement, in some circumstances, to be paid for repairs and maintenance necessary as a result of changes in the quality of "Influent". 5EGL was required to provide guarantees as security for the performance of its obligations under the contract. In broad outline, the amounts secured by those guarantees were to reduce over the life of the contract. At specified times, EGL was required to provide fresh guarantees (in a lesser amount than those then held) and, upon this being done, Unitywater was required to "account" to EGL for the guarantees then held. One of the occasions when this process was to occur was within 14 days of 30 June 2011. 6Clause 25.4 of the contract gives Unitywater an express right to convert any "Security" into money at any time. 7From 30 June 2006, EGL was required to provide Security in the amount of $1,000,000.00 together with an "escalation" amount. The escalation amount was agreed to be $218,014.50. EGL furnished two guarantees, each in the sum of $500,000.00, from Australia and New Zealand Banking Group Ltd (the ANZ guarantees), and a further guarantee, in the sum of $218,014.50 from Westpac Banking Corporation (the Westpac guarantee). From 30 June 2011, the amount of the guarantees was to reduce from $1 million (excluding the escalation amount) to $500,000. 8On 20 May 2009, EGL notified Unitywater that, in EGL's opinion, there had been an adverse change in the quality of the Influent, as a result of which EGL had incurred and would continue to incur expense. On 15 November 2010, EGL quantified the amount of the repair costs. They were said to exceed $3 million. Either then or the following day, EGL made a claim to be reimbursed for those costs. 9Unitywater reviewed the claim. It concluded that there had been no permanent adverse change in the quality of the Influent. Accordingly, it asserted both that EGL was required to continue to maintain and repair the plant at its own expense, and that EGL was in breach of the contract for failing to do so. 10On 30 June 2011 (that is to say, the day when, or within 14 days of which, the guarantees were to be replaced), Unitywater notified EGL that it proposed to call upon the ANZ guarantees. Unitywater said that it would "account for these funds to EGL in due course". 11Correspondence passed between the parties' solicitors. It is not necessary to look at that correspondence. 12On 6 July 2011, Unitywater gave notice of default to EGL. That notice alleged that EGL had breached the contract in two ways: (1) because it had failed to proceed with works with due expedition; and (2) because it had failed to carry out its obligations of repair and maintenance to the appropriate standard. 13The notice specified, or gave particulars of, the matters said to have given rise to those defaults. It did so by reference to EGL's letter of 15 November 2010 (see at [8] above). The notice of default required EGL to do one of two things by 8 November 2011: (1) remedy the defaults, presumably by performing the works at its own expense; or (2) show cause in writing why Unitywater should not exercise its rights if the defaults were not rectified. 14The notice of default asserted that the time allowed (18 weeks) "is a reasonable time to remedy the default described". That proposition does not appear to be contested. 15Although the notice of default was given after 30 June 2011 (but within 14 days thereafter), there is no doubt that it crystallised a dispute that had been brewing for a considerable time prior to that date. It was not suggested that either party had acted other than in good faith in asserting its position. 16The dispute as to liability for the maintenance and repair of the plant (more accurately, the dispute as to whether EGL was required to carry out the necessary works at its own expense, or whether it is entitled to be paid for them) has not been resolved. It will be resolved, presumably, through the dispute resolution mechanism contained in the contract. However, EGL asserts that, upon its tendering guarantees in the sum of $718,014.50, Unitywater is required to "account" to it for the $1 million in cash held by Unitywater, and that it must do so by paying that sum to EGL. Relevant provisions of the contract 17The contract was made between EGL (which contracted under its former name, and which is referred to in the contract as "the Contractor") and the Council (so called). Unitywater has by statute succeeded to all the rights, and has undertaken all the liabilities, of the Council under the contract. 18Clause 4 of the general conditions of contract which formed part of the contract documentation requires EGL, among other things, to accept all Influent for treatment at the plant and to make good any defect in the plant. Clause 4.3 deals with the costs of doing so. I set it out: 4.3 Except as expressly provided to the contrary in this Agreement, the Contractor will bear and pay all costs, expenses and losses and incur and be responsible for all liabilities and damages in carrying out or endeavouring to carry out or failing to carry out the obligations of the Contractor provided for in this Agreement, and will indemnify the Council from and against any such costs, expenses, losses, liabilities and damages. 19Clause 14 deals with "permanent change to Influent quality". By clause 14.2, EGL is entitled to be paid for "substantial additional costs or losses" incurred in complying with its obligations under the contract, if there were "a permanent adverse change in the quality of the Influent". There were limitations on this entitlement. It is not necessary to consider them. I set out clause 14.2: 14.2 If there is a permanent adverse change in the quality of the Influent from the quality of Influent at the Handover Date as determined by material adverse changes from the general Influent characteristics described in Schedule 2, and such change causes substantial additional costs or losses to the Contractor in producing Effluent and Waste Products to comply with this Agreement, and such change exists for a continuous period of at least twelve (12) months at any time after the Handover Date, the Contractor may give a notice to the Council under this clause. The Contractor will not be entitled to give a notice under this clause if the change was caused or contributed to by natural occurrences beyond the Council's reasonable control, whether or not an event of Force Majeure, or due to the Contractor's breach or default. 20Clause 25 deals with the requirement to give Security. I set it out, so far as it is relevant: 25. SECURITY 25.1 Security is for the purpose of securing the due and proper performance of the obligations of the Contractor under this Agreement. 25.2 The Contractor will provide Security for the amount or amounts and from the dates set out in the Schedule of Commercial Arrangements. The Security will be in the form of an unconditional undertaking or certificate approved in writing by the Council and given by a financial institution approved by the Council. If the Security is not transferable by delivery it will be accompanied by an executed transfer thereof to the Council and the costs and expenses (including all stamp or other duties) of and incidental to the transfer and any retransfer to the Contractor will be borne by the Contractor. ... 25.4 Council may at any time convert into money Security which does not consist of monies. 25.5 Council will account to the Contractor for the Security in the manner and at the times provided for in the Schedule of Commercial Arrangements. 21The expression "Security" is a defined term. It is defined to mean "the security to be provided by the contractor in accordance with cl 25 of this Agreement" (see clause 1.1). 22The "Schedule of Commercial Arrangements" is found in cl 4 of schedule 11 to the contract. That clause reads as follows: 4.0 PERFORMANCE SECURITY 4.1 The Contractor is to provide Security of $2,000,000 within fourteen (14) days of the Execution Date. Council will account to the Contractor for this Security upon the provision of the Security stated in Section 4.2. 4.2 The Contractor is to provide Security in an amount equal to $1,000,000 escalated in accordance with the Capacity Fee escalation formula given in Attachment 2, where the Execution Date is the base date for such calculation, within fourteen (14) days of 30 June 2006. Council will account to the Contractor for this Security upon the provision by the Contractor of the Security stated in Section 4.3. 4.3 The Contractor is to provide Security in an amount equal to $500,000 escalated in accordance with the Capacity Fee escalation formula given in Attachment 2, where the Execution Date is the base date for such calculation within fourteen (14) days of 30 June 2011. Council will account to the Contractor for this Security within twelve (12) months after the expiry or earlier termination of this Agreement. 23Although cl 25.2 of the general conditions of contract provided that the Security should be in the form "approved in writing by the Council", there was in fact a draft form of guarantee set out in an appendix to the contract. That appendix (Appendix "C") was expressly referred to in the contract as one of the documents that "will be deemed to form and be read and construed as part of" the contract (see cl 2.1). 24Clause 32 provides for "Indemnities" generally (i.e. over and above the specific indemnity given by cl 4.3). By cl 32.1, EGL agrees to indemnify Unitywater in the broadest of terms: 32.1 Subject to this clause the Contractor covenants and agrees to indemnity and keep indemnified the Council for, from or against all liabilities, proceedings, penalties whether civil or criminal (except where to recover the same is unlawful or renders any part of this clause void for public policy reasons)), fines or other sanctions, judgments, damages, losses, claims, costs and expenses whatsoever and howsoever arising from or connected with the Contractor's occupation of the Site or the Contractor's possession, use, maintenance or operation of the Plant (including, without limitation, the treatment of Influent and the production of Effluent and Waste Products) or from or connected with any breach of this Agreement by the Contractor (including, without limitation, any breach of the Warranties) (including also reasonable legal costs and the reasonable costs of other advisers) (all such matters and things herein referred to as "Losses") which may be suffered or incurred at any time directly or indirectly by the Council or which may be suffered, incurred, made or claimed at any time directly or indirectly by, to or against the Contractor. 25Clause 39.13 of the contract provides that it is not necessary for a party to incur expense or make a payment before enforcing a right of indemnity given by the contract. It appeared to be common ground that cl 39.13 would apply to the specific indemnity given by cl 4.3, as well as to the general indemnities given by cl 32. 26I note that, by cl 40.1, the contract is governed by and to be construed in accordance with the laws of Queensland. Neither party submitted that there was any particular provision of Queensland law that had any impact on the resolution of the dispute. The parties' submissions 27As I have said, the question to be decided is whether, on the proper construction of the relevant provisions of the contract and in the events that have happened, the obligation of Unitywater to "account" for the sum of $1 million that it holds (as a result of calling on the ANZ guarantees) requires it to return that sum to EGL in exchange for the fresh guarantees, or whether it may keep that sum pending resolution of the dispute as to repairs. 28It was common ground that EGL had tendered (or had demonstrated that it was willing and able to tender) performance of its obligation to provide the fresh guarantees, and that Unitywater had dispensed EGL from the necessity of physically doing so. Thus, the question as to whether the obligations are concurrent (interdependent), or consecutive (independent), need not be addressed. 29Mr Christie of Senior Counsel, who appeared with Mr Shipway of Counsel for EGL, accepted that Unitywater had an untrammelled contractual right to call upon the guarantees, as it had done. However, he submitted, the fact that the guarantees had been called upon (or in the words of the contract, converted into money) did not produce any relevant change. He submitted that, just as the guarantees (before conversion) were "Security", so too the proceeds of their conversion were, and remained, "Security". 30Mr Christie submitted that there was a distinction between drawing down on the guarantees, or converting them into money, on the one hand, and having recourse to the proceeds of the guarantees on the other. That is made clear, he submitted, by cl 25.4 itself, which expressly contemplated that "Security" might consist of, or comprise, money. Thus, Mr Christie submitted, where all that had happened was conversion into cash, the obligation to "account" encompassed the proceeds of conversion of the guarantees, because the proceeds of conversion were still "Security" held by Unitywater. 31Mr Christie submitted, next, that the obligation to "account", required, in the circumstances of this case, that Unitywater should return the cash to EGL. He accepted that the obligation to "account" would extend only to so much of the money as was "held" by Unitywater, but submitted that, since the whole of the proceeds of conversion had been paid into and were still held in a separate bank account, the obligation to return encompassed the whole of those proceeds. 32Mr Rudge of Senior Counsel, who appeared with Mr Cowpe of Counsel for Unitywater, submitted that Unitywater had done more than convert the security from one form into another. He submitted that Unitywater, by paying the proceeds of conversion into a bank account established specifically to fund repairs, had had recourse to those proceeds. Thus, Mr Rudge submitted, Unitywater no longer held the proceeds of conversion as "Security". Mr Rudge relied on the context in which that conversion had occurred, including that Unitywater had required EGL to repair and maintain the plant, and had called on the indemnity given by EGL, as demonstrating that there was more than mere conversion. 33Mr Rudge submitted that the obligation to "account" required only that, in the ordinary dictionary meaning of the word, Unitywater should give some explanation of what it had done with the proceeds of conversion. He submitted that the obligation, so construed, would be satisfied by a statement from Unitywater to the effect that the proceeds of conversion (and the Westpac guarantee) were being held to be applied against claims for the indemnity that had been made. 34Each party referred to what it submitted was the sound commercial sense served by its own construction, and the commercial nonsense resulting from the other's. Those submissions do not take the matter much further. In many cases, the proposition that a particular construction of a contractual obligation makes commercial sense, or will produce a commercial nonsense, depends not so much on objective analysis as on the perspective and interests of the proponent. In many cases, that is reductive and circular reasoning: no more than a restatement, as a principle of construction, of the position for which each party contends. The authorities 35The parties referred me to many decided cases. To some extent, the principles established by those cases were not in dispute. To a greater extent, those principles have little to do with the resolution of the particular question with which I am faced. That is because most of the cases to which I was taken deal with the question of whether, on the facts of the particular case, there was any right to draw down on the security given by one party in support of its performance of its obligations to the other, and whether any such right (if it existed) should be exercised. In this case, cl 25.4 of the contract makes it clear that there is such a right. 36Thus, without wishing to be thought to be disrespectful either to the submissions of the parties or to the authorities which their submissions addressed, I propose to state, without detailed references, the general principles, and otherwise to focus on the decisions that seem to me to bear directly on the question to be decided in this case. 37I proceed on the basis, so far as it is relevant, that every contract is to be construed having regard to the words that the parties have chosen to express their bargain. Nonetheless, decided cases may be important because they demonstrate the background or understanding on the basis of which commercially sophisticated and well advised parties (such as the EGL and the Council) must be taken to have contracted. 38The basic understanding of a bank or other guarantee given as security for the due performance of contractual obligations is that it is "as good as cash". If it is not "as good as cash" - for example, because there is some inhibition or restraint on the right to call upon the security - then it may not fulfil its contractual purpose. 39Where a contract provides for security to be given either by cash or by guarantee, and where the latter alternative is chosen, calling on the guarantee - converting it into cash - does not of itself alter the characterisation of the sum thus obtained as "security". 40There is a distinction between converting a guarantee into cash - in which case, the proceeds of conversion are held, as was the guarantee, as security for performance - and having recourse to the guarantee (or the proceeds of its conversion). 41Nonetheless, in a particular case, the same act may constitute both conversion of a guarantee into cash and recourse to the proceeds of conversion. Whether this is so will depend, in any given case, on the particular facts and on the particular contractual provisions. 42The last three points can be illustrated by referring to the decision of the Court of Appeal of the Supreme Court of Victoria in Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812. 43The judgments of Charles JA (at 821) and Callaway JA (at 826) in that case show that there may be two reasons why one party to a contract may stipulate for a guarantee of the obligations of the other. Callaway JA identified the reasons at 826. One reason is that the guarantee should provide security, so that the beneficiary of the guarantee could have recourse against it if there were difficulty in recovering from the other party in the event of default. The other reason, which his Honour said "is additional to the first", is to allocate risk: who should be out of pocket pending resolution of a dispute? 44As the judgment of Charles JA (at 821-822) makes clear, characterisation of the purpose for which a guarantee is given depends on the proper construction of the contract pursuant to which it is given. One matter that his Honour regarded as being "of great importance" in this context was that the form of guarantee was prescribed by the contract. What was required was that the guarantee be unconditional, so that in response to the stipulated demand, the guarantor was obliged to transfer the sum guaranteed to the beneficiary. In this case, the form of guarantee is prescribed by the contract (in an appendix which forms part of the contract), and in terms is not materially distinguishable from those considered by the court in Fletcher Construction . 45Another matter that Charles JA regarded as being important was the provisions of the contract that gave the beneficiary of the guarantee the right to call on it if the party whose obligations were guaranteed failed to meet some monetary obligation. There is no such express provision in the contract with which I am concerned. There is, however, the untrammelled right to convert a guarantee into cash. 46The court concluded, in Fletcher Construction , that the guarantee was intended to act as a risk-allocating device, pending final resolution of some dispute. Thus, the court concluded that the beneficiary of the guarantee was entitled to call on it provided that there were a genuine claim or dispute. It was not necessary, as a condition of entitlement to be paid the guaranteed sum, that the claim be admitted or adjudicated in favour of the claimant. 47It is, I think, significant that the dispute between the parties in Fletcher Construction concerned the principal's entitlement to time delay costs. That dispute had crystallised, because the work had been completed late. There was a dispute as to whether the delay costs were payable, but the fact that the principal's entitlement to those costs was contested did not affect adversely its right to hold the proceeds of the security until the dispute was resolved. 48The decision in Fletcher Construction was considered and applied by the Full Court of the Federal Court of Australia in Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd [2008] FCAFC 136. The court stated at [80] that, in the absence of fraud or other vitiating circumstances, "the beneficiary of a performance guarantee granted in its favour as a risk allocation device, will be entitled to call upon the guarantee even if it turns out, ultimately, that the other party was not in default". Their Honours held that, properly construed, the contract before them did have the effect of making the performance guarantee a risk allocation device. 49The decision in Clough Engineering was considered by the Court of Appeal of this State in Lucas Stuart Pty Ltd v Hemmes Hermitage Pty Ltd [2010] NSWCA 283. In that case, some doubt was expressed as to the correctness of the decision in Clough Engineering (see Macfarlan JA, with whom Campbell JA agreed, at [38]). It seems, however, that his Honour did not intend to disagree with the proposition that in some cases, a performance guarantee should be considered to be a risk allocation device. His Honour's reservation was, I think, as to whether the guarantee considered by the Full Federal Court should be so characterised. Decision 50There are essentially two questions to be resolved. The first is whether Unitywater holds the proceeds of conversion of the ANZ guarantees as "Security". The second is the proper construction and application of the obligation to account. First question: characterisation of the proceeds of conversion 51The ANZ guarantees and the Westpac guarantee were held by Unitywater as security for the performance of EGL's obligations under the contract. The fact of conversion of those guarantees into money did not mean that the proceeds of conversion were anything other than such security. This was, I think, common ground; and in any event, it follows necessarily from clause 25.4. That clause expressly recognises that "Security" may comprise either or both of a guarantee given pursuant to cl 25.2 and cash. It contemplates, also, that the form of any "Security" given and held may change from time to time. 52Accordingly, and consistent with the proposition stated at [39] above, Unitywater's conversion of the ANZ guarantees into cash does not of itself mean that the proceeds were held as anything other than "Security". If that position were to change, it would be necessary for Unitywater to have done something which changed the character of the proceeds of conversion, so that they will no longer held as "Security". That is why Mr Rudge submitted that, in the context of this particular case, it should be concluded that Unitywater had had recourse to the proceeds of conversion. 53There was however an element of inconsistency in this aspect of Mr Rudge's submissions, and in my view it highlights the essential difficulty which Unitywater faces. From time to time, in the course of his oral submissions, Mr Rudge said that the proceeds of conversion were held by Unitywater as "security" pending EGL's performance of its contractual obligations (see, for example, T 26.45-27.40). He sought to escape from the obvious consequences of this analysis by focusing on the obligation to account. Mr Rudge submitted that the process of accounting does not require Unitywater to repay the unexpended portion of the proceeds of conversion (in this case, nothing has been spent so all the proceeds of conversion are available). Instead, he submitted, Unitywater could "account" simply by stating that it proposed to use the proceeds of conversion, if necessary, to indemnify itself in the event that EGL does not perform its repair obligations (as Unitywater sees those obligations). 54Mr Rudge placed particular reliance on clause 39.13. He submitted that it was not necessary for Unitywater to have spent any money before a right of indemnity arose. That may be accepted. But it does not follow that the proceeds of conversion of the ANZ guarantees are held as anything other than security for the performance by EGL of its obligation to repair, or as security against the secondary obligation of EGL to indemnify Unitywater in the event that the repair obligation is breached. (In saying this, I am assuming, without deciding, that EGL has a conceded or demonstrated obligation to repair at no expense to Unitywater.) 55Unitywater has not expended any part of the proceeds of conversion. It has not incurred any expense on its own account in the performance of what it says are EGL's obligations to repair and maintain. It has given notice to EGL to carry out the necessary work, and is awaiting performance (or non-performance) of the requirements of that notice. In those circumstances, I think, Mr Rudge was correct to characterise the proceeds of conversion of the ANZ guarantees as being held by way of security for the performance of those obligations of repair and maintenance. 56As I have noted, Mr Rudge submitted that Unitywater had used, or had recourse to, the proceeds of conversion, so as to deprive them of their character as "Security", by paying them into a bank account opened for the specific purpose of funding repair and maintenance works. If this submission were correct, it could undermine the clear contractual mechanism for the gradual reduction, over time, of the amount of security that EGL was required to provide. That is so because Unitywater would have the ability, by a unilateral (and non-consensual) characterisation of the proceeds of conversion (or, for that matter, of "Security" comprising cash) to deprive that money of its contractual character as "Security", and thus, perhaps, take it outside the obligation to account. Whilst I have suggested earlier that appeals to commercial common sense (or nonsense) are not of great significance in the context of this case, that is one consequence that, I think, should be avoided if at all possible. 57Mr Rudge submitted that the ANZ guarantees (more accurately, the "Security" required to be given by EGL pursuant to cl 25.2 of the contract, and the proceeds of their conversion) should be regarded as risk allocation devices. 58In support of this conclusion is the circumstance that the form of guarantee to be given as security was prescribed by the contract. That was a matter which Charles JA regarded as important in Fletcher Construction (and which, it seems, the Full Court regarded as important in Clough Engineering .) However, the additional features on which Charles JA relied are notably absent in this case. 59First, and most important, there is no equivalent of the contractual provision that entitled the principal to call upon the guarantee if Fletcher Construction did not pay the costs on demand. 60Secondly, though there is a dispute as to performance of the obligations of repair and maintenance (because EGL says that it is not obliged to do so unless it is paid), the time limited by Unitywater for completion of those works has not yet expired. The notice that Unitywater gave to EGL required the works to be performed by 8 November 2011. 61Thirdly, Unitywater has not itself incurred any expense. 62Mr Rudge sought to overcome those points by referring to cl 39.13. He submitted, correctly, that it was not necessary that Unitywater should have incurred any expense before it enforced a right of indemnity. The right of indemnity is to be found in cls 4.3 and 32.1. But neither of those clauses to gives any right to Unitywater to recoup itself out of the guarantees or their proceeds, in the event that EGL does not perform some contractual obligation. Nor does cl 25.4 goes so far. On the contrary, it recognises that conversion, of itself, does not amount to appropriation. 63In my view, the obligation cast on EGL as "the Contractor" to provide Security to (as it now is) Unitywater has both characteristics identified in Fletcher Construction : security properly so called, and as a risk allocation device. In this context, as I have noted, Callaway JA recognised (in Fletcher Construction at 826) that the two purposes need not be inconsistent. 64In coming to this conclusion, I do not think that it is significant that the form of guarantee is prescribed by the contract. That is important, in a commercial sense, whether the guarantee is intended to serve only the first purpose - the provision of security - or whether it is intended to serve the second as well. Indeed, one might say, it would be particularly if the guarantee were intended to serve (only) as security that its unconditional nature should be specified in detail by the contract pursuant to which it was given. If that were not done, it might not be "as good as cash". 65However, there are other indicia in the contract with which I am concerned that the guarantee is intended to serve, as well, the function of risk allocation pending resolution of a dispute. 66The first of those indicia is the very fact that Unitywater is entitled to convert "Security" into cash at any time. It is axiomatic that, if Unitywater does so, it must hold the cash so obtained in some account, at least until (should it happen) there is an occasion to have recourse to the cash. The parties thus contemplated that at any time Unitywater was entitled to call upon guarantees held by it, and to hold the proceeds in its own name. 67The second indicium is to be found in the very wide terms of the indemnities given by EGL to Unitywater pursuant to the contract. Not only is EGL required to perform its various obligations, it gives indemnities to Unitywater against (among other things) the consequences of non-performance of those obligations. 68The third indicium - and in my view the critical one - is that a party having a right to indemnity is not required to spend its own money before calling upon the right. That indicates, in my view quite clearly, that where there is a genuine claim to be indemnified, the party making that claim is entitled to call upon the indemnity even though it is not out of pocket. It follows, where the party has the benefit of Security that supports performance of (among other things) the obligation to indemnity, then the Security is available in satisfaction of the claim. 69I have no doubt that, in some cases, it would be open to Unitywater both to convert a guarantee into cash and to take the proceeds for itself, in satisfaction of some right to indemnity. But in the circumstances of this case, I do not think that it has done so. On the contrary, I think, as Mr Rudge conceded, Unitywater is doing no more than keep the proceeds of calling on the guarantees until such time as it knows whether EGL has performed what are said to be its obligations of repair and maintenance. 70In my view, the proceeds of conversion are held as Security unless and until they are drawn upon, in the sense of being expended, for the purpose of making good EGL's (allegedly) unperformed obligations of repair and maintenance, or in satisfaction of EGL's obligation to indemnify. That conclusion focuses attention on the second question: the content of the obligation to account. It does so because Mr Rudge submitted that in any event Unitywater would "account" if it stated that it was holding the proceeds of conversion against performance of EGL's obligations. 71Before I turn to that question, I note that there was some debate between the parties as to whether, in the event that EGL carried out the requirements of the notice (or in the event that it was held, either through the contractual dispute resolution process or otherwise that EGL was not required to do so - at least, without being paid), Unitywater would be under some obligation to refund the proceeds of conversion to EGL. 72The decision of Charles JA in Fletcher Construction touches on this topic. At 822, his Honour referred to the possibility that, if the principal were permitted to call on the letters of credit, the contractor "would be very seriously disadvantaged if it were unable to recoup these monies later, with interest, if it should be determined in the arbitration that [the contractor's] contentions... are justified". The principal submitted that, in that event, the contractor would be entitled to the return of the money with interest. His Honour observed that this submission "would seem clearly correct". However, since his Honour based this observation on the terms of the contract, not all of which are set out in the reasons for judgment, it is a little difficult to evaluate it. 73In this case, Mr Rudge submitted that, if his client retained the proceeds of conversion and was later found not to have been entitled to do so, it would be liable to repay them to EGL. Mr Christie submitted that there was no basis on which, in the events under consideration, his client would be able to recover the money. 74Since the point was not fully argued, and since it does not seem to me to bear on the outcome, I do not propose to express a concluded view. However, for the reasons that I give at [84] - [85] below, my provisional view is that Mr Rudge's submission should be preferred. Second question: the obligation to account 75The ordinary English meanings of the phrasal verb "account for" include: "serve as or provide an explanation or reason for"; "give a reckoning of or answer for (money etc. entrusted); answer for (one's conduct)"; "...supply or make up a specified amount or proportion of"... . See the Australian Oxford Dictionary, 2 nd edition, 2004. 76The concept of account is well known in the law. The common law action of account was a cumbersome process involving three stages. The first stage was an enquiry to see whether the defendant was an accounting party. The second was an examination of the defendant before court-appointed auditors to take an account and to determine the balance one way or the other. The third was an action for payment of the balance so determined. In equity, the remedy of account was only available against an accounting party, but the procedure was somewhat less cumbersome than the procedure at law. Thus, both at law and in equity, it was necessary for the defendant to be someone who, if the balance of the account were found to be against him, would be liable to pay it before he could be characterised as an accounting party, and thus one against whom an account could be taken. The process of accounting was inextricably bound up with the obligation to pay any amount found due on the taking of accounts. 77I think it is unlikely that the parties intend to incorporate into their agreement the legal or equitable concepts of "account"; and likely that they intended the obligation to account to have its ordinary English meaning. That is to say, I think that the parties intended that, when Unitywater is required to account for the securities held by it, it is required to explain what has happened to them, or give a reckoning of what it has done with them (including so much thereof as had been comprised of, or had been converted into, money). 78Adapting those general observations to the facts of this case, Unitywater will explain what has happened to, or give a reckoning for, the guarantees by saying that they have been converted into money, and that the proceeds have been paid into the particular account to be held until it sees whether EGL performs what are said to be its obligations of maintenance and repair. 79I do not think that it follows that Unitywater is obliged to hand back the proceeds of conversion simply because they have not been spent. There is alleged to be an outstanding breach of EGL's obligations of repair and maintenance. EGL has been given an opportunity (one might say, a last opportunity) to rectify that alleged breach. Even accepting, as I have concluded, that Unitywater holds the proceeds of conversion as security for the rectification of the alleged breach, or against EGL's obligation to indemnify Unitywater for the consequences of that alleged breach, it does not follow that Unitywater is obliged to repay the money simply because the question of breach has not been decided and the amount of any liability has not been precisely quantified. 80If there were no case of breach, or alleged breach, then the mere fact of conversion would not entitle Unitywater to hold onto the money. In that hypothetical circumstance, the obligation to account would require Unitywater not just to explain, but also to hand over, or pay over, the old Security, in exchange for the new. In other words, the practical application of the obligation to account, and what must be done to satisfy it, will depend very much on the factual circumstances in which the obligation arises. 81Thus, where there is an alleged breach, and where it is clear that if there is a breach, its monetary consequences are likely to exceed substantially the amount of the security, in my view Unitywater is entitled to retain the proceeds of conversion until the question of breach is decided one way or the other. Any other conclusion would deprive Unitywater of the benefit of the Security. It would destroy the very purpose for which that security has been given: "for the purpose of securing the due and proper performance of the obligations of [EGL] under [the] Agreement" (cl 25.1). 82In short, I conclude, on the facts of this case, that Unitywater will account sufficiently for the Security held by it if it explains what it has done with the three guarantees that were given to it; and for what purposes, or more specifically in respect of what alleged breaches, those guarantees or the proceeds of their conversion are being held. 83That construction seems to me to be consistent with the characterisation of the "Security" required to be given as serving the dual purposes of security strictly so called and risk allocation. If the construction of the obligation to account for which Mr Christie contended were correct, that latter function would be rendered nugatory, even where there is a genuine and seriously arguable dispute, simply because the "rollover" date came and went before that dispute could be resolved. The risk in respect of that dispute, of being out of pocket until its resolution, that had been allocated to EGL would be reallocated to Unitywater. 84There is some practical advantage to the construction that I think is correct, of the obligation to account. When that obligation arises for performance, Unitywater is, in my view, required (at least initially) to give an explanation or reckoning of what it has done with the proceeds of conversion. The explanation or reckoning that it gives can be tested against the contractual purposes for which the security is held. If the explanation is not one that would authorise the retention of the Security, then Unitywater must hand it over (if unconverted) or repay it (if converted). Likewise, if the reckoning were to show that some of the proceeds of conversion had been applied for an unauthorised purpose, Unitywater would be obliged to repay or reinstate. 85Thus, what in my view is the correct construction does not mean that EGL is automatically denied any opportunity to recover the Security (in whatever form it exists). On the contrary, by entitling EGL to an explanation or reckoning, it enables EGL to determine whether the explanation or reckoning is sufficient, and to assert a right to return of the Security if it concludes that the explanation or reckoning is insufficient. 86I acknowledge that this construction means, in effect, that Unitywater is entitled to hold both the Security given for the period that expired on 30 June 2011 and the further (although lesser in amount) Security that is required to be given for the next period. However, that does not seem to me to lead to inconsistency, let alone to absurdity. 87The position may be tested fairly simply. Suppose that prior to 30 June 2011, the alleged breach were admitted, or had been held by the working out of the dispute resolution process under the contract to be a breach. There can be no doubt that Unitywater would be entitled to hold the guarantees, or the proceeds of conversion, until the breach had been rectified, either by it or by EGL. Why is the position any different because the question of liability has yet to be determined? In the former case, Unitywater would have the benefit of the Security and would be entitled to the fresh Security. (And if, in the former case, Unitywater had done the work itself, it would be entitled to reimburse itself from the proceeds of conversion of Security.) In the latter case, Unitywater has the Security against a determination on the question of breach. 88The situation would be otherwise if Unitywater had held onto the Security even though there was no alleged breach. But that hypothetical situation is far removed from the present facts. It was not suggested that Unitywater's complaint of breach was made in bad faith, or that it was groundless, or that it was merely a colourable attempt to give plausibility to its retention of the benefit of the Security. Conclusion and orders 89In my view Unitywater holds the Westpac guarantee and proceeds of conversion of the ANZ guarantees as "Security" under the contract, and not otherwise. 90In the factual circumstances of this case, Unitywater's obligation to account for those proceeds, as part of the Security held by it, does not require it to repay the proceeds of conversion until the question of breach has been resolved one way or the other. That obligation requires only that Unitywater give an explanation of, or answer for, what it has done with those proceeds. 91It follows that the summons should be dismissed with costs and I so order. ********** DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 02 November 2011