Security Under Construction Contracts: Bank Guarantees, Retention Moneys and Commercial Risk

Security under construction contracts refers to financial or performance-based instruments that ensure the Contractor meets their obligations. The most common types are Bank Guarantees and Retention Moneys, which protect the Principal against defects, non-performance, or default.

Key Takeaways

• Security protects Principals from financial risk if Contractors fail to meet contractual obligations
• Bank Guarantees and Retention Moneys are the most commonly used forms of Security
• Most contracts allow for part or full Security to be called if the Contractor defaults
• The release of Security usually occurs at Practical Completion and after the Defects Liability Period
• Improper calls on Security often lead to disputes, injunctions, and urgent court applications

Introduction to Contract Security in Construction

Security provisions are standard in commercial construction contracts. Their purpose is to safeguard the Principal against non-performance or defective works and to provide a mechanism for recovering costs if the Contractor fails to fulfil their obligations. At the same time, Security balances the Contractor’s right to be paid with the Principal’s right to enforce the contract.

Security may take different forms—Bank Guarantees, Retention Moneys, performance bonds, or cash deposits—but the underlying principle is the same. It acts as a buffer.

The commercial and legal implications of how Security is provided, held, called or released should be clearly understood by both parties before contract execution.

What Is Security in a Construction Contract?

Security in a construction context is an amount of money, or an instrument equivalent to money, that is provided to the Principal as assurance that the Contractor will comply with their contractual obligations. If the Contractor fails to do so—by delivering defective work, abandoning the project, or breaching the contract—the Principal may have a right to call on the Security to remedy or recover losses.

Security is usually capped as a percentage of the Contract Sum and is subject to specific terms about when it can be called, reduced, or released. The contract should outline these mechanisms clearly to avoid disputes.

Forms of Security: Bank Guarantees vs Retention Moneys

The two most common forms of Security in Australian construction contracts are Bank Guarantees and Retention Moneys. Each has a different legal structure and practical impact.

A Bank Guarantee is an unconditional undertaking by a financial institution to pay the Principal a fixed amount upon demand. It is not a bond or insurance policy—it is effectively a substitute for cash that can be accessed immediately, subject only to the wording of the guarantee.

Retention Moneys, by contrast, are amounts withheld from the Contractor’s progress payments and held by the Principal. These funds are gradually accumulated over the life of the project and form a pool of money that the Principal can access if the Contractor defaults.

Both forms serve the same commercial purpose but come with different risks, administrative requirements, and legal remedies.

Common Security Provisions in Standard Contracts

Standard-form construction contracts such as AS 4000, AS 2124, GC21, and the MBA suite all contain provisions for Security. These clauses usually cover:

• The type and amount of Security
• When and how Security must be provided
• Conditions under which Security may be called
• Timeframes for the return or reduction of Security
• The rights of each party in relation to the Security

For example, AS 4000 Clause 5 provides that Security must be in a form approved by the Principal and sets out when the Principal can call on it. The contract annexure often specifies the percentage and method of Security (e.g. 5% of the Contract Sum, with 50% in Bank Guarantee and 50% as Retention Moneys).

Calling on Security: What It Means and When It’s Allowed

Calling on Security means the Principal demands payment under the Bank Guarantee or applies Retention Moneys to cover a loss. Most contracts allow this if the Contractor has committed a breach, failed to rectify defects, or defaulted in some other way.

Bank Guarantees are often drafted to be payable “on demand” and “unconditionally,” which means the Principal does not need to prove a breach before accessing the funds. However, courts have limited this right where the call is fraudulent, made in bad faith, or clearly not permitted under the contract.

Retention Moneys are usually more straightforward. The Principal can apply them to rectify defective works or cover costs if the Contractor fails to do so. However, the contract must still be followed—arbitrary deductions are likely to be challenged.

When Can Security Be Released?

Most construction contracts provide for Security to be released in two stages: part at Practical Completion, and the remainder after the Defects Liability Period. A typical arrangement might be 50% returned at Practical Completion and 50% at the end of a 12-month defect rectification period, subject to the Contractor fulfilling all obligations.

If the Contractor fails to fix defects during the Defects Liability Period, the Principal may apply the remaining Security to do the work. However, they must still act within the bounds of the contract and not retain Security indefinitely.

Risks Associated with Bank Guarantees

Bank Guarantees pose specific risks because they are unconditional and readily enforceable. From a Principal’s perspective, this provides immediate recourse without the need for litigation. For Contractors, it presents the risk of financial loss and cash flow disruption—especially if the call is made while the parties are in dispute.

To mitigate this, Contractors often apply for injunctions to restrain the Principal from calling on the guarantee. However, such injunctions are only granted in narrow circumstances, such as fraud, unconscionability, or breach of an express contractual limitation. And if the Principal is able to call on the Security without giving the Contractor notice, it is often impossible for the Contractor to file for the injunction in the first place.

Courts are generally reluctant to interfere with a party’s right to call on Security, particularly where the Bank Guarantee is clearly intended to be unconditional.

Treatment of Retention Moneys

Retention Moneys (often spelled “Retention Monies”) are often easier to administer but raise other commercial risks. For Contractors, Retention represents a gradual reduction in their cash flow over the life of the project.

For Principals, holding Retention creates fiduciary obligations in some cases, especially where the Retention is placed in a trust account.

Modern contracts often require Retention to be held in a separate account or converted to a Bank Guarantee once a certain threshold is reached. Clear agreement on how Retention is administered and released can reduce administrative burdens and avoid end-of-project disputes.

Limitations on the Use of Security

Security cannot be used for any purpose the Principal chooses. Its use is limited to the terms of the contract and must relate to costs arising from breach, defect rectification, or failure to perform. A call made to exert pressure in a commercial dispute may be restrained by the court as an abuse of the Security mechanism.

If the contract imposes conditions for calling Security—for example, requiring notice or specific breach evidence—failure to comply may invalidate the call. As with all enforcement rights, the Principal must act in good faith and in accordance with the contract.

Injunctions and Dispute Resolution

Disputes over Security often escalate into legal proceedings, particularly where a Bank Guarantee is called. Contractors seeking to restrain the call must act quickly—injunctions are time-sensitive and require compelling evidence of bad faith or breach of contract.

The courts will not intervene simply because the parties are in dispute. The threshold for restraint is high, and most cases turn on whether the Principal’s conduct was clearly beyond the scope of the contract. Where Retention Moneys are in question, claims usually focus on whether deductions were justified or properly documented.

Differences Across Contract Types

AS 4000 and AS 2124 provide similar frameworks for Security, though the language varies slightly. Both allow for a combination of Bank Guarantees and Retention, subject to Annexure terms. The Principal’s right to call Security is broad but still subject to contractual limits.

GC21 is more prescriptive. It provides clearer rules about when Security can be called and imposes procedural fairness requirements, including notice before calling. It also encourages the use of Bank Guarantees over Retention Moneys to reduce administrative overhead.

MBA contracts tend to favour Retention Moneys, especially in residential and mid-tier projects. Defence contracts adopt rigorous Security requirements, often insisting on multiple layers of Security and tightly controlled procedures for release and enforcement.

Negotiating Security Terms Before Signing

Negotiating Security is one of the most commercially sensitive aspects of contract formation. Principals seek maximum protection, while Contractors aim to reduce cash flow pressure and exposure to unfair calls. Negotiation points often include:

• Reducing the overall percentage of Security
• Replacing Retention with Bank Guarantees after a threshold
• Capping the total value of Security that can be held at any one time
• Adding restrictions on when Security can be called

Contractors should engage legal and financial advisors early to ensure they understand the risks. Principals should ensure that Security provisions are enforceable and commercially reasonable.

For Principals

Principals should draft Security clauses that provide clear rights and timeframes for calling and releasing Security. They must ensure their Superintendents understand the difference between a valid call and an opportunistic one. Misuse of Security can damage commercial relationships and trigger reputational and legal consequences.

For Contractors

Contractors should read all Security provisions carefully and seek to limit exposure where possible. They must track the expiry dates of Bank Guarantees, verify that Retention is being correctly withheld, and maintain communication with the Principal about Security release milestones. Good record-keeping and proactive claims management are essential.

Conclusion

Security under construction contracts is a key risk allocation tool that must be handled with precision. Bank Guarantees and Retention Moneys serve legitimate purposes but also carry significant legal and financial consequences.

Whether you’re a Principal seeking protection or a Contractor managing cash flow, clear contract terms, consistent administration, and a proper understanding of your rights are essential to avoid disputes and protect the commercial interests of all parties.