Premier Ted Baillieu fends off leadership challenge reports to the media at the state Liberal Party conference held in Creswick.

Ted Baillieu. Photo: Jason South

THE Baillieu government will argue at a trial next month that its ability to govern Victoria will be reduced if a legal challenge to its crackdown on union-friendly deals in the building industry is successful.

It emerged in the Federal Court on Wednesday that lawyers for the Baillieu government will use constitutional arguments in their bid to defeat the case brought by the Construction, Forestry, Mining and Energy Union.

That will include arguing that its ability to govern Victoria will be impaired if it loses the case.

The trial in the Federal Court - which is expected to begin next month - is a crucial test of the state's new building code, which took effect from the middle of 2012. The code is a key part of the Baillieu government's plan to control building costs and change work practices in the industry.

If builders breach those rules through union-friendly deals, they risk missing out on government work.

Before Christmas The Age revealed that the government would ban major builder Lend Lease for up to four years due to a deal it signed with the CFMEU that requires union flags to be flown on site and placed limits on the use of outside labour.

The case in the Federal Court relates to Lend Lease's bid to build the $630 million Bendigo hospital; it is the builder for one of the two consortiums that is tendering for it. Lawyers for the CFMEU are arguing that the government is breaching the federal Fair Work Act by either threatening to or banning Lend Lease from the tender.

Finance minister Robert Clark, through a spokesman, said it considered its rules to be ''fully consistent with the Fair Work Act''.

''It would be beyond the constitutional power of the Commonwealth to restrict the state's ability to undertake key public projects in the way being sought by the CFMEU,'' he said.

''The [code] guidelines are intended to help bring an end to the kinds of unlawful practices and consequent cost blowouts for which the Victorian construction industry has been notorious.''