Unconditional bank guarantees: ‘like cash in the bank’. But not always …19 October 2017 Topics: Banking and financial services, Building and construction disputes, Insolvency and restructuring, Litigation and dispute resolution
It is common in construction and commercial leasing transactions for a party to provide an unconditional bank guarantee to secure the performance of their contractual obligations.
An unconditional bank guarantee is widely regarded as being ‘like cash’. Courts are reluctant to restrain the calling for and making of payment under an unconditional bank guarantee because it is an unqualified promise by the bank to pay the named beneficiary.
However, there are limited circumstances where a grantor of a bank guarantee can prevent a beneficiary from obtaining payment.
Practically speaking, a grantor will need to act quickly and file for an injunction to restrain both the beneficiary from drawing down and the bank from paying out on the bank guarantee.
Grantors’ hands not completely tied
Courts will rarely interfere with a party cashing in an unconditional bank guarantee because to do so reduces the commercial value of bank guarantees.
However, courts may intervene where the beneficiary of the bank guarantee:
- is restrained by the terms of a contract; or
- has acted fraudulently or unconscionably.
Contract restrains the beneficiary from drawing down
A party may be restrained from cashing in an unconditional bank guarantee where the terms of a contract:
- limit the scope of the beneficiary’s rights, for example, to only claiming liquidated damages, as was seen in Siemen’s Ltd v Forge Group Power Pty Ltd (in liq)  QSC 184; or
- require the beneficiary to do certain things before they have recourse to the guarantee, for example, to issue a notice specifying the breaches and detailing the losses ten days beforehand, as was the case in Best Tech & Engineering Ltd v Samsung C&T Corporation  WASC 355.
Fraud or unconscionable conduct
Grantors will often argue the beneficiary ought to be restrained from drawing down on a bank guarantee because the beneficiary is acting fraudulently or unconscionably.
However, these cases are rarely made out, as to do so the grantor must prove:
- the beneficiary holds no honest belief that they are entitled to draw down on the bank guarantee; or
- the beneficiary’s conduct in drawing down is reprehensible in the circumstances.
In Board Solutions Australia Pty Ltd v Westpac Banking Corporation  VSC 474 the beneficiary’s conduct was reprehensible because it attempted to draw down despite having given contrary oral assurances to the grantor that it would not do so.
Arbitration agreement won’t always prevent the grantor seeking an interim injunction
It is common in commercial contracts to include a dispute resolution or arbitration clause preventing a party from taking court action until the parties have complied with a specified process.
However, this doesn’t necessarily prevent a party seeking an interim injunction.
It is important to note the Court’s decision in Best Tech & Engineering Ltd v Samsung C&T Corporation  WASC 355, where it held that a court may still grant an interim injunction restraining a party from drawing down on a bank guarantee despite there being a clause requiring the parties to settle their disputes by arbitration.
Incorrect name on the guarantee
Beneficiaries should check (and double check) that a guarantee is in the correct name. Recently the High Court, in Simic v New South Wales Land and Housing Corporation  HCA 47, held that:
- a bank was entitled to refuse to pay a beneficiary because the name on the guarantee was incorrect; however
- fortunately for the beneficiary, the guarantee should be rectified to correctly name the beneficiary as described in the underlying contract.
Relying on a guarantee where there is a pending dispute
The general rule, applied in Fabtech Australia Pty Ltd v Laing O’Rourke Australia Construction Pty Ltd  FCA 1371, is that a beneficiary is still able to draw down on a guarantee despite a dispute between the parties as to whether the grantor has breached the contract.
Whether the general rule will be displaced is a question of construction of the underlying contract and the circumstances of the case.
For example, in Universal Publishers Pty Ltd v Australian Executor Trustees Limited  NSWSC 2021, a landlord was restrained from using the guarantee provided by the tenant because recourse was only available for the tenant’s actual breach and not the landlord’s claim of alleged breach. The Court considered there might not be an actual breach and granted an interim injunction in favour of the tenant until the outcome of the dispute.
Relying on a guarantee where the underlying contract has been terminated
As a rule of thumb, termination of an underlying contract does not prevent a beneficiary calling upon a guarantee. This is because a guarantee is considered a risk allocation device in favour of the beneficiary.
In Lucas Drilling Pty Ltd v Armour Energy Ltd  QCA 111, a clause in the lease required the return of the guarantee after termination of the lease. The tenant breached the lease resulting in the lease being terminated by the landlord. The clause did not deprive the beneficiary of its right to rely on the guarantee where the grantor had breached the lease causing termination.
Importance of reading contract provisions as a whole
In Tomkins Commercial & Industrial Builders Pty Ltd v Majella Towers One Pty Ltd  QSC 111, the Court found that, upon the proper construction of the terms of the building contract, there was no amount due and payable under the contract as a notice of dispute had been issued in relation to a final certificate. As a result, the beneficiary could not have recourse to the bank guarantee. Under the terms of the contract, the bank guarantee was required to be returned within 14 days of practical completion. As there was no amount due and payable secured by the bank guarantee and the 14-day period after practical completion had expired, the beneficiary was required to return the bank guarantee and could have no recourse to it.
When negotiating a contract, carefully consider the wording of any terms relating to a bank guarantee. It is important to read the terms of the contract as a whole, particularly any preconditions for having recourse to the bank guarantee and any provision relating to its return.
When drawing down on the guarantee, make sure you comply with any preconditions in the underlying contract.
Where the beneficiary indicates they intend to draw down on a bank guarantee, the grantor should immediately seek legal advice to ascertain whether any action can be taken to prevent the beneficiary from doing so.
As with any injunction application, the court will consider whether the balance of convenience favours the granting of the injunction. For example, if the injunction is not granted, will the grantor suffer irreparable harm where damages will not be an adequate remedy?
If you would like more information about these issues, please contact Graham Roberts on +61 7 3231 2404 or another member of our ligation and dispute resolution team.