Australia: High Court rules: a demand under a guarantee must comply with the terms of the guarantee

Last Updated: 23 December 2016
Article by Emma Hodgman
Services: Banking & Finance, Dispute Resolution & Litigation, Property & Projects
Industry Focus: Financial Services, Property

What you need to know

  • The High Court has handed down a decision which will interest those who deal with bank guarantees, whether as the party issuing them or otherwise seeking or making demands under them.
  • The High Court unanimously overturned a NSW Court of Appeal decision in which it was held that even though two bank undertakings identified the incorrect beneficiary, the intended beneficiary of the undertakings was still entitled to make demands under those undertakings.
  • While the High Court found that the equitable remedy of rectification could be applied, enabling the name of the entity who wished to call on the undertakings to be substituted for the named beneficiary, the decision is a reminder of the difficulties that can arise for all parties when undertakings or bank guarantees contain errors.

On 7 December 2016 the High Court handed down its decision in Daniel Matthew Simic & Ors v New South Wales Land & Housing Corporation & Ors [2016] HCA 47, ruling on the enforceability of two undertakings with an incorrectly named beneficiary. The High Court unanimously overturned the decisions of the NSW Supreme Court and NSW Court of Appeal, which held that despite the wrong name having been inserted in two undertakings issued by ANZ in respect of a construction contract, the intended beneficiary of the undertakings was entitled to make demands under the undertakings.

However, the High Court found that in the circumstances, the equitable remedy of rectification was available so that the name of the entity who wished to call on the undertakings could be substituted for the named beneficiary.

The High Court's decision is important from two perspectives:

  1. For banks, it confirms that the principle of strict compliance applies to performance bonds or bank guarantees. Banks are not required to be concerned with the underlying terms of the contract, however strict compliance is not a rigid rule – it must be applied intelligently, not mechanically, and requires the exercise of some judgment by banks.
  2. For those who take such instruments as security for performance under a contract, such as a lease or construction contract, the case provides a valuable lesson. It demonstrates the importance of carefully checking the accuracy of the security to avoid delays and costs when a call for payment is made, and most importantly, to avoid the risk that the security is found to be worthless.

Recapping the path to the High Court

In July we published a detailed update which set out the background facts to the matter and summarised the decisions at first instance and on appeal.

In brief:

  • At the request of its customer (Nebax), ANZ issued two undertakings in favour of 'NSW Land and Housing Department t/as NSW ABN 45 754 121 940' as favouree (and also described as the Principal), as security for Nebax's obligations under a construction contract. However, the named favouree was an error. The construction contract was not with the party described as the Principal in the undertakings, but rather a different entity 'NSW Land and Housing Corporation ABN 24 960 729 253' (Corporation).
  • The Corporation commenced proceedings in the Supreme Court of New South Wales seeking a declaration that the description of the Principal should be construed as referring to the Corporation, or otherwise an order that the undertakings be rectified by substituting the name of the Corporation for the named Principal.
  • The primary judge made the declaration sought by the Corporation and said that although it was unnecessary to deal with the rectification claim, he considered that the prerequisites for the making of an order for rectification were satisfied.
  • The guarantors of the undertakings to ANZ appealed this decision to the Court of Appeal. The Court found that despite the error there had not been and could not be any suggestion that the description of the Principal in the undertakings was capable of referring to any entity other than the Corporation. There was no finding made on the question of rectification in light of this finding.

The High Court's decision

Keifel J and French CJ each gave separate judgments while Gageler J, Nettle J and Gordan J provided a joint judgment.

Their Honours examined the construction of the undertakings and the question of whether the equitable doctrine of rectification could be relied upon to address the error in the undertakings.

Construction of undertakings

In their joint judgment Gageler J, Nettle J and Gordan J said:

  • it was not open to construe 'New South Wales Land and Housing Department' as referring to the Corporation, noting that the Corporation and the Department of the New South Wales Government were legally distinct
  • although the construction contract or agreement referred to in the undertakings provided a link to the Corporation, it was either irrelevant or of no assistance for the purposes of construction
  • an instrument of this nature (i.e. an unconditional promise to pay on demand) is independent of any underlying transaction and any other contract
  • when dealing with performance bonds or guarantees, the issuer is not required or intended to be concerned with the terms of the underlying contract or whether the construction contractor has sufficiently performed its obligations under the contract
  • bank guarantees, performance bonds and similar securities create a type of currency and should be treated as being as good as cash
  • instruments of this nature are essential to international commerce and, in the absence of fraud, should be allowed to be honoured free from interference by the courts
  • the commercial reality is that in issuing a banking instrument of this nature, the issuer relies upon and acts in accordance with the instructions of the applicant, and is contractually bound to do so
  • ANZ followed incorrect instructions provided by its customer and the undertakings recorded those incorrect instructions
  • without the error being rectified ANZ would be at risk of acting in breach of contract if, contrary to its customer's express instructions, it were to treat the instruments as referring to the Corporation
  • from a commercial and banking perspective, it is more efficient to require the principal to review the security before rather than after performance and if the principal acts without seeing or examining the security, the principal should bear the costs
  • the principle of strict compliance requires that an issuer like a bank should only accept documents that comply strictly with the requirements stipulated in an instrument of this nature; the principle is fundamental to the efficacy and dependability of banking instruments such as the undertakings in this case.

Their Honours accepted that the principle of strict compliance is not a rigid rule and it must be applied intelligently, not mechanically, and the issuer must exercise its own judgment about whether the requirements stipulated in the instrument have been satisfied. However, their Honours said that here the demand did not comply with the undertakings, and they noted that the discrepancies and errors were not minor or merely typographical.

Rectification

In finding that the equitable remedy of rectification was available in this case, the joint judgment of Gageler J, Nettle J and Gordan J noted:

  • for rectification to be available it must be demonstrated that:
    • when the written instrument sought to be rectified was executed, there was an 'agreement' between the parties in the sense that the parties had a 'common intention' (viewed objectively from their words or actions) and that the written instrument was to conform to that agreement
    • critically, the written instrument does not reflect the 'agreement' because of a common mistake
  • in this case it was apparent that all parties to the transaction intended that the undertakings would be available for the benefit of the party with which Nebax had entered into the construction contract
  • ANZ unwittingly perpetuated a mistake, however Nebax told ANZ and therefore ANZ knew that Nebax obtained a contract with the entity trading as Housing New South Wales and that the applications and the resulting undertakings were acquired under that contract
  • as the primary judge said, if at the time the undertakings were issued someone had told Nebax and ANZ that the name of the counterparty was wrong, the error would have been plain and obvious to both of them; there can be no doubt that their actions were the result of a common mistake.

Their honours concluded that rectification would give effect to what Nebax required, as well as ANZ's stated intention to provide the security to the entity which Nebax had contracted to provide the building and construction services. That intention was the actual or true common intention of ANZ and Nebax and that was the actual intention of each party viewed objectively.

Key takeaways

For banks who are faced with calls made on bank guarantees or performance bonds by eager beneficiaries, the High Court's decision is helpful in affirming that banks are not required to have regard to the underlying contract. However, the principle of strict compliance should not be applied too rigidly and on occasion a bank may need to make a judgment call about whether the discrepancy is minor or merely typographical in nature.

For those who rely on such instruments as security for a party's performance under a contract, at times the pressure to close a deal can mean that important details get overlooked. This case serves as an important reminder to carefully check the accuracy of such instruments before accepting them. The additional time spent getting it right at the outset can avoid the significantly greater delays and costs encountered when a call is made on a defective instrument, as well as the potential for the security to be rendered worthless if a remedy such as rectification isn't available.

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories

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