Australia: Bank guarantees in practice

Last Updated: 21 April 2018
Article by Scott Alden, Victoria Gordon and Joshua Clark
Most Read Contributor in Australia, September 2018

The construction industry is high risk and disputes and insolvencies are common. As a result parties to a construction project typically seek to secure the counterparty's contractual obligations by a variety of means, most frequently a bank guarantee.

Principals often regard these instruments as the gold standard of security for its "cash-like" quality. This status stems from its unconditional nature which means that, if called on by the principal, the bank must unconditionally and on demand pay cash to the equivalent amount stated in that guarantee – irrespective of the terms of, or proof of breach of, the underlying construction contract.

But – what actually is a "bank guarantee" and, are they really "as good as cash"?

What is a bank guarantee?

What is frequently called a "bank guarantee" is in fact an unconditional performance bond given by a bank. The use of the term "guarantee" to describe such bonds has been deemed misleading by Courts.i This is because a guarantee, strictly speaking, is a contract of suretyship – where the guarantor (the "surety") takes on a secondary obligation to which it is held only after the liability of the contractor is established.

Usually, an unconditional performance bond or undertaking from a bank ("bank guarantee") or an insurance company ("insurance bond") can be called upon by the principal without requiring proof of the contractor's breach of the construction contract. In this case, the liability of the institution issuing such a bond is primary, and the bond is said to operate autonomously from the construction contract (however, as seen below, this is becoming less so with the erosion of the "autonomy principle").

Set out below are common characteristics distinguishing an unconditional bond (either a "bank guarantee" or "insurance bond") from a conditional undertaking or bond ("surety bond", "contract of surety" or "guarantee").

Characteristic

Unconditional performance bond

Conditional performance bond or undertaking

Commonly called

Bank guarantee – issued by bank

Insurance bond – issued by insurance company

Unconditional bond / undertaking

Surety bond

Conditional undertaking

Guarantee

Contract of surety

How to determine if "unconditional" or "conditional"

Must state "unconditional" undertaking / bond or the issuing party "unconditionally undertakes"

Must state the issuing party will pay a fixed sum of money on demand / upon written demand

Usually states without reference to the contractor or the underlying contract

May have an expiry date

Only signed by the issuing institution

Will state payment is conditional upon proof of breach of the contract or proof of damage

Will not state "unconditional" or "on demand"

Subject to obligation on Principal to notify Contractor prior to call

Usually has an expiry date

Signed by both issuing institution and the contractor

When can it be called on by the principal?

On written demand by beneficiary to issuing institution

Upon the beneficiary providing written proof of breach to the issuing institution

Circumstances where regard will be given to the underlying contract

Usually never as bond autonomous from underlying contract

Unless Court finds "underlying contract exception" to exist, in which case it will examine the terms of the underlying contract

Always – liability of the issuing institution only ignited when the contractor is liable for breach of the underlying contract

When can a bank guarantee be called on?

If a bond is unconditional, and intended to be cash equivalent, it can (subject to the below exceptions) be called on by the beneficiary upon written demand to the issuing institution, without regard to the underlying construction contract. This is what is known as the "autonomy principle."

The beneficiary need only have a bona fide claim of a breach of contract.ii

Traditionally, Courts have been reluctant to interfere with the autonomy principle as the parties (often sophisticated commercial entities) have agreed to the unconditional nature of the security. Any such interference not only undermines the intention of the contracting parties, but also diminishes the commercial worth of these forms of security.

Here the intended purpose of the security comes into play.

It is common for security under a construction contract to serve a dual purpose, being:

  1. to secure the contractor's performance of the contract / provide security against the contractor becoming insolvent
  2. to give the principal access to funds it claims notwithstanding a dispute with the contractor is on foot. Here, the security is called a "risk allocation device" as it is used to allocate the risk between the parties as to who will be out of pocket during a dispute under the contract.

Courts are more likely to uphold the autonomy principle where the parties have agreed that the security is also a risk allocation device.iii To allow an injunction to restrain a call on a guarantee that is intended to act as a risk allocation device would defeat the purpose of that security: i.e. that the principal will have access to funds during a dispute between the parties.

In complex transactions involving multiple parties and multiple security instruments, the intended purpose of a particular bond can be critical to a beneficiary's right to call on that bond – as seen in the recent case of Kawasaki Heavy Industries Ltd v Laing O'Rourke Australia Construction Pty Ltd [2017] NSWCA 291 (Kawasaki) (see our recent case note here).

Exceptions to the autonomy principle

There are exceptions to the rule, and the three exceptions to the autonomy principle are:

  1. fraud by the principal
  2. unconscionable conduct by the principal (under section 20 of the Australian Consumer Law)
  3. an "underlying contract exception".

Due to the commercial nature of performance bonds, the bar is set high for both fraud and unconscionability. For example, an element of predatory behaviour must be proven to establish unconscionable conduct.iv In a commercial context, disparity in bargaining power or use of superior bargaining power to achieve a legitimate commercial interest will not necessarily amount unconscionable conduct.v

Not surprisingly, the underlying contract exception is the most frequently argued exception. It is also the most contentious, as it provides the greatest opportunity for the erosion of the autonomy principle.

The underlying contract exception

This exception arises where a contractor asserts that the principal is attempting to call on the bond beyond the circumstances in which a call is permitted under the underlying contract, and applies for an injunction to prevent such a call.

For the exception to be established by a Court, there must be "clear words" in the underlying contract that limit the principal's rights to call on the performance bond.vi However, the necessary "clear words" are often difficult to distinguish.vii

If established, the Court will then examine the terms of the underlying construction contract to determine whether the principal rightfully called on the bond in accordance with those terms.

An obligation on the principal to provide notice to the contractor prior to a call on security is an example of a term that may exist in the underlying contract, which if found to be expressed in "clear words", could restrict a principal's unconditional right to call on that security. This can be difficult to reconcile with the autonomous nature of an unconditional bond, especially if the terms of the unconditional bond itself expressly exclude any obligation on the principal to provide notice to the contractor prior to a call on the bond.

Fighting back with a no injunction clause – fruitful or futile?

One way principals have attempted to thwart a contractor from successfully obtaining an injunction restraining a call on a security is by including a "no injunction clause" in the underlying contract.

If Courts are more willing to look behind an unconditional bond to the terms of the underlying contract to determine whether an underlying contract exception exists, then it is thought that more weight will also be given to an express intention of the parties from precluding the contractor seeking an injunction from restraining a call?

However, the case law on "no injunction clauses" appears unsettled. Some Courts have held that a no injunction clause is invalid as it is an ouster of the Court's jurisdiction.viii Indeed, it is a long standing principle that parties cannot contract out of the Court's jurisdiction, or preclude a Court from granting a remedy at law.ix

However, some recent decisions have cast doubt on this position. In Anaconda Operations Pty Ltd v Fluor Daniel Pty Ltd [1999] VSCA 214, the Court held "It matters not that it may be argued that the latter part of this provision is bad as ousting the jurisdiction of the Courts. The important thing is that both parts of it show an intention that the owner is to be at liberty to call on the security at any time".x Further, the Western Australian Court of Appeal held that if a no injunction clause is unenforceable as an ouster of the jurisdiction of the Court, it is nevertheless permissible to take it into account in construing whether the parties intended the principal to have unfettered recourse to the security.

Therefore, where the parties have expressly agreed that the contractor will not injunct a principal's right to have recourse to security, Courts appear to struggle to reconcile that intention with an award of an injunction on the basis of a finding that the "no injunction" clause is invalid.

Practical take outs

The underlying contract

Whether you are the principal or contractor, always carefully consider the wording of any clause relating to security.

Principals should:

  1. reflect the intended purpose of the security is in the contract. If it is intended to act as a risk allocation device, clearly state that the principal may have recourse to it, pending the resolution of a dispute between the parties
  2. consider including a "no injunction / obstruction clause" – however these may be held to be invalid as ousting the Court's jurisdiction. It may survive if:
  3. the intention of the clause is to preclude a contractor from restraining a call where the principal has a bona fide claim to the security and the purpose of the security is to act as a "risk allocation device". A "no injunction clause" that seeks to completely defeat access to the Courts, or preclude a party from seeking other kinds of remedy (such as damages) is likely to be invalid.xii
  4. the terms of the underlying contract, and the bond itself, are consistent and unequivocal with regards to the security being an autonomous, unconditional form of security which the principal may have recourse to for a bona fide claim
  5. the clause also contains less prohibitive restrictions on the contractor which may survive if the "no injunction" part of the clause is severed from the clause e.g. the contractor must not hinder or obstruct the principal's right to recourse of the security.xiii
  6. ensure that there are no contradictory conditions or restrictions on the principal's recourse to security in the underlying contract e.g. notice provisions
  7. always go for an unconditional performance bond by a bank or reputable insurance company over any other kind of security
  8. include a clause that the form of security must be on terms approved by the principal, or include an approved pro forma bond as an attachment to the contract.

Reviewing the terms of an unconditional performance bond

If you are a principal:

  1. make sure it includes the words: unconditional and on demand
  2. make sure it is from a bank or a reputable insurance company
  3. include an assignability clause
  4. resist an expiry date, but if one is needed ensure it is suitably in the future (well past the likely date of final completion)
  5. carefully check all details are correct and are consistent with the terms of the underlying contract (party names, ACN's, the amount of the bond and any notice provisions)
  6. execute as a deed to avoid any issues of consideration.

Footnotes

iSee, eg, Ottoway Engineering Pty Ltd v Westpac Banking Corporation (No 3) [2017] FCA 1500, Simic v NSW Land and Housing Corporation [2016] HCA 47, [2]; Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443, 445.

ii Clough Engineering Ltd v Oil and Natural Gas Corp Ltd [2008] FCAFC 136 at [102]; Kawasaki Heavy Industries Ltd v Laing O'Rourke Australia Construction Pty Ltd [2017] NSWCA 29 at [68]; however note that this position has been questioned: see FMT Aircraft Gate Support Systems AB v Sydney Ports Corporation [2010] NSWSC 1108 at [14] which held that a mere honest or bona fide belief in a claim is insufficient; what was required was an "arguable claim - one that is not specious, fanciful or untenable"; see also Lucas Stuart Pty Ltd v Hemmes Hermitage Pty Ltd [2010] NSWCA 283 at [43] which held that what is required is an objective fact of material non-compliance.

iii CPB Contractors Pty Ltd v JKC Australia LNG Pty Ltd [2017] WASC 112 at [81] - [82].

iv Kakavas v Crown Melbourne [2013] HCA 25 at [161].

vIpstar Australia Pty Ltd v APS Satellite Pty Ltd [2018] NSWCA 15 at [200] and [211].

vi Clough Engineering Limited v Oil and Natural Gas Corporation Limited [2008] FCAFC 136 at [83]; Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98 at [89].

vii See for example Sugar Australia Pty Ltd v Lend Lease Services Pty Ltd [2015] VSCA 98 at [141] – [142]; Pearson Bridge (NSW) Pty Ltd v State Rail Authority of New South Wales (1982) 1 ACLR 81 at [14]; Lucas Stuart Pty Ltd v Hemmes Hermitage Pty Ltd [2010] NSWCA 283 at [36] - [43].

viii Bateman Project Engineering Pty Ltd v Resolute Ltd (2000) 23 WAR 493 at [23]; CPB Contractors Pty Ltd v JKC Australia LNG Pty Ltd [No 2] [2017] WASCA 123 at [56].

ixDobbs v National Bank of Australia (1935) 53 CLR 643 at 652.

xAnaconda Operations Pty Ltd v Fluor Daniel Pty Ltd [1999] VSCA 214 Anaconda Operations Pty Ltd v Fluor Daniel Pty Ltd [1999] VSCA 214.

xi CPB Contractors Pty Ltd v JKC Australia LNG Pty Ltd [No 2] [2017] WASCA 123 [95] – [97]; upheld by CPB Contractors Pty Ltd v JKC Australia LNG Pty Ltd [No 3] [2017] WASCA 132 [21] –[22]; see also CPB Contractors Pty Ltd v JKC Australia LNG Pty Ltd [2017] HCATrans 147.

xiiBateman Project Engineering Pty Ltd v Resolute Ltd (2000) 23 WAR 493 at [24]; CPB Contractors Pty Ltd v JKC Australia LNG Pty Ltd [2017] WASC 112 [56].

xiii See for example Bateman Project Engineering Pty Ltd v Resolute Ltd (2000) 23 WAR 493 at [26] where the requirement that the contractor not 'hinder' or 'obstruct' the principal's recourse to the security remained valid where the requirement that the contractor not 'restrain' or 'injunct' the contractor was severed from the contract.

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Scott Alden
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions