Is your unconditional bank guarantee really unconditional?

For many years the courts viewed unconditional bank guarantees as virtually as good as cash, able to be called on by a principal notwithstanding a dispute between the contractor and principal as to whether the contractor was in breach.

However a number of decisions in recent years have chipped away at this view.

The decision of the ACT Supreme Court in Walton Construction Pty Ltd v Pines Living Pty Ltd[1] in December 2013 represented yet another departure from the generally accepted view that an unconditional bank guarantee can be accessed by the principal in the event of a dispute. This decision is particularly pertinent to those using the PC1 contract, but has broader implications for all contracts (not only construction contracts but also other commercial contracts such as sale agreements and leases) under which unconditional bank guarantees are given as security for performance of a party’s obligations.

The PC1 Contract

PC1 contracts were developed by the Property Council of Australia and are currently used by commercial principals in Australia, as well as for a number of Department of Defence projects.
PC1 contacts require the contractor to provide the principal with an unconditional bank guarantee to secure the contractor’s performance of the contract. The contracts do not specify the circumstances in which the bank guarantee may be called on.

This type of security is adopted in a number of other contract suites, including Australian Standard and GC21 contracts.

Shifting the risk

There is a long line of cases that that say that an unconditional bank guarantee is presumed to serve two purposes:

to provide security to the principal for its valid claims; and
to allocate the risk of a dispute such that the principal is not out of pocket pending resolution of the dispute.The traditional view was that (subject to anything to the contrary in the contract) the principal will only have to meet the administrative requirements of the issuing bank, such as presenting the original guarantee at the specified branch. A principal would only be prevented from calling on a bank guarantee in exceptional circumstances, such as fraud or unconscionable conduct.

However there are now an increasing number of cases in which courts have held that the principal is not entitled to call on the bank guarantee because the principal has not established an ‘entitlement’ to payment or damages under the contract. These cases have all turned on the particular wording of the contract, but the message being sent to principals is that they need a clear contractual right before calling on the security. Walton Construction v Pines Living is another such case.

Walton Construction Pty Ltd v Pines Living Pty Ltd

In June 2011 Walton provided two NAB issued unconditional bank guarantees totalling $380,000 to Pines, to secure performance of a construction contract. A dispute arose between the parties in early 2013. A statutory payment claim was issued by Walton for unpaid invoices, an adjudication followed, and Walton was largely successful. Pines appealed the adjudicator’s decision, raising issues about defects and liquidated damages (amongst other things), but the appeal was dismissed by the ACT Supreme Court. The appeal decision was discussed in our October eBrief (link)

Pines then looked to cash in the bank guarantees to recover the cost of defect rectification. It made enquiries with the NAB in September 2013 about doing so. The NAB, as most banks do, tipped off its customer Walton. Walton wrote to Pines requesting that Pines give three days’ notice of any intention to call on either guarantee. Pines agreed, and gave that notice to Walton on 20 September 2013. Walton applied to the ACT Supreme Court for an injunction.

The PC1 contract was silent on when the bank guarantee could be called on. The guarantee itself said ‘the bank will pay the Amount to Pines whether or not notice is given, and irrespective of performance or non-performance by Walton’. This is not an uncommon position. A number of widely used construction contracts, including the GC21 and the Australian Standards do not give an unconditional right to access the security within the contract, preferring to restrict the terms of the guarantee to the guarantee document only.

Walton argued that where there was no express contractual term dealing with the circumstances in which the security could be accessed, the parties could not have intended that access would be unqualified and unconditional. Pines argued the opposite, namely that where there was no contract term preventing it from calling on the security, it was implied that Pines was entitled to access the security.

The decision

Master Mossop found that the contract did not allow Pines to call on the security where the grounds relied upon as the basis for calling on the security (i.e. the defects and liquidated damages) were themselves the subject of a genuine dispute. He reasoned that the contract did not make it clear that the security was intended to protect Pines from any risk involved in a genuine dispute about contractual breach, and he refused to imply a term to that effect.

The effect of the decision is:

  • Under the PC1 contract, the principal cannot call on the guarantee if the contractor disputes that it owes the principal anything; and
  • Under any contract without an express provision to call on the guarantee when the parties are in dispute, the principal is probably not entitled to call on the guarantee where parties do not agree as to whether either has breached the contract, the usual ‘unconditional’ right to call the guarantee may not exist.

How can you secure performance of your contract?

Every contract is different, as is every job, so it is important to make sure your contractual provisions regarding security reflect your intentions from the outset. Where your security is an unconditional bank guarantee, you may need to amend your construction contracts to:

  • Clearly state who can call on the guarantee and when; and
  • If the intention is for the contractor to bear the risk of dispute, set out a positive entitlement for the principal to call on the security in the event of any alleged breach, not just one that is proved or admitted.

The construction team at Meyer Vandenberg would be happy to assist you to ensure that your contracts will allow you to access your security in the event of a dispute.

Alisa Taylor — Partner — Dispute Resolution Team
(02) 6279 4388
alisa.taylor@meyervandenberg.com.au

Tessa Dignam — Lawyer — Dispute Resolution Team
(02) 6279 4478
tessa.dignam@meyervandenberg.com.au