What is a Bank Guarantee and what is its purpose under a Construction Contract?
A bank guarantee is a guarantee made by a financial institution to meet the liabilities of an individual or business in the event that they fail or refuse to fulfill specific obligations. These ‘obligations’ are typically set out within a contract, whereby if the party who provides bank guarantee as security under a contract, breaches a contractual obligation, the party/s receiving the benefits of the bank guarantee may seek to recoup any damages they suffer by way of making a “call” on the bank guarantee.
In a construction contract, typically the purpose of a bank guarantee is to secure the performance of one party’s obligations set out by the contract. For example, a bank guarantee provided as security within a construction contract is typically provided by contractors to assure the performance and quality of their construction works.
Can a Court intervene to restrain a call on a Bank Guarantee?
In short, the answer is yes, however this occurs in limited situations.
The law recognises a principal called the “Autonomy Principle”, whereby in the context of bank guarantees, outlines that a bank’s obligation to pay under the guarantee is independent of the underlying construction contract.
This means that a bank must pay a bank guarantee to a beneficiary party under the construction contract upon a valid call of the bank guarantee, regardless of any other disputes arising from the underlying contract.
This Autonomy Principle recognises the ‘autonomy’ of the bank to respond to a call on a bank guarantee without the influence of the underlying contract.
However, despite the Autonomy Principle, there are still limited instances where a Court can intervene to restrain a call on a bank guarantee. The circumstances when a Court will do this are outlined directly below:
When will a Court intervene to restrain a call on a Bank Guarantee?
A Court will typically intervene and prevent the call of a bank guarantee under a Construction Contract in the three (3) following circumstances:
i. Fraud perpetrated by the Beneficiary
A Court may intervene by restraining the beneficiary from calling on the bank guarantee in circumstances where a beneficiary is attempting to call on a bank guarantee in a fraudulent manner.
Examples include:
(a) Dishonest intent or falsehoods within a statement supporting the call of a bank guarantee; or
(b) The bank issuing the guarantee was aware that a demand for payment, which has or will be made, was clearly fraudulent.
It is important to note that this exception can be difficult to prove and requires a party to meet a high threshold of evidence to successfully restrain the call of a bank guarantee.
ii. Unconscionable Conduct perpetrated by the Beneficiary
Unconscionable conduct is a statutory exception to the Autonomy Principle as set out in Australian Consumer Law (ACL). The ACL provides two broad grounds of pursuing unconscionable conduct, namely:
1. Section 20 of the ACL – Unconscionable conduct within the meaning of unwritten law, whereby a person must not engage in conduct (in trade or commence) that is unconscionable “within the meaning of the unwritten law from time to time” (i.e. conduct that is unfair or oppressive).
2. Section 21 of the ACL – Unconscionable Conduct in connection with goods or services, whereby a person must not (in trade or commerce), engage in conduct that is unconscionable in connection with:
(a) The supply or possible supply of goods or services to a person; or
(b) The acquisition or possible acquisition of goods or services from a person.
The common law expands upon these ACL exceptions, to provide clarification as to the interpretation of these statutory exceptions to the “Autonomy Principle”.
Specifically, the case of Australian Competition and Consumer Commission v Samton Holdings Pty Ltd (2002) provides that unconscionable conduct may arise where one party “knowingly exploits” another party to the other’s party’s “Special Disadvantage”.
As to what a “Special Disadvantage” may entail, the below common law cases provide some clarity:
- Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447 – where Gibbs CJ indicated, referencing Blomley v. Ryan [1956] HCA 81, that a special disadvantage may entail illness, ignorance, inexperience, impaired faculties, financial need or other circumstances that affect a person’s ability to protect their own interests, which another party unconscientiously takes advantage of. This case also highlighted that a special disadvantage can also derive from age, and language barriers.
- Bridgewater v Leahy (1998) 194 CLR 457 – where Deane J made comment on the law of unconscionable conduct and noted that adverse circumstances which may constitute a special disability, may take a wide variety of forms and are not susceptible of being comprehensively catalogued, however, the common characteristics of such ‘adverse circumstances’ are that they have the effect of placing one party at a serious disadvantage to another.
From the above, the key points to the unconscionable conduct exception are that one party takes advantage of another party in circumstances where something clearly unjust or unreasonable is demonstrated to have affected the call of a bank guarantee.
iii. An Underlying Contractual Exception
Lastly, and what is most often argued, is that there is a clause within the underlying contract which limits a party’s right to make a call on a bank guarantee.
In Reed Construction Services Pty Ltd v Kheng Seng (Aust) Pty Ltd (1999) 15 BCL 158 the Court held that if the party in whose favour the bank guarantee has been given has made a contractual promise not to call upon the bank guarantee, breach of that contractual promise will support an application for an injunction on the normal principles regarding enforcement by injunction of negative stipulations in contracts.
Below are examples of some attempts to restrain a call on the bank guarantees made in the Courts:
1.In Bachmann Pty Ltd v BHP Power New Zealand Ltd [1998] VSCA 40, the Court was faced with a dispute about a clause as follows:
5.5 A party shall not convert into money security that does not consist of money until the party becomes entitled to exercise a right under the Contract in respect of the security. The party shall not be liable for any loss occasioned by conversion pursuant to the Contract.
The Court held that such a clause entitled the principal to have recourse to the security where according to a bona fide claim made by the principal moneys are due to it from the contractor which exceed any moneys due from it to the contractor.
2. In Rejan Constructions Pty Ltd v Manningham Medical Centre Pty Ltd [2002] VSC 579 the Court dealt with clauses found in a AS4300-1995 contract. In particular, a clause in the following form:
5.6 Conversion of Security and Recourse to Retention Moneys
A party may have recourse to security, retention moneys or both and may convert into money security that does not consist of money where-
(a) the party has become entitled to exercise a right under the Contract in respect of the security, retention moneys or both;
(b) the party has given the other party notice in writing, for the period stated in Annexure Part A or, if no period is stated, 5 days of the party’s intention to have recourse to the security, retention moneys or both; and
(c) the period stated in Annexure Part A or, if no period is stated, 5 days, has or have elapsed since the notice was given.
The Court distinguished the decision in Bachmann Pty Ltd v BHP Power New Zealand Ltd [1998] VSCA 40 on the basis that the contract in Bachmann was an Australian Standard version from 1986 whereas the contract in the present case was a 1995 version. The Court noted the requirement of the Principal to give notice before converting the non-cash security into money or having recourse to it and that the Standards Australia commentary on the AS2124-1992 form points out this is directed to giving to the contractor the right to approach the Court for relief where it disputes the principal’s right to act under cl. 5.5.
The Court found that such a right would be illusory if the contractor could obtain relief only where the entitlement to exercise the right in respect of the security were construed to depend only upon a claim for the payment of money, and one which is bona fide and not specious or fanciful. The Court also noted differences in the drafting in various other clauses governing the right to set off by the Principal and recourse for unpaid moneys.
The Court ultimately determined that the Principal was required to demonstrate that the liability in fact exists and, until this has been achieved, the purpose for the granting of the security was sufficiently achieved by requiring that the security remain in place.
3. In Clough Engineering Limited v Oil and Natural Gas Corporation Limited [2008] FCAFC 136 the Court held that ‘clear words’ are required to support the construction of a term which acts to restrict a beneficiary from making a call upon a bank guarantee.
In that case, the Court had to determine whether under the proper construction of the contract the principal was entitled to call upon the bank guarantee.
The Court rejected Clough’s argument that a call could only be made upon an actual breach of contract and found that the Contract entitled the principal to call on the bank guarantee notwithstanding any dispute between the parties. The Court found there were no clear words in the contract inhibiting the call on the bank guarantee.
4. In Pearson Bridge v State Rail Authority (1982) 1 ACLR 81the Court prevented a call on a bank guarantee due to the use of the word ‘if’ in the wording of a clause, which was found to limit the circumstances in which the principal could call upon the bank guarantee. The relevant underlying clause in this case read as follows:
“If the principal becomes entitled to exercise all or any of his rights under the contract in respect of the security the principal may convert into money the security that does not consist of money”.
5. In Total Construction Pty Ltd v Catholic Healthcare Limited [2023] NSWSC 585, the parties entered a contract in which the contractor (Total Construction) provided two (2) unconditional bank guarantees which the principal (Catholic Healthcare) was entitled to have recourse to if it had a ‘bona fide claim’ pursuant to a clause in their contract. During the term of the contract, Catholic Healthcare issued a show cause notice alleging that Total Construction breached the terms of the contract, and ultimately terminated the contract, demanding money for extra costs incurred. Total Construction applied for an ex parte injunction application to restrain Catholic Healthcare from calling on the bank guarantees, alleging that Catholic Healthcare did not have a bona fide claim and the amount payable to Catholic Healthcare had not been quantified, and they had engaged in unconscionable conduct.
The Court refused to extend the injunction as Total Construction had failed to prove why the call on the bank guarantee should be restrained. The Court found that the underlying contract exception did not apply as Catholic Healthcare successfully set out reasons in its show cause notice and its termination for why it said that Total Construction was in default under the contract which Total Construction never disputed. Additionally, based on the interpretation of the underlying contract, the Court held Catholic Healthcare was not only entitled to exercise a right under the guarantees once completion costs had been quantified.
Conclusion
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