Factual Summary: Tenant, a manufacturer, leased Landlords' industrial premises. For security, Tenant provided a bank guarantee for AUD 564,144.50, an amount equal to one year's rent. The lease provided, in part:

"16.3 If the Tenant fails to pay Rent or other money payable under this Lease or if the Landlord suffers loss or damage because of any other breach of this Lease by the Tenant, then the Landlord may use the security deposit towards paying the arrears of rent or other money or towards repairing the loss or damage.

In using the earned [sic] deposit, the Landlord does not waive the Tenant's breach and does not waive any other right or remedy arising from the breach.

16.4 If the Landlord does use the security deposit, it must notify the Tenant that it has done so. Within 14 days of the notification, the Tenant must reinstate the security deposit by paying to the Landlord the amount used."

After the lease period expired, Tenant paid no further rent.

Landlords claimed Tenant had not fulfilled its obligations under the lease, resulting in damages in excess of AUD 840,000. Although there was a dispute regarding the condition of the premises, Tenant claimed that it had discharged its obligations. Landlords then drew upon the Bank Guarantee and were paid.

Tenant demanded the return of the proceeds from the guarantee. When Landlords refused, Tenant sought and was granted an interim injunction preventing Landlords from making use of the proceeds. On a subsequent hearing on Tenant's motion for an interlocutory injunction, the Judge dismissed the motion, allowing the interim injunction to expire.

Legal Analysis:

1. Proceeds

Landlords claimed the lease allowed them to use the Bank Guarantee proceeds pending court resolution. Tenant claimed that the phrases in the lease "fails to pay [r]ent" and "because of any breach" required a final judgment to have been rendered prior to use of the proceeds. The Judge decided that Landlords were entitled to the proceeds.

Examining the terms of the lease, the Judge ruled that it "[did] not provide any contractual limit on [Landlords'] capacity to draw down on the bank guarantee pending the resolution of the underlying dispute. On the contrary, [it] strongly support[ed] [their] right to do so". The Judge also noted that Landords' claim for damages exceeded the amount of the security.

2. Injunction

The Judge determined that the Bank Guarantee was an unconditional bank guarantee. The Judge noted that, "[c]ourts have traditionally treated an interlocutory application to restrain the calling upon or use of money secured by a bank guarantee or other performance bond as being in a special category. . . . [T]he general rule is that a court will not enjoin the issuer of a performance guarantee from performing its unconditional obligation to make payment."

The Judge noted that the beneficiary of an independent guarantee who draws on it in good faith (without fraud or unconscionability) should not be restrained. The Judge also observed that there was no evidence of lack of good faith or of unconscionability. The Judge noted that, "[t]he rationale for the general rule is that by providing for security to be given, the parties implicitly agree that the party giving the security deposit shall be out of pocket pending resolution of the underlying dispute." The Judge further determined that damages would be adequate were Tenant to prevail in trial and so an injunction was inappropriate.

The Judge also noted that the evidence regarding the harm to be experienced by Tenant/Applicant was contradictory. The Judge concluded that damages would be adequate were Tenant to prevail at trial, making an injunction inappropriate.

The Judge stated that, "[h]ad the case been more finely balanced, it might have been necessary for me to consider whether Otter's conduct in approaching the court and obtaining urgent injunctive relief without proper notice (and possibly without proper disclosure of all facts) would have otherwise been a discretionary consideration against the continuation of the interim injunction. However, Otter's case for injunctive relief is so weak, that I will say nothing further in relation to the matter."

Comment: The Judge did not distinguish between pre and post honor injunctive relief, raising the interesting question of whether the LC standards for injunctive relief should be applied in an action to enjoin use of LC proceeds that had been paid to the beneficiary. The only significant difference from the general equitable principles would be the requirement that there be LC fraud or abuse.

The Judge also looked to the text of the demand guarantee to determine the right of the landlord/ beneficiary to draw on it. Resort to the lease would be appropriate in a post honor action for wrongful drawing but less so if the analysis related to the independent underwriting in a pre honor situation.



The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.