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Note: To assure payment on a construction contract to upgrade a refined sugar station, Lend Lease Services Proprietary Ltd. (Contractor/ Applicant) provided Sugar Australia Proprietary Ltd. (Owner/Beneficiary) with two bank guarantees totaling AUS 4,190,000. They were payable upon written claim by Owner/Beneficiary to Contractor/ Applicant acting reasonably for costs entitled under the contract.

When Contractor/Applicant terminated the contract, Owner/Beneficiary drew on the bank guarantee for the full amount. The contract provided that form of the security: "The approved form of unconditional undertaking in Annexure Part B to the Construction Contract was entitled 'Unconditional Undertaking'. The purpose of the security was relevantly expressed as follows:

'....[the Bank] Unconditionally undertakes to pay on demand a sum or sums which may from time to time be demanded by [Sugar Australia] ...

'The undertaking is to continue until a notification has been received from [Sugar Australia] that the Sum is no longer required by [Sugar Australia] or until this undertaking is returned to the Bank or until payment to [Sugar Australia] by the Bank of the whole of the Sum or such part as [Sugar Australia] may require.

'Should the Bank be notified in writing purporting to be signed by or for and on behalf of [Sugar Australia] that [Sugar Australia] desires payment to be made of the whole or any part or parts of the Sum, it is unconditionally agreed that the Bank will make the payment or payments to [Sugar Australia] forthwith without reference to [Lend Lease] and notwithstanding any notice given by [Lend Lease] to the Bank not to pay same.'...

'5.2 Availability of Security

'Any security provided by the Contractor in accordance with the Contract shall be available to the Principal whenever the Principal may claim (acting reasonably) to be entitled to:

'(i) the payment of moneys or an indemnity by the Contractor under or in consequence of or in connection with the Contract;

(ii) reimbursement of any moneys paid to others under or in connection with the Contract; or

(iii) other moneys payable by the Contractor to the Principal (whether by way of set-off or otherwise).

'Recourse to security shall only be subject to the Principal having given the Contractor 5 days' notice of its intention to have recourse to the security for the purpose of allowing the Contractor to replace the security with cash where it has been issued in a form other than cash. Where the Principal has recourse to security in accordance with clause 37.3, the Contractor shall provide replacement security in accordance with clause 37.3.'

"Clause 5.2 provides for negative stipulations in relation to recourse to the security. The conditions are specified as follows:

'(a) the Principal must make a 'claim' for the specified entitlements;

(b) the Principal must act 'reasonably' in making the 'claim';

(c) the 'claim' must be for an entitlement to: (i) the 'payment of monies' under or in consequence of or in connection with the Construction Contract; or

(ii) an 'indemnity' by Lend Lease under or in consequence of or in connection with the Construction Contract; or

(iii) 'reimbursement of any monies paid to others under or in connection with the Contract'; or

(iv) other moneys payable by the Contractor to the Principal (whether by way of set-off or otherwise).'"

Contractor/Applicant sued Owner/Beneficiary seeking an interlocutory injunction, contending that there was no entitlement under the contract, the notice of recourse was invalid under the contract, and Contractor/Applicant would suffer irreparable harm if the injunction issued. The Supreme Court of Victoria, Commercial and Equity Division in an opinion by Vickery, J., issued the interlocutory injunction and ordered that the case proceed to trial.

The Supreme Court noted that injunctive relief is discretionary, and "the Court must be satisfied that:

(a) there is a serious question to be tried in the sense that the plaintiff must show a sufficient likelihood of success to justify in the circumstances the preservation of the status quo pending trial;

(b) if there is no injunction but the plaintiff claim is ultimately vindicated, the plaintiff will have suffered irreparable harm for which damages will not be an adequate remedy; and

(c) the balance of convenience must favour the grant of the injunction."

The court noted that, "[T]he Court will be concerned to adopt the course which carries the 'lesser risk of injustice' if it should turn out to have been wrong." It further stated, "It follows that if a party in whose favour a bank guarantee has been given has bound itself to a contractual fetter or qualification under which that party promises not to call upon the guarantee in the circumstances defined, breach of that contractual promise, or a threatened breach, may be enjoined by applying the usual principles relating to the enforcement by injunction of negative stipulations in contracts."

The court noted that the commercial purposes of security provisions are to provide security by providing recourse against a third-party bank if the other party is in default and to allocate the risk of who bear the cost. In this case, the proper recourse is governed by the term of the underlying contract, but the court will require clear words to support a construction prohibiting a beneficiary from calling on a guarantee. The court will have to determine the provision was for providing security, risk allocation, or both.

The court determined that resolution of those points rested on the meaning of the phrase "acting reasonably." If a subjective standard was used, then Owner/Beneficiary was fine in calling upon the guarantees. If an objective standard was used, then Owner/Beneficiary must show that a reasonable person in similar circumstances would call upon the guarantees. Because there are significant arguments that can be made for both, the court granted the injunction pending trial.

[JAH]

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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.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.