Article

Factual Summary: Lessee leased a parcel of land in New South Wales from Lessor. The lease provided for the removal and remediation of a reserve fuel tank on the property. To secure the performance of Lessee, its parent company, Applicant/Surety, requested that Issuer issue a bank guarantee to pay Lessor/Beneficiary "any sum which might from time to time be demanded...to a maximum aggregate sum of [AUD] 936,000."

Clause 19.8 of the lease defined the "Bank Guarantee" as "an unconditional undertaking or guarantee from an Australian bank in favour of the Lessor in a form and content acceptable to the Lessor to enable the Lessor to be paid on demand an amount up to the sum referred to in item 16 in total in one or more drawings and containing no expiry date."

Clause 19.4 of the lease provided:

"19.4. In the event that the lessee:

19.4.1.1 defaults in the payment of Rent or in the performance or compliance of any other obligations under this Lease; or

19.4.1.2 breaches any other obligation, term, condition or covenant under this Lease,

19.4.1.2 [sic] the Lessor is hereby authorized to demand that the guaranteeing bank pay to the Lessor such amount that (in the reasonable opinion of the Lessor) may be due to the Lessor as a result of such default, breach, or nonobservance by the Lessee or termination of the Lease pursuant to it."

On 8 November 2012, Lessor/Beneficiary sued Lessee, alleging that it breached clauses 8.8 and 21.1 of the lease by respectively failing to yield the property duly repaired and maintained in accordance with the covenants of the lease and failing to remove and in the remediation of a reserve fuel tank ("2012 Proceedings"). Lessor/Beneficiary claimed damages based on a reduction in value of the property, as well as loss of rent and contributions to outgoings. At the time the opinion was written, the 2012 Proceedings had not yet been determined.

On 26 November 2013, Lessor/Beneficiary gave Lessee notice that it intended to call on the guarantee. On 3 December 2013, the Supreme Court of New South Wales, White, J., granted Lessee's application for an ex parte injunction to restrain Lessor/Beneficiary from calling on the guarantee, which was extended until the question of whether the Lessor/Beneficiary was entitled to call on the guarantee could be determined. Lessor/Beneficiary filed for a discharge of the injunction. The Judge denied Lessor/Beneficiary's motion.

Legal Analysis:

Demand versus Performance: Judge White determined that principal question in extending or discharging the injunction was whether Lessor/ Beneficiary was entitled to make a demand on the guarantee because it claimed that Lessee was in breach of the lease, or whether it was only entitled to do so if in fact Lessee had breached the lease.

The Judge noted that in either case, a party may be restrained from calling on a performance bond, such as the guarantee in this case, if it is acting fraudulently or if doing so is "in breach of an express or implied negative stipulation of the contract." Citing Clough Engineering Ltd. v. Oil & Natural Gas Corp. Ltd. [2008] FCAFC 136 [summarized in The 2008 Annual Survey of Letter of Credit Law & Practice], the Judge added that a party may also be restrained from calling on a performance bond if doing so is a breach of an express or implied negative stipulation in the contract:

The Judge stated, "Whether the purpose of the provision of the performance bond in the form of the banker's undertaking is only to provide security for the performance of the lessee's contractual obligations, or whether the purpose is also to allocate the risk as to who should be out-of-pocket pending resolution of a dispute, is a conclusion to be drawn from the construction of the lease."

Looking at the lease, the Judge stated, "In this case, cl 19.1 expressly provides that the purpose of an unconditional bake guarantee is to provide security for the lessee's performance of its obligations. No further purpose for the security is identified. In my view, the clause does not provide for an allocation of the risk as to who should be out of pocket whilst a dispute as to the lessee's asserted breach is determined. Clause 19.4 specifies the circumstances in which the security can be called on, namely, an actual breach of default. That does not mean an indisputable breach of default. Nor does it mean a claimed breach or default."

Lessor/Beneficiary argued that because the guarantee was unconditional, it was entitled to have recourse if it claimed in good faith that Lessee and Applicant/Surety had defaulted or breached the lease. In support of its claim, Lessor/Beneficiary argued that because clause 19.6 provided that any demand is not to constitute a waiver by the lessor of any default of the lessee, the parties intended that the lessor should be entitled to immediate recourse to the guarantee while preserving its other rights for a later trial. The court rejected Lessor/Beneficiary's argument, finding that that clause 19.6 was neutral.

Lessor/Beneficiary argued that an explicit provision is required in the terms of an unconditional performance guarantee before a beneficiary can be enjoined from calling upon the guarantee in good faith. The Judge rejected this argument, noting that a claim of default may be raised in good faith but be disputed. Because clause 19.4.1.1 of the lease referred specifically to a default or breach by the lessee, the Judge ruled that it necessarily implied that Lessor/ Beneficiary was only be entitled to make a demand on the occurrence of an actual breach - not if it claimed that a breach occurred or if a breach were established by judgment or award.

In so ruling, the Judge drew parallel to Bachmann Pty Ltd. v. BHP Power New Zealand Pty Ltd., where the Victoria Court of Appeal ruled that "[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 Judge also took the position of the Victoria Court of Appeal in Fletcher Construction Australia Ltd. v. Varnsdorf Pty [1998] 3 VR 812 that the commercial background informs the construction of the contract, and that a court ought to not too readily favor a construction which is inconsistent with the agreed-upon risk allocation pending resolution of an alleged breach.

Damages: The Judge also considered whether damages would be an adequate remedy if Lessor/ Beneficiary made a demand on the guarantee it was not entitled to make. The court noted that to obtain an interlocutory injunction to restrain Lessor/Beneficiary from calling on the guarantee, Second Plaintiff had to show that damages for the alleged breach of a negative stipulation in clause 19.4 would not be an adequate remedy.

Lessor/Beneficiary, which held the property as Issuer's trustee, had assets of AUD 33,029. The audited accounts for the trust indicated trust liabilities of AUD 6,140,000, including a provision of AUD 893,000 for site remediation, and assets of AUD 6,667,000 including AUD 6,600,000 as the value of the property. A later evaluation stated that the property had a market value of AUD 5,500,000 if free of contamination. Lessor/Beneficiary would be entitled to indemnification out of the assets of the trust in respect of liabilities incurred while discharging its functions as trustee.

The Judge concluded that Lessor/Beneficiary's right of indemnity would not be sufficient to provide it with funds to pay damages or make restitution for an unentitled drawing of the guarantee in addition to the cost of the 2012 Proceedings. The Judge subsequently ordered Lessor/Beneficiary to pay Lessee's costs of the application for interlocutory injunctive relief.

Comment: This decision is only consistent with LC law and practice if it is accepted that the guarantee is dependent. Otherwise, it makes no sense to determine the scope of the obligation by looking at the terms of the lease, the underlying contract, then, the guarantee.

[KCM/mjs]

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