Article

Underlying Transaction: Mechanical and piping installation work on two dewatering buildings.

Underlying: AUD 1,000,000 bank guarantee to secure advance payment on a subcontract.

Decision: The Federal Court, Besanko, J., granted an interlocutory injunction at the request of Subcontractor/Applicant. On application for a final order, the court lifted the injunction, but limited the amount Lender/Beneficiary could draw to the amount owed under the Bill Facility.

Rationale:The instrument was a performance bond or demand guarantee, not a contract of suretyship because the obligation on the Guarantor was a primary obligation. A performance bond or demand guarantee operates independently of the underlying contract, and Lender/Beneficiary was not obligated to act with regard to the underlying subcontract in drawing on the bank guarantee.

Factual Summary: Subcontractor/Applicantcontracted with Contractor to perform mechanical and piping installation work on two dewatering buildings for AUD 17,350,000. The parties entered into an Advance Payment Agreement and Contractor advanced AUD 1,735,000 to Subcontractor/Applicant. In exchange, Subcontractor/Applicant agreed to a ten percent monthly deduction in payments fromContractor.

In order to make the advance payment, Contractor applied for and received a loan under a Bill Facility from Lender/Beneficiary in the amount of AUD 1,735,000. Pursuant to the Advance Payment Agreement, Subcontractor/Applicant obtained a bankguarantee from Guarantorin favor of Lender/Beneficiary in the amount of AUD 1,735,000. The bank guarantee was later replaced by a bank guarantee of AUD 1,000,000.

The terms of the bank guarantee provided,“[i]n consideration of the [Lender/Beneficiary] agreeing at the request of [Subcontractor/Applicant] and [Guarantor] to accept this guarantee in connection with the agreement, the [Guarantor] undertakes to pay the [Lender/Beneficiary] an amount or amounts not exceeding the Amount in total.” The Agreement specified that thebank guarantee was to secure the lending obligations of Contractor to Lender/Beneficiary. Pursuant to the bank guarantee, Lender/Beneficiaryhas a right to payment upon written demand without reference to the customer, despite any notice by Subcontractor/Applicant and irrespective of the performance or non-performance of Subcontractor/Applicant or Lender/Beneficiary. Furthermore,the Guarantor is not obligated to inquire as to the performance or non-performance of either Subcontractor/Applicant or Lender/Beneficiary,nor must Guarantor inquire as to the correctness or validity of an unconditional written demand made by Lender/Beneficiary under the bank guarantee.

Following the liquidation of Contractor, Lender/Beneficiary drew on the bank guarantee.Subcontractor/Applicant sought an injunction restraining Lender/Beneficiary from making a demand. The Federal Court of Australia, Besanko, J., granted Subcontractor/Applicant an interlocutory injunction. Upon application by Subcontractor/Applicant for a final order, Besanko, J., ruled Lender/Beneficiary may enforce the bank guarantee only to the extent of the amount outstanding under the Bill Facility.

Legal Analysis:

Legal Analysis: Subcontractor/Applicant argued the bank guarantee was a performance bond or demand guarantee which secured Contractor’s obligations under the Advance Payment Agreement.Subcontractor/Applicant argued that the purpose of the bank guarantee was to assure its performance of the installation, and that upon its completion, the bank guarantee was “null and void”. Because Subcontractor/Applicant performed its obligations, it claimed it was unconscionable for Lender/Beneficiary to draw on the bank guarantee. Subcontractor/Applicant also claimed Lender/Beneficiary acted unconscionably by twice extending the Bill Facility. In the alternative, Subcontractor/Applicant argued that if the bank guarantee secured Contractor’s obligations to Lender/Beneficiary, then the bank guarantee was a contract of suretyship and Subcontractor/Applicant’s obligations under the bank guarantee were discharged by Lender/Beneficiary’s conduct in extending the time for repayment of the Bill Facility without reference to Subcontractor/Applicant. Subcontractor/Applicant amended its complaintto add a claim of fraud against Contractor because Contractor did not repay the Bill Facility in circumstances where Subcontractor/Applicant had repaid the advance payment to Contractor.

1. Proper Construction of the Bank Guarantee

The Judge noted that the document’s title “Bank Guarantee” is of little significance because titles can be misleading, and the language of the document itself determines the nature of the document. The Judge noted the difference between a suretyship and a demand guarantee is that “the liability of a surety is secondary, whereas the liability of the issuer of a demand guarantee is primary.” (citing Paget’s Law of Banking (Malek A and Odgers J) (14thed, LexisNexis, 2014). Additionally, the essential principle underlying demand guarantees is that each contract is autonomous. The Judge found the decisive factor was whether the obligation was a primary obligation or a secondary obligation.Here, the Judge found the obligation was primary because the obligation on the Guarantor was to pay Lender/Beneficiary upon Guarantor receiving at any of its branches an unconditional written demand accompanied by the bank guarantee. The Judge concluded the bank guarantee was a performance bond or demand guarantee, not a suretyship contract.

Lender/Beneficiary argued that because Guarantor’s obligation to pay is independent of the underlying subcontract, the bank guarantee is a performance bond or demand guarantee. The Judge agreed, noting the principle of autonomy “require[s] that the obligations of the issuer are not determined by reference to the underlying contract.” The Judge agreed the bank guarantee was separate from the circumstances and commercial purpose of the underlying subcontract.

The Judge further ruled that it would be unconscionable for Lender/Beneficiary to draw on the bank guarantee beyond the amount owed under the Bill Facility because the facts clearly show that Lender/Beneficiary believed the bank guarantee was provided in connection with the Bill Facility. Lender/Beneficiary argued the bank guarantee should not be limited to the amount owed under the Bill Facility because Subcontractor/Applicant’s repayment obligation was secured under the Advance Payment Agreement. Using the principle of autonomy and the fact that Lender/Beneficiary was not a party to the Advance Payment Agreement or any agreement with Subcontractor/Applicant, the Judge rejected Lender/Beneficiary’s argument.

2. Unconscionability

Subcontractor/Applicant’s primary argument was that Lender/Beneficiary engaged in unconscionable conduct under section 20(1) of the Australian Consumer Law (ACL) in calling on the bank guarantee because 1) Subcontractor/Applicant’s work on the project was completed and 2) Lender/Beneficiary twice extended the Bill Facility with knowledge Contractor was unable to pay the Bill Facility. Subcontractor/Applicant claims a type of unconscionable conduct where the assertion or reliance on a legal right is unconscionable. Lender/Beneficiary responds that type of unconscionability Subcontractor/Applicant claims is not cognizable within section 20(1).The Judge ultimately agreed with Lender/Beneficiary and held a narrow view of the scope of unconscionable conduct within section 20(1) of the ACL in cases involving performance bonds or demand guarantees because of the nature of those instruments.

Regarding Subcontractor/Applicant’s completion of the work, the Judge rejected Subcontractor/Applicant’s argument, noting that disputes are common in the construction industry, and Lender/Beneficiary was under no obligation to investigate the dispute between Contractor and Subcontractor/Applicant. The Judge also noted that the bank guarantee was to secure Lender/Beneficiary’s advance to Contractor under the Bill Facility, not Subcontractor/Applicant’s obligation to repay the advance payment.

Subcontractor/Applicant made several factual assertions regarding Lender/Beneficiary’s knowledge of the underlying dispute between Contractor and Subcontractor/Applicant and Lender/Beneficiary’s knowledge of Contractor’s liquidation. Subcontractor/Applicant alleges that with this knowledge, it was unconscionable for Lender/Beneficiary to extend the Bill Facility to Contractor then call on the bank guarantee.

Lender/Beneficiary possessed a performance bond or demand guarantee issued by Guarantor. The Judge noted that even if Lender/Beneficiary relied on the bank guarantee in extending the Bill Facility to Contractor, it was entitled to do so. Lender/Beneficiary owed no duty to Subcontractor/Applicant, and the Judge did not find any unconscionable conduct in granting Contractor extra time to repay the Bill Facility. The Judge held that Lender/Beneficiary’s conduct would only be unconscionable if it had an obligation to make further inquiry regarding what was going on with Contractor. The Judge ultimately found Lender/Beneficiary was under no such obligation.

3. Fraud

Subcontractor/Applicant also made a claim of fraud against Contractor for failing to repay the Bill Facility to Lender/Beneficiary in circumstances where Subcontractor/Applicant had repaid the advance payment to Contractor. Subcontractor/Applicant argued that to allow Lender/Beneficiary to call on the bank guarantee furthers Contractor’s fraud. The Judge ruled that Lender/Beneficiary cannot be liable for fraud for the same reasons that there was no unconscionability.

Comment: The analysis in this case reveals the poverty of notions such as “primary”, “secondary”, and “unconditional” (as well as names given to the undertaking) in determining whether the undertaking is independent.

Text of Bank Guarantee:

National Australia Bank Limited (“Bank”)

ABN 12 004 044 937

Bank Guarantee

Guarantee No : 24705739

Ref :852967227 - 860556674

To:

WESTPAC BANKING CORPORATION

A.C.N./A.R.B.N./ABN 33 007 457 141

(The Beneficiary)

For:

OTTOWAY ENGINEERING PTY LTD

A.C.N./A.R.B.N./ABN 125531428

(The Customer)

Agreement:

PROJECT MOBILIZATION COST PLANT, EQUIPMENT’S AND RECOURSE FOR CONTRACT BETWEEN OTTOWAY ENGINEERING PTY LTD ABN 70 125  531 428 AND BLUENERGY CMC PTY LTD ABN 33 160 063 187 EXECUTED ON THE 21ST OF AUGUST 2014 FOR THE PROVISION OF MECHANICAL & PIPING INSTALLATION & COMMISSIONING WORKS RELATING TO DEWATERING BUILDINGS 313 AND 314 CONVEYOR REPAIRS.  THIS BANK GUARANTEE ISSUED TO SECURE THE LENDING OBLIGATIONS OF BLUENERGY CMC PTY LTD TO WESTPAC BANKING CORPORATION

Amount:  1,000,000 Currency of AUSTRALIAN DOLLARS

Amount in words:  ONE MILLION DOLLARS

  1. In consideration of the Beneficiary agreeing at the request of the Customer and the Bank to accept this guarantee in connection with the agreement, the Bank undertakes to pay the Beneficiary an amount or amounts not exceeding the Amount in total.
  2. Payment of the Amount or any part or parts of the Amount will be made by the Bank to the Beneficiary:
    1. upon the Bank receiving at any NAB branch located within Australia while this guarantee remains in force an unconditional written demand from the Beneficiary accompanied by this guarantee; and
    2. without reference to the Customer; and
    3. despite any notice given to the Bank by the Customer not to pay the Beneficiary any moneys payable under this guarantee; and
    4. irrespective of the performance or non-performance by the Customer or the Beneficiary of the Agreement in any respect; and
    5. with no obligation on the Bank to enquire as to the performance or non-performance of the Agreement in any respect by the customer or the Beneficiary; and
    6. with no obligation on the bank to enquire as to the correctness or validity of any demand pursuant to sub-clause 2(a) of this clause.
    7. at the Bank’s election in cash, bank cheque or funds transfer into the Beneficiary’s nominated account.
  3. Where a demand and payment is made pursuant to clause 2, for a sum that is less than the Amount, the Bank will issue to the Beneficiary a replacement guarantee for the balance of the Amount then remaining, after such part payment or payments.
  4. The Bank’s liability under this guarantee is not affected or discharged in any way by any variation of the Agreement or by any extension of time or other forbearance on the part of the Beneficiary or the Customer to the other.
  5. The Bank may terminate this guarantee at any time upon payment to the Beneficiary of the Amount or the balance of the Amount remaining after any part payment of the amount, or such lesser amount as the Beneficiary requires.
  6. If two or more persons are named as the Beneficiary, this guarantee takes effect for the benefit of them jointly and a demand under this guarantee by any one or more of them is deemed to be a demand by both or all of them jointly.  Payment by the Bank under this guarantee to any one or more of them discharges this guarantee to the extent of the amount so paid.
  7. The benefit of this guarantee is not assignable by the Beneficiary.
  8. This guarantee continues in force until the earliest of the following occurs:
    1. this guarantee is returned to the Bank at any NAB branch located within Australia (other than for a payment in accordance with clause 2(a));
    2. notification in writing has been received by the Bank at any NAB branch located within Australia from the Beneficiary that this guarantee is no longer required;
    3. payment is made under clause 2 or 5 to the Beneficiary by the Bank of the whole of the Amount or the balance of the Amount remaining after any part payment or payments of the Amount, or such lesser amount as the Beneficiary requires;
    4. the close of business on the Termination Date (if any).
  9. In the events of clause 8(b), (c) & (d), the Beneficiary must return this guarantee to the Bank at any NAB branch located within Australia.
  10. This guarantee is governed by and is to be construed in accordance with the laws of the place where it is executed by the Bank.

[MMY]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.