Introduction

It is common for tenants under commercial and retail leases, as well as contractors under construction contracts, to provide a bank guarantee to the landlord or principal to secure the performance of its obligations under the relevant contract. The recent decision of the Supreme Court of New South Wales in Universal Publishers Pty Ltd v Australian Executor Trustees Ltd [2013] NSWSC 2021 casts doubt on the generally accepted understanding that a party cannot be restrained from calling on a bank guarantee for an alleged breach so long as the claim is made in good faith and there are no words in the contract preventing the party from doing so.

The Court’s decision was that, despite the absence of negative stipulations or fetter on the landlord’s right to call on the bank guarantee under the lease, the landlord was nevertheless restrained from calling on the bank guarantee. This decision appears to significantly restrict a landlord’s or principal’s right to have recourse to a bank guarantee where the parties to the contract are in genuine dispute and the contract does not expressly provide which party will be out of pocket pending resolution of the dispute.

Purpose of Bank Guarantee

A bank guarantee is an unconditional and unilateral promise by a bank or financial institution to pay on demand a sum up to a specified amount upon the occurrence of certain events, such as where a tenant breaches an obligation under a lease.

Bank guarantees are often required by landlords and principals for the following reasons:

  • To provide security in the event the other party breaches the terms of the contract.
  • To allocate the risk as to which party will be out of pocket pending resolution of a dispute between the parties to the relevant contract.
  • As an alternative to a cash deposit.

The Parties and Background

Australian Executor Trustees Ltd (the Landlord) was the lessor of commercial property at Macquarie Park, New South Wales, and the lessee of the property was Universal Publishers Pty Ltd (the Tenant). The Landlord commenced proceedings against the Tenant in the Supreme Court for the Tenant’s alleged failure to reinstate and remediate the property following the removal of an underground fuel storage tank from the property at the end of the lease, and sought damages of approximately $2.7 million. The Tenant denied that it had breached the lease and defended the proceedings.

In 2013, the Landlord advised the Tenant that it would call on the bank guarantee for the Tenant’s alleged breaches of the lease. The Tenant responded by obtaining an ex parte interlocutory injunction to restrain the Landlord from calling on the bank guarantee. A dispute arose between the Landlord and Tenant as to whether the Landlord was entitled to call on the bank guarantee and whether the injunction should be discharged.

The Bank Guarantee Clause

Clause 19 of the lease, which sets out the parties’ rights and obligations in relation to the bank guarantee, was the critical clause.

Clause 19.4 of the lease provides that:

19.4. In the event that the lessee:

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

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

the Lessor is hereby authorised 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 non-observance by the Lessee or termination of the Lease pursuant to it.

Clause 19.6 states that any demand on the bank guarantee is not to constitute a waiver by the Landlord of any default or prejudice any other right of the Landlord arising from such default.

Clause 19.7 requires the Tenant to reinstate the bank guarantee in the event it was called upon by the Landlord from time to time.

The lease defines “Bank Guarantee” as meaning “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.”

It is noteworthy that this bank guarantee provision contains terms that are standard amongst commercial leases and contracts.

Was the Landlord entitled to call on the Bank Guarantee?

The question for the Court to determine was whether the lease provided that:

  • the landlord was only entitled to call on the bank guarantee if, in fact, the tenant had committed an actual breach of the lease (Circumstance 1); or
  • the landlord was entitled to make demand on the bank guarantee where the Landlord claimed, in good faith, that the tenant was in breach of the lease (Circumstance 2).

In arguing for the discharge of the injunction and the right to call on the bank guarantee, the Landlord submitted that, upon the proper construction of the lease, the parties intended that the Landlord was entitled to have recourse to the bank guarantee if it claimed, in good faith, that the Tenant had breached the lease. To support its position, the Landlord pointed to, amongst other factors, the unconditional nature of the guarantee, the Tenant’s obligation to reinstate the bank guarantee where called upon by the Landlord from “time to time”, and the Landlord’s right to demand from the bank the amount that “in the reasonable opinion” of the Landlord may be due to it as a result of the Tenant’s breach.

Prior to Universal, it was generally accepted that Wood Hall Limited v Pipeline Authority [1979] HCA 21 stood as authority for the proposition advanced by the Landlord, that a party is entitled to call upon an unconditional bank guarantee where it claims it is entitled to do so in good faith, provided there is no explicit language in the underlying contract that prevents that party from doing so.

The Court’s Ruling

The Court rejected the proposition that the Landlord may rely on the good faith entitlement and held that the injunction should continue.  The Court stated that a landlord’s entitlement to call on a bank guarantee is a question of construction of the relevant provisions of the contract as to whether the bank guarantee is provided:

  • solely as security for performance of the other party’s contractual obligations, in which case the Landlord would only be entitled to call upon the bank guarantee in Circumstance 1; or
  • also for the purpose of allocating which party will be out of pocket pending resolution of a dispute as to whether the other party had breached the contract, in which case the Landlord would be entitled to call on the bank guarantee in Circumstance 2.

In looking at clause 19, the Court concluded that the purpose of clause 19 was to provide security only and that it did not have the additional purpose of allocating risk. In coming to this decision, the Court noted that:

  • the lease specified the purpose of the bank guarantee to be to “secure the Lessee’s obligations under this Lease and loss and damages suffered by the Lessor pursuant to breach by the Lessee” (clause 19.1);
  • clause 19.4 entitled the Landlord to call on the bank guarantee where the Tenant “breaches any other obligation, term, condition or covenant under this Lease”, suggesting that if the Tenant was not actually in breach of the lease, the Landlord had no right to call on the bank guarantee.

The Court clarified that an actual breach does not mean it must be an indisputable breach, or a breach confirmed by judgement of a court. Rather, whether a landlord can be restrained from calling upon a bank guarantee in circumstances where a tenant disputes a landlord’s entitlement depends on whether the tenant is able to establish that there is a serious question to be tried as to the existence of the breach.

In reviewing the evidence, the Court was satisfied that there was a genuine dispute as to whether the Tenant had in fact breached its obligation to reinstate and remediate the property and therefore, the Landlord was not entitled to call upon the bank guarantee under the terms of the lease.

Where does this decision leave us?

If the reasoning in Universal is not overturned on appeal, then where a dispute arises which is pending resolution, and the contract does not expressly provide the landlord or principal with the right to call on the bank guarantee in such circumstances, the landlord or principal will likely be restrained from calling on the bank guarantee. The case suggests that a party’s ability to claim under a bank guarantee will depend on the construction of the underlying contract.

Existing bank guarantee clauses, previously drafted on the understanding that express words were needed to preclude the beneficiary from calling on the bank guarantee where a breach is alleged in good faith, may now be interpreted by courts in a way which makes it easier for landlords to be restrained from calling on a bank guarantee where there is a pending genuine dispute as to the alleged breach.

Going forward, it is imperative that clauses dealing with bank guarantees, and a party’s ability to call on a bank guarantee, are drafted with careful consideration and that the terms reflect the intentions of the parties. An effective bank guarantee clause should explicitly address the risk allocation and state which party should be out-of-pocket pending resolution of a dispute between the parties to the relevant contract. The clause should clearly state the preconditions to the landlord’s entitlement to call on the bank guarantee. Specifically, landlords should ensure the clause addresses their authority to call on the bank guarantee where the landlord believes, acting in good faith, that the tenant has breached the lease.