Key Points:

There are three basic issues to be considered with bank guarantees: autonomy rules, balance of convenience, and the agreement itself.

Bank guarantees are readily accepted in lieu of cash deposits under contracts for sale and as security bonds under leases. However, both the beneficiary under a bank guarantee and the giver of the bank guarantee (usually the buyer under a contract or a tenant under a lease) should be aware of the risks associated with accepting or providing a bank guarantee.

As good as cash?

Being "as good as cash" in the eyes of those to whom it is issued is an essential function of any guarantee or bond [1]. This is a result of the "autonomy principle" – that a beneficiary can demand payment on a bank guarantee and the bank must meet the demand, regardless of whether the party that provided the guarantee is in breach.

If this were not the case, cash bonds would arguably be the only form of security accepted.

It is widely accepted that there are three principal exceptions to the rule that a court will not direct the issuer of a guarantee or bond from performing its unconditional obligation to pay the beneficiary:

  1. to prevent the beneficiary from acting fraudulently;
  2. to prevent the beneficiary from acting unconscionably; or
  3. in circumstances where there has been a contractual promise by the beneficiary not to call on the guarantee. [2]

Risk allocation

Giving and accepting bank guarantees is all about the allocation of risk: as with most circumstances in commercial world, the party who requires it the most is generally the party that is willing to accept greater risk. In property transactions, the party benefitting from the giving of a bank guarantee or a deposit bond is almost always the buyer or tenant, in that their cash is not tied up for the term.

Where a party clearly accepts the risk under an agreement, it then has a significant hurdle to overcome when that risk crystallises. [3]

Is your bank guarantee really unconditional?

The unconditional quality of the bank guarantee is impacted upon not only by the construction of the instrument itself but also by the provisions of the agreement under which it was provided.

There are generally two motives for a beneficiary to require a bank guarantee:

  1. to provide security for a valid claim by the beneficiary; and
  2. to allocate risk between the parties as to who shall be out of pocket pending resolution of a dispute between them. [4]

There is often no need for the beneficiary to show it is owed the moneys – it is just a risk allocation method. [5]

However, it has recently been held that a contractual obligation for a beneficiary to act "reasonably" in making a claim against a bank guarantee precluded the beneficiary from making the claim. [6]

How can you best secure your rights?

  1. Autonomy rules: beneficiaries should ensure their right to call on the bank guarantee is unfettered, so that recourse to the giver of the guarantee is not required before the bank will release the moneys.
  2. Balance of convenience: the party who accepts the risk under an agreement will wear the risk when the right to call on the bank guarantee is triggered, even in circumstances where the giver of the bank guarantee disputes the beneficiary's right to payment.
  3. Construction of the agreement: the right to call on a bank guarantee will be strictly construed in accordance with the agreement. Even the softening of a right by requiring reasonableness can affect a beneficiary's right to call on a bank guarantee.