In the recent decision of Other Group Pty Ltd v Wylaars & Anor [2013] VSC 98 the Supreme Court of Victoria confirmed that a lessor has an almost unfettered right to call on a lessee’s  bank guarantee, unless the lessee can show that the lessor has acted:

  1. fraudulently;
  2. in breach of consumer protection legislation (being the Competition and Consumer Act or the Fair Trading Act); or
  3. in breach of a promise with the lessee not to call on the security.

Facts

In 1999 the parties entered into a commercial lease.  Pursuant to the lease the lessee was required to provide security by way of bank guarantee equal to one year worth of rent.

When the lessee vacated the premises a dispute arose as to whether the lessee returned the premises in a reasonable condition and whether it was still required to pay rent.

Pending the outcome of the dispute the lessor called on the bank guarantee.  The lessee brought an application in the Supreme Court of Victoria seeking an interlocutory injunction to restrain the lessor from dealing with the proceeds of the bank guarantee pending the outcome of the dispute.

The question for the Court

As the lessee sought an interlocutory injunction, the question for the Court was whether there was a serious question to be tried about the lessor’s entitlement to have drawn on the bank guarantee.

Ultimately the Court held that the lessor was entitled to draw on the bank guarantee and therefore did not grant the injunction sought.  The reasons for the Court’s decision are discussed below.

When can a lessor call on a bank guarantee?

As the lease in question was a commercial lease (and therefore not subject to the Retail Leases Act) the Court immediately looked to the general law principles regarding a party’s right to call on a bank guarantee. 

First the Court reviewed the contract between the parties to determine whether or not there were any terms that operated to limit the lessor’s ability to call on the bank guarantee.  In this case, like most commercial and retail leases, the lease did not contain any limiting terms but rather provided the lessor with an unconditional right to call on the bank guarantee in the event of a breach under the lease.

The Court relied on a long line of authority that stands for the general rule that a court will not prevent the issuer of a bank guarantee, that is the bank, from performing its unconditional obligation to make payment to the party calling on the bank guarantee.  In this case the Court was not in a position to disturb the lessor’s right to call on the bank guarantee.

Three exceptions apply to the general rule that a court will not interfere with a party’s unconditional right to call on a bank guarantee.  Those exceptions are:

  1. where the party calling on the bank guarantee has acted fraudulently;
  2. where the party calling on the bank guarantee has acting unconscionably in breach of consumer protection legislation; or
  3. where the party calling on the bank guarantee has made a contractual promise not to call on the bank guarantee

The rationale behind the general rule and the exceptions listed above is that in a commercial relationship it is implicit that a party who is required to provide a bank guarantee by way of security will be out of pocket pending the outcome of any dispute and/or until it has completed its obligations under the contract.

In this case Justice Hollingworth found that there was nothing in the lease the limited the lessor’s right to call on the bank guarantee, and that the lessee could not satisfy any of the exceptions to the general rule.  Therefore the Court held that the lessor was entitled to call on the bank guarantee even through the dispute between the lessor and lessee was still on foot.

Conclusion

Most leases (both retail leases and commercial leases) provide the lessor with an unconditional right to call on a bank guarantee where the lessee is in breach of the lease.  Unless a lease contains terms that specifically limit the circumstances in which a lessor can call on a bank guarantee, or unless a lessee can point to one of the three exceptions set out above a lessee will be unable able to prevent a lessor from calling on a bank guarantee.

Note

Section 24 of the Retail Leases Act sets out specific requirements in relation to how security deposits are to be obtained and maintained by lessors.  The legislation does not displace the common law which continues to apply in relation to the question of when a lessor can validly call on a bank guarantee.