North Sydney Commercial Lawyers

PPSA, bank guarantees and cash bondsPrint This Post

When can a bank guarantee be called upon?

Can a lessor call upon the bank guarantee when a tenant disputes that there is a fault under the lease? It is settled law that a guarantor’s liability is contingent upon the principal debtor’s liability and default – Commercial Banking Co of Sydney Limited-v-Patrick Intermarine Acceptances Ltd (in liq) (1978) 52 ALJR 404 at 406.

However, the liability arising under an unconditional bank guarantee is not secondary in nature – Barwick CJ in Wood Hall Ltd-v-Pipeline Authority and Another (1979) 141 CLR 443 at 445.

An unconditional bank guarantee provides that where there is a right to call on the guarantee, the bank has to immediately pay out the sum. Where the conditions in the bond are fulfilled, a liability to pay arises without any room for negotiation or argument.

Nevertheless there are some limitations on this wide scope. Clough Engineering Limited-v-Oil and Natural Gas Corporation (2008) 249 ALR 458 at 77 provides the following principles:

(a) any fraud excludes the operation of the bank guarantee;

(b) any unconscientious act in contravention of the then section 51AA of the Trade Practices Act (now section 20 of the Australian Consumer Law) is grounds for relief;

(c) relief can also be obtained where the party calling on the bond, has made an independent contract under which he or she promised not to call upon it.

Courts cite that (c) in reality iterates the problem. Should a beneficiary of a bank guarantee be entitled to present it to the bank when there is a dispute as to the triggering event or should that dispute be resolved first?

The general rule is that the guarantee should be paid out upon presentation and any argument dealt with later.

Application of PPSA if guarantees create security interests

By reference to the above decision of Clough Engineering Limited-v-Oil and Natural Gas Corporation (2008) 249 ALR 458, it will be seen that in addition to the qualifications on when a lessor will be permitted to call on a bank guarantee, Chapter 4 of the PPSA must also be taken into account. Chapter 4 deals with enforcement and section 111 requires security holders to exercise their enforcement rights “honestly” and “in a commercially reasonable manner.” This cannot be contracted out of (s 115).

Section 143 Reinstatement

This section entitles a person to reinstate a security agreement after enforcement action has commenced but before the collateral is disposed of or retained, by paying arrears and any enforcement expenses and by remedying any default. The right is only available once during the term of the security agreement. The Explanatory Memorandum provides that reinstatement will protect grantors and debtors where the default is minor, temporary or aberrational. It says it will also allow other persons to safeguard their interests in the collateral, where such an option is beneficial to them.

However, s 143 may not be available in all circumstances.

What about cash bonds as security interests?

Cash bonds are easier to analyse than bank bonds and guarantees. Firstly, cash bonds are currency which is part of the definition of financial property which is personal property under the Act – s 10.

Cash bonds – Is there a transaction?

Yes – the lease.

Does the transaction secure an obligation? The obligation is of course the tenant’s obligation to pay rent or any other obligation on the tenant under the lease.

Cash Bonds – Is there an attachment?

Yes, the grantor has rights in the collateral under section 19(2)(a) and value is given for the security interest under section 19(2)(b) in the form of the lessor’s contractual obligation under the lease agreement.

Section 20 is satisfied (enforceable security interests against third parties) as the lessor holds the cash bond and holding constitutes possession.

If the secured party possesses the cash bond then possession is established under section 21(2)(b) and in those circumstances registration is not necessary.

What about the lessee’s interest in the return of the cash bond on the conclusion of the lease?

This does not appear to fall under the PPSA.

Application of Retail Leases Act 1994 (NSW)

Section 16C of the Retail Leases Act provides that security bond must be deposited with the Director General. The bond is held in a statutory trust account (s16T). And this means that it is not the property of the lessor that is distributable to the creditors of the lessor in the lessor’s bankruptcy or winding up. It is therefore not property subject to a fixed, floating, or fixed and floating charge or any other security agreement in respect of the lessor.