The proper construction of a bank guarantee was the subject of the Federal Court’s decision in Ottoway Engineering Pty Ltd v Westpac Banking Corp[1] (Ottoway v Westpac). The court considered the circumstances in which the laws in relation to guarantees generally will apply to bank guarantees in particular. This article explores the court’s findings in relation to that issue, which confirm that a bank guarantee will almost never be treated as a guarantee in the orthodox sense.
Background facts
Somewhat unusually, the bank guarantee under consideration in Ottoway v Westpac was provided by National Australia Bank Ltd (NAB) to Westpac Banking Corporation in the amount of $1 million. The circumstances in which that occurred were as follows.
Bluenergy CMC Pty Ltd (Bluenergy) had contracted with Sino Iron to install mechanical equipment and piping for a mining project. Bluenergy engaged Ottoway Engineering Pty Ltd (Ottoway), a metal fabrication and installation company, to perform some of the contract works on the basis that Bluenergy would make an advance payment to Ottoway. The advance payment, intended to cover the costs of Ottoway mobilising to the remote location at which the work was to be performed, was the subject of a side agreement. It was a term of that agreement that Ottoway would provide a bank guarantee to Bluenergy to ensure the repayment of the advance payment. A lesser bank guarantee would be provided from time to time as the work progressed and the advance payment was progressively repaid, with Bluenergy to withhold a portion of each progress payment to Ottoway in repayment of the advance payment.
Bluenergy borrowed the amount of the advance payment from Westpac, and told the bank that those borrowings were to be supported by a bank guarantee in Westpac’s favour to be provided by Ottoway. Westpac provided a bill facility for this purpose. A bank guarantee was initially provided by NAB (at Ottoway’s request) in Westpac’s favour in the amount of $1,735,000, which was later replaced by a bank guarantee in the amount of $1 million.
The relationship between Ottoway and Bluenergy deteriorated to the point where Ottoway ceased work and issued Bluenergy a creditor’s statutory demand in the amount of $1,455,794. Ottoway had, by this time, repaid all of the advance payment.
Westpac called for the repayment of the bill facility, which had expired. Bluenergy advised Westpac of a dispute with Ottoway (which gave rise to a substantial amount owing by Ottoway to Bluenergy) and reassured the bank that the bill facility would be repaid on completion of the project. Westpac agreed to extend the time for repayment of the bill facility on two occasions.
In late March 2016, Westpac became aware of an action to wind up Bluenergy and on 29 March 2016, made a demand under the bank guarantee. At that stage, the amount owing by Bluenergy under the bill facility was $858,158.96. Bluenergy was wound up in insolvency on 13 April 2016.
Ottoway advanced two arguments in support of its contention that Westpac was not permitted to call on the bank guarantee. First, it argued that, by repayment of the advance payment, it had performed the obligations secured. Second, it contended that the two extensions of time granted in respect of the bill facility, without reference to Ottoway, had the effect of discharging the guarantee. This was because the bank guarantee was, or was analogous to, a contract of suretyship. Westpac argued that the bank guarantee was a performance bond, or demand guarantee, and in the circumstances, there was no occasion to enquire as to the nature of the agreement secured.
Bank guarantee not a guarantee
It has long been accepted that the term “bank guarantee” is a misnomer. Despite its name, a bank guarantee exhibits few of the elements of a guarantee.
In simple terms, a guarantee is a promise by one person to meet the obligations of a principal debtor if that principal defaults. It is, therefore, a secondary obligation. There are two common classes of guarantee. The first is an undertaking by a guarantor to pay an amount if the principal does not pay. The second is a promise that the guarantor will “see to it” that the principal will meet its obligation. Thus, the guarantor will be in breach of its contract immediately upon the principal’s breach.
On the other hand, a bank guarantee is in the nature of a performance bond. While under a guarantee the liability of the guarantor is secondary (ie, arising on the breach of the borrower), a bank guarantee creates a primary liability.
In considering the legal character of the bank guarantee, Besanko J noted it was unusual that although the bank guarantee was in respect of an agreement between Ottoway and Bluenergy, it was provided to Westpac. His Honour also highlighted the presence of some indications that the bank guarantee was a contract of suretyship, namely:
- The bank guarantee was security for the obligations of Bluenergy to Westpac.
- It contained a provision for NAB’s continued liability under the bank guarantee notwithstanding variation, extension of time or forbearance (a term which, generally speaking, only has work to do in contracts of suretyship).
However, the court was ultimately persuaded by the fact that, properly construed, the bank guarantee created a primary rather than a secondary obligation. It was in the terms which obliged NAB to pay Westpac upon receipt at any of its branches in Australia a written demand accompanied by the bank guarantee. That is a primary obligation. Moreover, the fact that the guarantee was given by NAB, and not Ottoway, was found to strongly favour the conclusion that the bank guarantee was a performance bond or demand guarantee.
That being the case, the principle of autonomy applicable referred to in the High Court case of Simic v New South Wales Land and Housing Corp[2] was relevant. There, French CJ stated that “the further purpose of performance bonds of allocating risk between the parties to the underlying contract until their dispute, if there be one, is resolved.”[3]
Gageler, Nettle and Gordon JJ observed:
“… subject to fraud perpetrated by a beneficiary, an instrument of this nature (unconditional promise to pay on demand) is independent of any underlying transaction and any other contract. That principle — the principle of autonomy — reflects that those instruments, by their nature, stand alone. Not only are they equivalent to cash, but, by their terms, they also require that the obligations of the issuer are not determined by reference to the underlying contract.”[4]
The court in Ottoway v Westpac ultimately found that Westpac was entitled to call upon the bank guarantee.
Conclusion
The result must have been extremely disappointing for Ottoway. While the aim of the bank guarantee was to secure amounts borrowed by Bluenergy to fund an advance payment to Ottoway, what occurred was that Ottoway repaid the advance payment it received and an amount borrowed by Bluenergy to fund it. A bank guarantee was simply an inappropriate instrument to achieve Ottoway’s commercial objectives.
Ottoway v Westpac is a valuable illustration of the significant differences between bank guarantees and guarantees in the strict sense, notwithstanding the nomenclature. The short point is that bank guarantees are a documentary substitute for cash, and are as good as cash. There is no room for the application of the law of guarantees in adjudicating the rights and obligations of parties to a bank guarantee, or parties (like Ottoway) who suffer loss in connection with them.