Has Your Performance Bond/ Bank Guarantee Been Issued Correctly?

By 11/12/2016Contract
bank guarantee

In this recent High Court case the ANZ bank refused to pay performance bonds (also known as bank guarantees) it had issued at the request of a builder, in favour of a principal under a construction contract.  The principal issued proceedings against ANZ.

Facts

The bonds were wrongly issued by ANZ in favour of the “New South Wales Land & Housing Department”, an entity which did not exist.  They should have been issued in favour of the “New South Wales Land and Housing Corporation” (the Corporation).

When the Corporation made a demand for payment of the bonds, ANZ refused on the basis that the Corporation was not the party named in them.

The performance bonds were issued incorrectly because the builder wrongly described the Corporation in its finance application to ANZ.  ANZ followed the builder’s instructions and issued the bonds in the name of the wrong entity.  The Corporation failed to pick up the error, and accepted the bonds.

There were other errors in the builder’s finance application: the wrong ABN number was used for the Corporation, and references to the underlying construction contract were incorrect.

Legal Principles

  1. Each bond, being an unconditional obligation to pay a named beneficiary upon demand, was in the nature of a performance bond. Such bonds are commonly used in the construction industry.
  1. The bonds were to be interpreted in accordance with ordinary principles of contractual construction. That is, objectively by reference to its text, context and purpose.  Further that a commercial contract should, in the absence of a contrary intention, be given a businesslike interpretation on the assumption that the parties intended to produce a commercial result.
  1. Two complementary principles apply to performance bonds:

(a)       the principle of autonomy or independence: meaning that a performance bond stands alone. The obligations of the issuer are not determined by reference to the underlying contract (in this case the construction contract);

(b)      the principle of strict compliance: meaning that an issuer (like a bank) should only honour a performance bond if the party making demand for payment is named in the bond as the beneficiary, and the conditions of payment are strictly complied with.  A demand for payment cannot be accepted on the basis that near enough is good enough.

These principles serve the commercial purpose of performance bonds, namely of providing the equivalent of cash, and allocating risk between the parties to the underlying contract until their dispute, if any, is resolved.

Findings

The High Court held that it was not possible to interpret the performance bonds as applying to the Corporation.  The misdescription of the Corporation and the other errors in the bonds were not minor or merely typographical.  A reference to a non-existent entity could not be interpreted as a reference to an existing entity with quite a different name.  Further it would have been contrary to the principle of strict compliance for the bank to have to make inquiries as to the correct entity.

ANZ was therefore entitled to refuse to pay the demand by the Corporation, and it would have been at risk of breach of contract (to the builder) had it done so.

However the Court held that the performance bonds should be rectified, so that they applied to the Corporation.

Rectification is a (discretionary) equitable remedy, which rectifies a written agreement to make it conform to the true agreement of the parties, where by their common mistake they fail to accurately express their agreement.

In this case it was the builder’s and ANZ’s actual common intention that the performance bonds would benefit the party who had entered into the building contract with the builder, namely the Corporation.

Comment

This case illustrates the importance of ensuring that a performance bond is issued correctly, particularly in the name of the correct party.  If not issued correctly, an issuer (such as a bank) will be entitled to refuse to honour a performance bond in accordance with the principle of strict compliance.

If a performance bond incorrectly describes the beneficiary, and the issuer fails to honour the bond, the only remedy for the beneficiary may be to commence legal proceedings to seek rectification.  Only a Court can make an order for rectification.  An order for rectification is not guaranteed – rectification is a discretionary equitable remedy.  Rectification requires admissible evidence of proof, to a high standard, of the actual intention of each of the parties.  As Justice Kiefel said in this case:

It is not to be expected that parties to contractual negotiations will express themselves in terms of their intentions.  It is therefore to be expected that proof to the necessary standard will usually require some manifestation of the intention of each party by their words or conduct and that the requisite common intention will be a matter of inference for the court from that evidence… It would not be sufficient for proof of intention to refer to a party’s state of mind which remained undisclosed in the course of negotiations.”

The case is Simic v New South Wales Land and Housing Corporation [2016] HCA 47 (7 December 2016).

For a related post please see:

WA Supreme Court on restraining the enforcement of performance bonds