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Focus: The unconditional nature of bank undertakings

30 June 2011

In brief: The Supreme Court of Queensland has affirmed that there are very limited circumstances in which a court will interfere with the calling on an unconditional bank undertaking. Partner John Cooper , Senior Associate Matthew Senescall and Lawyer Tom Levi report on the decision and consider the lessons for parties entering into contracts which require provision of unconditional undertakings as security for performance.

How does it affect you?

  • This case serves as a reminder that, without clear words in the contract or the undertaking, the courts are likely to decide that an unconditional bank undertaking is to operate as a risk allocation device as to who shall be out of pocket pending resolution of any dispute (rather than as a security only) and will give effect to it as such.
  • This means that the beneficiary, in the usual course, will be entitled to call upon the unconditional bank undertaking where, in good faith, it alleges breach of contract, even if it ultimately turns out that the other party was not in breach.
  • Therefore, where the unconditional bank undertaking is intended to be provided as a security only1 and not as a risk allocation device, then the party providing the undertaking should be very careful to make this abundantly clear both in the underlying contract and the undertaking itself.

The facts

Ceresola TLS AG contracted to provide tunnel forming machines to Thiess John Holland (TJH), as a joint venture, for construction of the Airport Link Project in Brisbane. Ceresola provided an unconditional bank undertaking to TJH and the contract stated that the bank undertaking was to secure Ceresola's due and proper performance of the contract.

When the machines were delivered late, TJH contended that it was entitled to liquidated damages and flagged an intention to call on the bank undertaking. Ceresola argued that TJH did not have an entitlement to liquidated damages and applied for an interim injunction to restrain TJH from calling on the bank undertaking.

The contract provided that, if there was a delay in delivery, Cersola was required to pay liquidated damages to TJH. While the contract provided that TJH was entitled to set off any payments due prior to relying on the bank undertaking, the contract did not impose restrictions on when TJH could call on the bank undertakings. Further, the bank undertaking was unconditional and required the bank to make payment 'irrespective of the performance or non-performance by the supplier of the terms of the agreement'.

The decision

The court declined to issue an injunction.2 Generally, a court will not prevent the issuer of an unconditional undertaking (in this case, the bank) from performing its unconditional obligation to make a payment unless the party in whose favour the undertaking has been given is acting (or seeking to act) either fraudulently or unconscionably (in contravention of the Australian Consumer Law contained in the Competition and Consumer Act 2010 (Cth)).

However, the court may issue an injunction to prevent the party in whose favour the bank undertaking has been given from seeking to call on a bank undertaking where the contract between the parties imposes a restriction on the circumstances in which it can be called on. In each case, the court will need to consider the contractual terms to determine whether the bank undertaking was intended to be used only as a security or, more generally, to allocate the risk 'as to who shall be out of pocket pending resolution of the dispute'. Clear words must be used if the parties wish to limit the circumstances in which a beneficiary, acting in good faith, may call on a bank undertaking following an alleged breach of contract.

The court found that, in this case, the bank undertaking was provided for the reason of allocating risk. The contract stated that the bank undertaking was to secure Ceresola's due and proper performance of the contract. It was implicit that this applied to all of Ceresola's obligations under the contract. The set-off clause provided just one of many circumstances in which the parties had agreed the undertaking could be called on. Therefore, in the absence of fraud or unconscionability, the court had no grounds on which to prevent TJH from calling on the unconditional bank undertaking.

Conclusion

The Supreme Court, relying on the recent decision of the Full Federal Court in Clough Engineering Limited v Oil and Natural Gas Corporation Limited,3 has provided a very clear explanation of the law on bank undertakings. The court will not intervene in the use of a unconditional bank undertaking in the absence of fraud or unconscionability unless the parties have provided clear limitations on the use of the undertaking either in the contract or the undertaking itself. Accordingly, parties that intend for a bank undertaking to only be used as a security must include specific language to this effect.

Footnotes
  1. That is, to protect the beneficiary where it has a valid claim and there are difficulties about recovering from the party in default.
  2. Ceresola TLS AG v Thiess Pty Ltd & John Holland Pty Ltd [2011] QSC 115.
  3. (2008) 249 ALR 458.

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