Bank Guarantees As Security: Part 2 – Calling On The Guarantee

May 22, 2023

Calling on a bank guarantee (also known as ‘having recourse’) is a mechanism used by principals to recover amounts owing by a contractor or to compensate it for loss suffered due to contractor’s breach. Calling on a bank guarantee can have a drastic impact on contractors – this threat should be taken seriously.

Even though a bank guarantee may be unconditional, there are often contract clauses which may restrict the principal’s ability to call on a bank guarantee. Therefore, it is important for parties to be aware of the steps and their rights in relation to a principal’s entitlement to call on a bank guarantee during a construction project.

What does it mean?

When a principal is seeking to ‘call on’ your bank guarantee, the principal will go to the bank (being the issuer of the bank guarantee) who will then be required to pay the principal an amount no greater than the secured amount on demand, or otherwise in accordance with the terms of the bank guarantee.

When is the principal entitled to call on a bank guarantee?

Where a contract requires the contractor to provide a bank guarantee as security, the principals rights to call on the bank guarantee is usually set out in the contract.

Some common circumstances which give rise to this entitlement include inter alia:

  1. if the contractor fails to pay a debt under the contract;
  2. the contractor can no longer perform the contract;
  3. the principal notifies the contractor of defects in the works which the contractor fails to rectify by the required time period;
  4. liquidated damages are due; or
  5. other set offs are available under the contract.

It is important to read a contract’s clauses carefully as they may also provide impediments or further ‘steps’ required to be taken prior to calling on a bank guarantee. Even if the bank guarantee is ‘unconditional’ these additional steps aim to prevent or restrict the principal’s ability to call on the bank guarantee.

For example, this could include clauses which provide:

  • that the principal can only have recourse if there is a debt due and payable by the contract (as opposed to damages). This may be where the mere assertion by the principal that an amount is owing is not enough and needs to be certified as owing;
  • the principal must give written notice to the contractor (i.e., 7 days) of its intention to call on the bank guarantee before doing so; and
  • that you must comply with relevant legislation.

Does legislation apply?

Parties may also be subject to legislation which governs entitlement to security. For example, in Queensland section 67J of the Queensland Building and Construction Commission Act 1991 requires the principal to give notice within 28 days after the contracting party becomes aware, or ought reasonably to have become aware of the principal’s right to obtain the amount owed.

For a principal to give a section 67J notice, it must first be aware of the ‘amount owed’ – this may affect the time period in which the notice must be given. Where the claim by the principal is for liquidated damages, this requires knowledge of the period of delay.

Importantly, notice given outside of the required 28-day window may invalidate the notice.

How to stop it?

Contractors can be left exposed if contracts are poorly drafted. The best way for a contractor to limit a principal’s ability to call on a bank guarantee is to engage as many of the impediments under the contract as possible to ensure their interests are protected.

Where a dispute arises and a call on a bank guarantee is likely (or the principal has already provided notice of its intention) the contractor should immediately consider both parties’ positions with respect to entitlement to prevent the principal from calling on the bank guarantee.

A call on a bank guarantee can negatively impact the contractor’s cash flow, reputation and ability to secure security in the future, therefore, if it is arguable that the principal has no entitlement the contractor can (and should) make an application to the Supreme Court to seek an order injuncting the principal from calling on the bank guarantee. This will be discussed next week.

What if the contractor is insolvent?

Contractor insolvency has been a frequent occurrence in the Australian construction industry which may leave some wondering whether a principal can have recourse to the bank guarantee of a contractor that has gone insolvent.

Short answer is yes. Typically, security protects principals in events such as insolvency and will not affect their rights to call on a bank guarantee (assuming they are entitled to do so under the contract).

If a principal wishes to call on a bank guarantee but has been notified that the contractor is insolvent, its obligations under the contract remain the same, however, any notices that are required to be provided prior to having recourse are to be served on the administrator or liquidator (not the contractor) as they are the ones who are in control of that company at that time.

Lamont Project & Construction Lawyers

We have the industry knowledge and experience to assist both the principal and the contractor on any issue involving security. If you have any questions regarding a dispute under your construction contract, please contact Lamont Project and Construction Lawyers.

The content of this article is for information purposes only; it does not discuss every important topic or matter of law, and it is not to be relied upon as legal advice. Specialist advice should be sought regarding your specific circumstances.

Contact: Peter Lamont or Stephanie Purser

Email: [email protected] or [email protected]

Phone: (07) 3248 8500

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