Developers and landlords can release their breath – performance bonds and guarantees remain enforceable

In a decision that would otherwise have had serious ramifications, not only in the construction industry but across other industry sectors such as commercial leasing, developers successfully enforced performance and maintenance bonds where the paying financier tried to dodge payment on the basis of an underlying dispute between the developers and contractor.

In Swanhill Enterprises Pty Ltd v QBE Insurance (Australia) Ltd [2017] WASC 279*, various performance and maintenance bonds had been issued by a financier (QBE) in favour of developers Swanhill and Adelaide, to guarantee the obligations of the contractor, Diploma Construction.  Swanhill and Adelaide were related to Diploma Construction.

Swanhill and Adelaide called on the bonds in September and December 2016 respectively.  The Diploma Group collapsed in December 2016.  The financier refused to pay out the bonds.  The financier argued Diploma was not actually in breach contract and thus Swanhill and Adelaide were not entitled to call on the bonds; that Swanhill and Adelaide knew there was a dispute with Diploma and therefore calling on the bonds was unconscionable conduct.

A similar issue arises with a landlord’s call on a lease bank guarantee, when the tenant disputes a breach or asserts a set-off or counter-claim.  Is the bank entitled to ‘look behind’ the call on the guarantee and refuse to pay if there is a dispute between landlord and tenant?

In this case the Court held the bonds were contractual promises between the developers and the financier independent or autonomous of the underlying contracts between the developers and contractor and, if the developers called on the bonds in accordance with their terms, the financier was contractually obliged to honour them notwithstanding its knowledge of any dispute between the developers and contractor.

Further, the Court decided there could not be unconscionable conduct (between developers and financier) in calling on the bonds when the financier would have been aware, when offering to provide the bonds in the first place, of the risk Diploma may dispute the developers’ right to call on them.

Put another way, the financiers could not use the excuse of a dispute between the developers and Diploma to avoid paying on the calls.

A secondary issue arose as to actual compliance with the requirements of the bonds.  Although ‘strict compliance’ was required, the Court was willing to ignore matters it deemed inconsequential or minor.  Given the ‘main requirements’ of the bonds were met – for the developers to certify a breach and specify the amount of the loss – the Court was satisfied there was strict compliance with the requirements of the bonds.

Take away lessons for beneficiaries

  • Ensure the contractual right to call on a guarantee or bond is expressed in unconditional terms, and is not reliant on an independent finding of ‘who is right’. At second best, the guarantee or bond should be enforceable if the beneficiary (the developer/landlord) believes, in their discretion, there is a breach entitling them to call on it.
  • Check the bond or guarantee when received, to make sure it accords with the beneficiary’s rights in the contract/lease.
  • Make an effort to ensure the call on the bond or guarantee is made in accordance with the conditions on that document. This is simply a process of jumping through the hoops.

* Williams + Hughes acted for the successful developers.