Bank guarantees have, therefore, provided much needed certainty for a beneficiary.
This is why traditionally, bank guarantees have been an effective way of providing security for performance and are commonly used in a number of commercial situations. In a property context, these include use of a bank guarantee:
in lieu of payment of a security deposit under a lease;
in lieu of payment of a deposit by the purchaser under a sale contract – these are more commonly seen in off the plan strata sale contracts where there is a long period of time between the contract date and settlement of the purchase;
in works and construction contracts as security for the contractor’s remedy of defects;
in a supply arrangement as security for the recipient of the supply of the supplier’s obligations; and
in development agreements and joint venture agreements as security for the performance of obligations by one party in favour of another.
However, beneficiaries (whether they be a seller, landlord or counterparty to some other commercial arrangement) need to be aware that there is a narrow set of circumstances in which a bank guarantee may be deemed an “unfair preference” pursuant to the terms of s 588FA of the Corporations Act 2001 (Cth) (Corporations Act).
If the bank guarantee is deemed an unfair preference it may allow a liquidator to recover or “claw back” a payment made pursuant to the call on the bank guarantee.
The legislation
Section 588FA of the Corporations Act provides as follows:
(1) A transaction is an unfair preference given by a company to a creditor of the company if, and only if:
(a) the company and the creditor are parties to the transaction (even if someone else is also a party); and
(b) the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company.
An unfair preference occurs (generally) where a creditor receives a payment within the six months prior to the appointment of a liquidator or administrator to a company. For a liquidator to recover a payment to a creditor, the liquidator must establish that:
the payment was made within the 6 month window prior to the appointment of the liquidator; and
the creditor received a preference over other creditors.
The recent case of Commissioner of Taxation v Kassem and Secatore [2012] FCAFC 124 (Kassem) cast some doubt as to whether a bank guarantee would survive an attempt by a liquidator to claw back the payment under that bank guarantee as an unfair preference.
In the context of a landlord calling upon a bank guarantee provided by a leasee to a landlord to secure its obligations under a lease, if the liquidator of the insolvent leasee is able to demonstrate that the payment by the bank to the landlord pursuant to the bank guarantee was:
an unfair preference pursuant to the Corporations Act;
an insolvent transaction pursuant to the Corporations Act; and
made in the relevant relation-back period as defined in Corporations Act (generally six months),
then the liquidator may be entitled to relief including an order requiring the landlord to repay the benefit of the payment.
Similarly, if the liquidator of the insolvent buyer, contractor or supplier is able to demonstrate that the payment by the bank to the creditor (being a seller or recipient of works or services) pursuant to the bank guarantee was:
an unfair preference pursuant to the Corporations Act;
an insolvent transaction pursuant to the Corporations Act; and
made in the relevant relation-back period as defined in Corporations Act (generally six months),
the liquidator may be entitled to relief including an order requiring the creditor to repay the benefit of the payment.
Unfair preference
An unfair preference occurs (generally) where a creditor receives a payment within six months of the appointment of a liquidator or administrator to a company.
In order for a liquidator to recover a payment made to a creditor (such as the landlord), the liquidator must establish that the payment was made in the six month period and that the creditor received a preference or advantage over other creditors.
The historical position has been that where the payment pursuant to the bank guarantee is made by a bank to a creditor and not by the insolvent company to a creditor, such a transaction will fall outside of the scope of the unfair preference regime as the creditor and the insolvent debtor were not “parties” to the transaction.
The Court in Kassem was asked to determine whether the payment by one company of a related company’s debt to a creditor, was an unfair preference. The Court found that in circumstances where a transaction or payment is characterised as a lender paying moneys advanced to a borrower’s creditor in accordance with the borrower’s direction, such a transaction or payment is likely to fall within the scope of the unfair preference regime.
In addition, the Court found that a transaction or payment made by a third party (ie a bank) “by or on behalf” of the debtor, is also likely to constitute an unfair preference payment.
This is supported by the judgment of by Gordon J in Burness v Supaproducts Pty Ltd (2009) 259 ALR 339 (Burness), where the Court found that “where the third party payment is authorised by the debtor, nothing more is required. The debt is discharged by the third party at the request of or with the acceptance of the debtor”.
The decisions of the Court in Kassem and Burness suggest that payments by a bank to a creditor may fall within the scope of the unfair preference regime and, accordingly, may be subject to an attempt by a liquidator to claw back the payments.
Defences to an unfair preference
The Corporations Act provides creditors with a potential defence to an attempt by a liquidator to claw back a payment as an unfair preference.
Where a creditor receives a payment in good faith and where there are no reasonable grounds for believing the company is insolvent at the time of the payment, it is likely that the creditor will be able to avail itself of a defence to a liquidator’s claim.
The risk for creditors is where a bank guarantee is called upon after the appointment of an administrator or liquidator to the debtor as the creditor will have knowledge of the insolvency of that company at the time of the payment and will not be able to rely on that defence. Note that the key point is the time at which demand is made under the bank guarantee (not when the bank guarantee is issued).
Reducing the risk
Clearly, with any commercial arrangement the requisite prudent due diligence enquiries should be made of the counterparty before entering into the arrangement.
Bank guarantees are an effective form of security when the beneficiary under the bank guarantee is satisfied as to the financial viability of its counterparty.
While this update highlights that a bank guarantee is not entirely bulletproof, a bank guarantee is still a very effective form of security. The holders of bank guarantees need to be aware that there is still a risk that a bank guarantee may not be effective.
