Bank Guarantees in Australia: As Good as Cash?

In Short

The Situation: The recent decision in Lanskey Constructions Pty Ltd v Westrac Pty Ltd [2022] WASC 90 involved an application by a contractor for injunctive relief in relation to a call on its security. The case turned on the meaning of the bank guarantee clause in the construction contract, which entitled the principal to make a demand on the bank guarantees to meet a 'bona fide claim' arising out of or in connection with the contract. 

The Result: The court dismissed the contractor's application, but provided a helpful ruling on what constitutes a 'bona fide' claim for the purpose of a call on security. It set a low threshold for the test: all that is required is that the principal's claim be made in good faith, or in other words, that it bring the claim honestly with a 'proper or real foundation for the belief that it is or will be entitled to recover' the amount claimed.

Looking Ahead: A 'bona fide claim' test such as this is employed commonly in bank guarantee clauses. The ruling therefore provides certainty for parties that wish to include the test as part of their contractual arrangements. The decision also highlights that Australian courts will generally be reluctant to grant an interim injunction to prevent a call on security where doing so would interfere with the parties' agreed allocation of risk. For example, here, the court considered that the parties' intention was for the principal to have access to the security pending the determination of an underlying dispute. This was an important factor which swayed the balance of convenience against the grant of an injunction.

Bank guarantees are a common feature on construction projects. Most modern contracts require a contractor to give at least one unconditional bank guarantee to secure its performance of the works. This has given rise to a host of disputes over whether, and on what terms, a principal can have recourse to such security. However, as the recent decision in Lanskey Constructions Pty Ltd v Westrac Pty Ltd [2022] WASC 90 ("Lanskey Case") highlights, it is notoriously difficult in Australia to obtain an interim injunction preventing a principal from having recourse to a bank guarantee pending the determination of a dispute.

The Facts

The Lanskey Case concerned a project for the expansion of an industrial facility in Western Australia. The parties entered into a contract which provided that: 

  • The contractor was required to complete the project in various stages by 25 May 2021;
  • In the event of late completion, the contractor would be liable to pay liquidated damages; 
  • The contractor would give several bank guarantees as security to the principal;
  • The principal would be entitled to have recourse to the security to meet any bona fide claim that it had against the contractor arising out of, or in connection with, the contract.

Ultimately, the contractor achieved practical completion later than intended under the contact; completing the final separable portion on 25 June 2021. The principal claimed liquidated damages and reserved its rights in relation to the contractor's bank guarantees.

In response, the contractor filed an application seeking an urgent interlocutory injunction restraining the principal from calling on the security. It filed an affidavit in support deposing that, earlier in the course of the project, there had been an oral agreement between two senior personnel from the parties to the effect that 'no [liquidated damages] would apply whilst finalising the works' provided the contractor did not seek to recover delay costs from the principal. The contractor's affidavit exhibited several emails which tended to show that some form of oral agreement had been made between these personnel in that regard (although the emails were not entirely clear as to the precise terms of that agreement).

The contractor argued that: 

  • In light of the oral agreement, there was a strong prima facie case that it would be unconscionable for the principal to have recourse to the security; and
  • The balance of convenience favored the grant of an injunction because, if an injunction was not granted, the plaintiff would likely suffer reputational harm and increased borrowing costs associated with a call on its security.

The principal disputed the oral agreement and denied that it had waived any entitlement to claim liquidated damages. It also disputed that the balance of convenience favored an injunction, as it was open for the contractor to avoid the risks associated with a call on the security by paying the principal an amount equal to the value of the bonds.

The Ruling

At the outset, the court noted that, where an application is made to restrain a call on an unconditional bank guarantee, the general position is that the court will not restrain payment under the guarantee unless one of the three recognized exceptions to the rule are made out. Namely: 

  • Fraud;
  • Unconscionable conduct contrary to the Australian Consumer Law; or
  • A breach of a contractual promise to not call upon the bond.

The Lanskey Case concerned a claim under the third exception. It was therefore necessary for the court to interpret the phrase 'bona fide claim' within the contract's bank guarantee clause to determine whether the principal had sought to call upon the bank guarantees in accordance with the terms of the clause. The court construed the phrase to mean 'a demand made in good faith in relation to an amount due under the Contract', and thus, all that was required was that the principal 'honestly and genuinely believe it is entitled to recover the amount claimed under the Contract and that it is a genuine claim which is not fraudulent or untenable'. Although this was seen by the court as requiring more than a subjective belief as to the claim, it was enough for principal's claim to not be specious or fanciful.

Applying this threshold, the court held that: 

  • In order to find there was a strong prima facie case that the principal did not have a bona fide claim for liquidated damages, the court would need to be satisfied that an oral agreement had been formed as alleged, that such agreement prevented the principal from making any claim for liquidated damages, and that there was no serious argument to the contrary;
  • Although the principal did not file any evidence challenging the contractor's affidavit, the evidence led by the contractor deposed to the oral agreement in general terms only. It did not reveal the words used by either party or what the precise terms of the agreement were; and
  • As such, it could not be said on the evidence that the principal's claim for liquidated damages was lacking in bona fides, and the contractor had not established a strong prima facie case which warranted the grant of an injunction.

As to the balance of convenience, while it was unnecessary to rule on the issue given its findings above, the court accepted that there was a risk of the contractor suffering reputational damage and increased lending costs in the event its bank guarantees were called upon. However, the court considered that the balance nevertheless favored the principal for two reasons: 

  • As the principal had contended, it was open for the contractor to pay the principal the amount of the security in order to avoid those risks (in exchange for the return of its bank guarantees); and
  • There was no evidence to suggest that the principal would be unable to repay that amount if the contractor was ultimately successful.

Four Key Takeaways

  1. The Lanskey Case provides a clear interpretation of what constitutes a 'bona fide claim' in the context of a bank guarantee clause (wording which, in our experience, is used quite commonly in such clauses). The phrase requires that a claim be made in good faith, or in other words, that the party calling on the security bring the claim honestly with a 'proper or real foundation for the belief that it is or will be entitled to recover' the amount claimed.
  2. Although this case turns on its own facts, it highlights the difficulty involved with seeking to establish a lack of bona fides on an interlocutory basis to justify an injunction. Even here where the contractor's evidence of an oral agreement was uncontradicted, and tended to suggest that some agreement of the kind alleged had been formed, it was still unsuccessful.
  3. The decision also confirms that a defending party to an injunction application is not compelled to file responsive evidence. It remains the applicant's burden to evidence a strong prima facie case that warrants an interim injunction.
  4. This case continues a trend in which Australian courts have ruled against contractors in injunction applications on the balance of convenience. That question will always be fact sensitive. However, the decision demonstrates that if a bank guarantee is found to be a risk allocation device under a contract, the court will be reluctant to grant an injunction altering the agreed allocation of risk (even where the evidence shows that the contractor will likely suffer reputational harm from a call on its security).
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