Unconditional bank guarantees

Unconditional bank guarantees are sometimes used in construction contracts as security for a contractor's performance. They are seen to be useful because they provide the holder of the bank guarantee with a ready source of cash. To access that cash, all that the beneficiary has to do is to go to the relevant bank and demand the money. There is no need to show that the contractor was actually in default.

Even though default does not have to be shown before the security may be called up, the purpose of a contractor providing an unconditional bank guarantee is to secure the owner against the contractor's default. For example, if a massive defect appears in a building under construction, and the contractor does not fix it, the owner may want to access funds quickly to pay someone else to rectify the problem and get the project completed. An unconditional bank guarantee can provide a ready source of cash for this to occur.

But what if the contractor takes the view "It wasn't my fault. The defect appeared for reasons that have nothing to do with me". The contractor may feel aggrieved if the owner goes off to the bank and collects the proceeds of the unconditional bank guarantee. The contractor may feel that it has done nothing wrong, even though the owner takes a different view about where the blame lies. Why should the contractor's cash flows take a hit when it is not responsible for the damage to the building?

What happens quite commonly is that when an owner tries to call up an unconditional bank guarantee, the contractor who supplied it will race down to court and seek an injunction to restrain the owner from making or pursuing the demand. If, however, the owner has already got the money in its pocket, the contractor may seek an order that the money be frozen, so that the owner cannot use it.

When the matter goes before the Court (on an urgent basis), the judge will usually have a very limited amount of evidence before him or her about the dispute, with the parties at loggerheads as to whether the contractor was in default, and whether the owner was entitled to call upon the bank guarantee. And yet the Court will be required to make a decision very quickly as to what happens to the unconditional bank guarantee and/or its proceeds pending final resolution of the matters in dispute (which may be resolved months or years later). Bank guarantees may also be for very large amounts of money - sometimes millions of pounds.

How do the courts resolve these disputes? What criteria do they apply in deciding whether to grant an injunction against an owner with an unconditional bank guarantee in its hands? To view an article which discusses these matters, please click here.

For further information, please contact Julian Bailey at [email protected] or on +44 (0)20 7367 2057.