Landlords’ right to call on a bank guarantee before a dispute is determined

The Victorian Supreme Court has recently confirmed that landlords cannot be restrained from calling on a tenant’s bank guarantee unless the tenant can show an arguable case that the landlord is acting:

1. fraudulently;
2. unconscionably in breach of consumer protection statutes;  or
3. in breach of a contractual promise not to call on the security.

In a recent online note available here, Allens Linklaters have provided a useful summary of Hollingsworth J’s decision in Otter Group Pty Ltd v Wylaars & Anor [2013] VSC 98.

The Court held that there was a serious question to be tried as to whether the tenant was in breach of its make good and other obligations.

However, in Hollingworth J’s words (at [17]):

The rationale for the general rule is that by providing for security to be given, the parties implicitly agree that the party giving the security deposit shall be out of pocket pending resolution of the underlying dispute.

The judgment leaves open the possibility of the lease containing a covenant to the opposite effect, although clear words would be required to displace the presumption (see paragraph [18]).  I am yet to see a lease that contains a covenant to this effect and a brief review of the authorities show only cases in which an injunction is refused.

As the note from Allens Linklaters suggests, landlords and their lawyers can take comfort from the decision.

It also gives a landlord who has called on the guarantee during a dispute about whether the tenant is in default a tactical advantage during negotiations because the tenant needs to win the case about the underlying liability and to recover from the landlord the amount called from the bank guarantee.

Lawyers acting for tenants should:

1. to avoid a rude shock at the end of the lease or when a default is alleged, advise their clients that the landlord normally has an unfettered right to call on the bank guarantee or bond, even if the tenant disputes the default. This does not appear to be widely known;
2. consider requesting an amendment to the lease that would prevent the landlord calling on a bank guarantee or bond in the event that there is a bona fides dispute over the tenant’s liability.  It would be interesting to see how that clause would be drafted and whether it would be accepted by many landlords;  and
3. consider whether a landlord, having called on the bank guarantee, actually gives the tenant a tactical advantage in a no-cost jurisdiction (like the retail tenancies list at VCAT).  For example, if the landlord alleges that the tenant has failed to make good to the value of $100,000, it may call on the bank guarantee for that amount.  If the tenant disputes that breach and sues for the $100,000 back, the landlord has nothing to gain from the litigation and faces a hefty legal bill in order to keep that money.  This, coupled, with good arguments to undermine the landlord’s right to keep that money, may be used to exert pressure on the landlord to settle the dispute.

Thanks to Joseph Rose of Rose Lawyers and John Byrne, John J Byrne Lawyer Pty Ltd, for passing the note from Allens Linklaters to me.