Can a Bank Guarantee be relied upon when it was procured by the fraud of a third party?

In this case an investor was duped into making out a bank guarantee to a third party on the understanding it would not be cashed and would in effect be held in trust by the fraudster.

In Yu v Brownvalley Investments [2010] NSWSC 253 Brownvalley agreed to loan $552,000 to Golden Harvests, secured by a bank guarantee. Yu separately agreed with Golden Harvests to obtain a $500,000 bank guarantee made out to Brownvalley – in the belief that the guarantee was for the purpose of evidencing their financial capacity only, and that an intermediary would retain the original so that it could not be cashed.

Despite Yu’s understanding that he would retain the original bank guarantee, in fact, the original bank guarantee was delivered to Brownvalley by Golden Harvest. Golden Harvests defaulted on the loan from Brownvalley and Brownvalley presented the guarantee to the bank and demanded payment. There followed negotiations during which the original guarantee was replaced pending resolution of the dispute.

Yu sought, a perpetual injunction restraining Brownvalley and CBA from calling on and paying the fifth guarantee. The main issues before the court were:

  1. Was delivery of the original bank guarantee to Brownvalley authorised?,
  2. if not, was Brownvalley entitled to the benefit of that guarantee?, and
  3. Can the replacement guarantee be enforced at the suit of Brownvalley?

1. Was delivery of the original bank guarantee to Brownvalley authorised?
The evidence accepted by the judge was that Yu was hoodwinked as follows:

Mr Atkins told him that CBA would not allow his company to obtain as bank guarantee in favour of itself (as had originally apparently been envisaged), but that Golden Harvests had arranged for National Australia Bank’s trading corporation, Brownvalley, to provide the credit line for the Private Placement Programme, and that Antler needed to procure a bank guarantee of US$500,000 in favour of Brownvalley, the original of which Antler would continue to hold for safe-keeping, with only a coloured copy to be given to Brownvalley. “As long as you hold the original bank guarantee, Brownvalley nor anyone else can redeem the bank guarantee”, said Mr Atkins.

Accordingly on this point His Honour held:

At the very least, therefore, Mr Atkins exceeded his actual authority by delivering the original bank guarantee to Mr Snelson. Nor in my judgment did Mr Atkins have ostensible authority to deliver the bank guarantee to the favouree. It is true that he was in a sense “armed” with the bank guarantee, but it is well-established that merely entrusting a person with the muniments of title is not of itself enough to give that person ostensible authority to deal with the title; for such circumstances to create apparent authority there must be something more – some indication of authority to deal with the subject matter over and above mere possession. In any event, Brownvalley did not receive the original guarantee from Mr Atkins, but from Mr Snelson, of Golden Harvests, who certainly had no actual authority to deliver it to Brownvalley, and there was no act of holding out by the plaintiffs to give Mr Snelson ostensible authority to do so. It follows that the delivery of the original guarantee to Brownvalley was unauthorised. What then are the consequences?

2. Was Brownvalley entitled to the benefit of that guarantee?
This turned upon the characterization of the guarantee, with His Honour holding:

Notwithstanding that as a matter of commercial practice, a bank guarantee is frequently treated as if it were equivalent to money, it is not money, any more than is a cheque or a bill of exchange: it is a promise to pay upon certain conditions being satisfied. And a bank guarantee is not a negotiable instrument; it operates only in favour of the favouree. Because it does not have the quality of negotiability, it is not akin to a cheque. It follows that receipt by the favouree of a bank guarantee does not automatically entitle the favouree to the benefit of the guarantee, but does so only if it is delivered by the true owner (or its duly authorised agent). Thus, whether or not Brownvalley acquired a good legal title depends upon whether the immediate prior possessor (relevantly Mr Snelson) had title or right to transfer it. It follows from the above that Mr Atkins, and a fortiori Mr Snelson, had no such authority. Thus because the guarantee was not delivered by the true owners or their authorised agent, Brownvalley never acquired legal title to it.

3. Can the replacement guarantee be enforced at the suit of Brownvalley
Here Yu fell down on the basis of the legal advice (or lack of it) that they had at the time of providing the replacement guarantee, with His Honour holding:

In distinction from the initial guarantee, Yu executed the second and subsequent guarantees knowing and intending that they be delivered to Brownvalley, as they were. No question of irregularity in their delivery arises. The fifth guarantee, which is that now presented and relied on by Brownvalley, was regularly received from the true owners.

There is no evidence of any agreement or understanding that the replacement guarantees were “without prejudice”, that the rights of the plaintiffs in respect of the initial guarantee were to be preserved. Essentially, in return for a deferral of the risk of their exposure, the plaintiffs gave a new guarantee. In so doing, they entertained some hope that the moneys would be recovered and the problem dissipate as a result, but nonetheless appreciated that they were confirming a solemn and important undertaking.

There is no basis for impugning the enforceability of the fifth guarantee, or for restraining Brownvalley from making demand under it, or CBA from paying on it.

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