Tenant solvency issues have always been a risk for commercial landlords to consider, but the unprecedented fears surrounding the default of tenants that landlords experienced during the COVID-19 pandemic brought this risk to the forefront like never before.

This risk has long been, at least partially, mitigated by accepting security in the form of a bank guarantee prior to engaging in a lease. A bank guarantee is considered as good as “cash in the bank” given that it is the bank’s money being paid in the event the guarantee is called upon.

But is this always the case? Can you cash, and keep, a bank guarantee if a tenant goes into voluntary administration or liquidation?

Corporations Act 2001 (Cth) - Restriction

Section 588FA of the Corporations Act 2001 (Cth) (the “Act”) provides a restriction which states that a transaction can be considered an “unfair preference” given by a company to a creditor of the company if the transaction satisfies the following two conditions:

the company and the creditor are parties to the transaction (even if someone else is also a party); and
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.

If both criteria are satisfied, the creditor may be liable to have to repay the funds it received in the “unfair preference” transaction to the company’s external administrator. If both criteria are not satisfied, then the transaction cannot be considered an “unfair preference”.

With these criteria as a guideline, to determine whether a transaction will be one of “unfair preference” requires that two key points be considered:

can a bank’s payment of a tenant’s debt to a landlord be considered a transaction of the debtor (in this case, the tenant) to satisfy the first condition?
if so, is a payment by a bank to a landlord pursuant to a bank guarantee a payment received from the tenant?

First Condition

The Federal Court of Australia[1] has determined that a transaction for the purposes of section 588FA of the Act will still be considered a transaction regardless of whether payment was received from a third party on behalf of the debtor. The transaction is the totality of the dealings initiated by a debtor to extinguish the debt, irrespective of whether part of the dealings in the debt repayment sequence does not involve the debtor but does require the involvement of a third party.

The first condition of section 588FA will therefore be satisfied in a landlord’s calling on a bank guarantee, as the company (tenant) and the creditor (landlord) are both parties to the transaction, even if a third party (in this case, the Bank) is required to extinguish the debt.

Second Condition

To establish that a transaction is an “unfair preference” given by a company to a creditor of the company, it is not enough to simply establish that both the company and the creditor are parties to the transaction. It must also be clear that the payment is from the company's assets, whether that be by way of redirecting money owed by debtors of the company[2], or from its own funds[3].

Conclusion

Could a bank guarantee be considered a payment from a company’s assets?

The title of “bank guarantee” is slightly misleading in this regard. It is not a guarantee that the tenant has the amount noted on the guarantee present in its account, or that the money under the guarantee will be coming from the tenant’s funds.

A bank guarantee is essentially a performance bond given by a bank. It is a promise that the bank will pay, out of its own funds, a guaranteed amount of money if called upon to do so. In the case of a tenant and landlord, the money cannot be considered to be part of the assets of the tenant when the money paid under the bank guarantee comes from the funds of the bank.

For this reason, the payment of funds under a bank guarantee to a landlord who has called on the bank guarantee is:
(a)   not a payment which a landlord receives from the tenant company;
(b)   would not satisfy an essential element of section 588FE of the Act; and
(c)   would not be recoverable by an external administrator of the tenant company as an unfairly preferential transaction.
For any leasing enquiries, please contact leasing@terraconlegal.com.au

For any insolvency or litigation enquiries, please contact Harry Kay at harry@terraconlegal.com.au