Can You Guarantee It?29 June 2010 Beverley Bentley
Funders are leaving themselves open to losing out when they unwittingly release guarantees made by commercial customers. Beverley Bentley, a partner in the banking team at law firm Halliwells LLP, examines how banks and other funders can rectify the situation.
As funders well know, many guarantors will look for ways to set aside or at least reduce their obligations in the event that a guarantee is called upon.
One way in which a guarantor who has not given an 'all monies' guarantee might seek to attack the enforceability of its guarantee is to argue that the underlying contract (i.e.the loan agreement) has been varied in such a way as to have the effect of releasing the guarantor from its obligations.
The basic rule here, established in Holme v Brunskill (1878) is that a (material) variation of the principal underlying contract may discharge a guarantee if the variation occurs without the consent of the guarantor.
Over the years, much case law has been built on this topic with the result that most 'standard form' guarantees used by banks and other institutional lenders contain wording which provides that the guarantor, in signing the guarantee, consents in advance to any variation to the loan agreement no matter how fundamental. This clearly provides a certain degree of comfort to a funder but by no means puts a guarantee beyond challenge.
The well-known case of Triodos Bank NV v Dobbs(2005)saw the decisionthat a clause in a guarantee, which provided that the bank could agree to any variation of the obligations of the principal debtor, was not sufficient to protect the bank where the original loan agreement had been replaced by a substantially different document, in circumstances where the amount of the loan made available to the principal debtor had been increased. (Notwithstanding that the guarantor was, in fact, aware of the new loan facilities and had not objected to them.)
The Triodos case is a reminder that if a funder is amending any terms of the underlying loan agreement in circumstances where its guarantee purports to contain a consent to amendments made to that loan agreement, it needs to be satisfied that the amendments being made are actually within the scope envisaged by the guarantee.
The recent case of Bank of Scotland Plc v (1) Constantine Makris (2) Ben O'Sullivan (2009) considered the validity of a guarantee following an amendment to the underlying loan agreement in circumstances where the amount of the loan was actually reduced (as a result of the principal debtor's inability to comply with the initial loan pre-conditions, the bank felt that its security package was not sufficient to support the loan facility at its initial level). Makris argued that the reduction in the amount of the loan facility was a material variation of the underlying principal contract, which had the effect of discharging the guarantee. While the court accepted and re-iterated the basic rule in Holme v Brunskill, Makris' arguments were rejected on the grounds that the reduction in the amount of the loan facility was not a variation of the contract but represented a new offer of a reduced amount on different terms and that the guarantee was wide enough to catch this liability. It should be noted that Makris had, in fact, co-signed the revised loan agreement, which the court took as evidence of his consent to the reduced amount of the facility.
What are the implications?
If a funder has made facilities available in circumstances where a guarantee has been given in respect of all or any part of those facilities, the ability of a guarantor to escape liability under that guarantee could result in funders being left without security or even a valid recoverable debt from anyone other than the primary debtor.
This is simply because when a guarantee is unenforceable, any security granted by the guarantor is highly likely to be unenforceable too. The security taken by most funders will only secure the debt owed by the guarantor - which comes into existence via the guarantee itself - and hence if the guarantee obligation falls away, there is no debt to secure.
Why is this of particular concern now?
During the past two years or so we have seen, for whatever reason, a decrease in long-term committed facilities and an increase in short-term funding, with a corresponding need to renew or replace those short-term facilities upon expiry, and also an increase in existing facilities being amended, perhaps as a result of covenant breaches etc. Many funders, when agreeing the terms of such renewed, replaced or amended facilities will check they took a guarantee for the original facility and will assume that the guarantee will remain enforceable in respect of the renewed, replaced or amended facilities, although clearly this assumption should not be made without any further verification.
What is the solution?
If in any doubt as to whether an existing guarantee can be relied upon for a new, replaced or amended facility, a funder should check the terms of that guarantee and consider the following options, preferably after seeking the advice of its lawyers. Firstly, ask the guarantor to expressly confirm consent to all of the amendments being made to the underlying contract. This could be achieved by the guarantor becoming a party to the amended facility agreement and confirming its consent in that way, by signing a detailed consent letter or by executing a more formal deed of confirmation to confirm that, notwithstanding any amendments to the facility agreement, the guarantee remains valid and enforceable in respect of the primary debt. Alternatively, a funder could take an entirely new guarantee from the guarantor, perhaps retaining the existing guarantee as a protection against the new guarantee being challenged under the provisions of the Insolvency Act 1986.
In each of the options referred to above, the funder will need to satisfy itself that the directors of corporate guarantors have concluded that sufficient corporate benefit will accrue to justify the consent being granted or the guarantee being entered into. Funders are also advised to ensure that the guarantor has been independently advised and that any potential issues of undue influence have been considered (in the case of personal guarantors).