Personal Guarantees

The personal guarantee sounds from the banker's perspective to be such a simple document. The guarantor is simply agreeing to pay a debt when demanded and that as far as the banker is concerned should be the end of the issue. The Courts have, however, yet again reminded us in the form of the decision in GE Capital Commercial Finance Limited v Sutton and others [2004] EWCA Civ 315 of the need to be mindful of the separate and distinct legal relationships which are created when guarantees are taken. As well as considering this decision (which is significant for both banks and insolvency practitioners) in a little bit more detail, this issue of the Newsletter will also look at some of the other more familiar pitfalls associated with this form of security.

 

Most banks now operate on standard guarantee documentation which overcomes many of the legal problems associated with this type of security. In particular, the Unfair Contract Terms Act 1977, the Unfair Terms in Consumer Contracts Regulations 1999 (held in the decision of Bayerische Hypotheken - und Weshselbank AG v Dietzinger [1998] 1 WLR 1035, ECJ, to be applicable to a guarantee between a bank and a consumer) and the Consumer Credit Act 1974 (which now applies to all agreements entered into with a consumer where the value is up to £25,000). These issues are still however, worthy of review if one is faced with a trade related or bespoke document.

 

Even armed with a well drafted guarantee, it is still worthwhile bearing in mind certain of the fundamental legal principles when one is engaged at the sharp end in either taking the guarantee or attempting to enforce it.

 

The first issue, which is likely to be of key importance on enforcement, but which is settled from a factual stand point at the outset, is that of representations and statements. That is what is said by the banking staff to the guarantor in relation to the meaning of the legal document prior to the execution of the guarantee.

 

Most guarantees have been carefully produced so that they preserve the bank's ability to treat the guarantor as the primary debtor, and to recover from that guarantor notwithstanding any other action which the bank may either decide to take or not to take. Most businessmen, however, have a fundamentally different understanding of how the guarantee operates from that actually set out in the guarantee document which is signed by them. This is particularly so in relation to the issue of whether a bank is required to exhaust all recovery options against the principal debtor before pursuing the guarantee and also the treatment of any co-guarantors.

 

Despite the inclusion in most standard form guarantees of entire agreement clauses which prevent the guarantor from relying on pre-execution representations and a requirement that the guarantor take independent advice, such representations should still be avoided. The general law in this area is firmly on the side of the bank in relation to entire agreement provisions. See Inntrepreneur Pub Co, Inntrepreneur Pub Properties, Gamma Limited v Duncan Sweeney [2002] EWHC 1060 (Ch) and the decision in Watford Electronic Limited v Sanderson CFL Limited [2001] EWCA Civ 317. The Courts having held on both occasions that an entire agreement clause prevented a party to the contract relying upon any pre-contract misrepresentations. Notwithstanding this, one has to bear in mind that these cases were not cases relating directly to guarantors. In the case of a bank guarantee the Court is likely to take into account the uneven bargaining position of each of the parties. Like it or not, the Courts (particularly the lower Courts) will favour the guarantor.

 

Even where the bank requires the proposed guarantor to take independent legal advice (which is not a universal requirement), and the bank employs a standard letter of advice (which confirms that the guarantor has been told that he or she cannot rely on any pre-execution representations) there is always the factual issue of how this advice was given and how clear the explanation. The simple truth remains that if there were no representations by bank staff none of these points would be an issue.

 

While as a matter of law a guarantor can ultimately be prevented from relying on an argument that there was a misrepresentation or that proper pre guarantee disclosure (see below) was not provided, such allegations will always provide ammunition to a defence lawyer to prevent the bank from obtaining a summary judgement. This may ultimately force the bank to accept some form of compromise rather than risk significant costs in pursuing a guarantee claim through to full trial.

 

In strict theory, the bank has very limited obligations to guarantors in relation to pre guarantee execution disclosure. The classic statement of law in relation to the obligation on the bank is set out in the Hamilton v Watson (1845) 12 Cl & Fin 109. This lays down that unless the guarantor asks for information there is no obligation to supply it. This general principle has been whittled down to the point where it is certainly best practice to ensure that the guarantor is aware of the nature of the facility which he or she is being asked to guarantee, and any information which is known to the bank which would be considered to be relevant to a person when deciding whether or not to provide a guarantee. See in this regard Levett v Barclays Bank PLC [1995] 1WLR 1260.

 

When disclosing information to a guarantor about the principal debtor's account in order to meet the requirements highlighted by cases such as the Levett decision, one needs to be mindful of the separate legal identity of the guarantor and the customer. The Bank should always seek to obtain the consent of the customer before any information is released. See Lloyds Bank Limited v Harrison (1925) 4 LDAB 12.

 

It is this need to recognise the continuing separate legal identity of the guarantor and the principal debtor that was picked up by the Court in the GE Capital case.

In that case the administrative receivers were criticised by the Court for simply complying with a request by a guarantee holding bank to release information which the guarantee holding bank required for the purposes of pursuing a party who had guaranteed the obligations of the company in administrative receivership.

 

The Court pointed out in that case that the administrative receivers should have considered whether or not the release of the information was in the interests of creditors as a whole. This Court when coming to this conclusion applied the legal fiction that the administrative receivers are agents of the company rather than of the bank (notwithstanding that they would have been appointed in reality by the bank).

 

Clearly in the case of an administrator (even if appointed at the request of the bank), the administrator would have no justification whatsoever for automatically releasing documentation to the bank in such circumstances. The administrator certainly owes no special or primary obligation to such a bank.

 

Guarantees therefore, continue to be a useful form of security available to the bank. What is clear, however, is that adherence to the above principles will greatly assist in the recovery process and more particularly reduce the prospects of the bank being delayed in its recovery efforts, or needing to incur disproportionate costs in relation to that process.