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Part E Guarantees and Security, 26 Guarantees

From: The Law and Practice of International Banking (2nd Edition)

Charles Proctor

Content type:
Book content
Product:
Financial Law [FBL]
Published in print:
01 March 2015
ISBN:
9780199685585

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: null; date: 06 June 2023

Subject(s):
Regulation of banks

(p. 529) 26  Guarantees

Introduction

26.01  The present chapter is designed to provide a brief overview of the law of guarantees as it applies in a banking context.

The selection of topics considered in this chapter is as follows:

  1. (a)  the purpose, definition and characteristics of a guarantee;

  2. (b)  the formal requirements applicable to the creation of a guarantee;

  3. (c)  the distinction between a guarantee and an indemnity;

  4. (d)  the interpretation of, and liability under, a guarantee;

  5. (e)  the application of legislation on unfair contract terms;

  6. (p. 530) (f)  the rules applicable to individual and corporate capacity;

  7. (g)  the duties of the bank to the guarantor;

  8. (h)  the discharge of the guarantor;

  9. (i)  certain vitiating factors;

  10. (j)  termination by the guarantor; and

  11. (k)  the rights of the guarantor following payment.

Purpose, Definition, and Characteristics

Purpose

26.02  First of all, what is the purpose of taking a guarantee? The main answer to this question is obvious. The lending bank is looking for additional recourse in the event that the primary borrower is unable to repay. Yet the requirement may flow from the manner in which the customer chooses to organize its business. If a company maintains all of its assets under a single corporate ‘roof’, then that entity will be the borrower and no guarantees will be needed. If, on the other hand, a parent company chooses to organize its businesses and assets through a variety of subsidiaries, then its creditworthiness may depend on a group, cross-guarantee structure.

26.03  There may even be cases where it is favourable to the borrower itself to provide a guarantee from its parent company. For example, a particular subsidiary may be regarded as sufficiently creditworthy on its own. But, if the parent has a higher credit rating, then the provision of a parent guarantee may mean that the bank is able to dedicate a reduced amount of its capital to the transaction. This, in turn, may mean that the cost of the facilities can be reduced, to the benefit of the borrower.1

Definition

26.04  A guarantee may be defined as a contract by which one person (the ‘guarantor’) agrees to answer for a liability of another person (the ‘borrower’ or ‘principal debtor’) to a third person (the ‘creditor’).2

26.05  It has been more fully defined as ‘…an accessory contract by which the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promisee must exist or be contemplated…’.3

Characteristics

26.06  In view of the definitions given above, a guarantee necessarily connotes an overall arrangement between three parties, even if established by separate contracts. A guarantee involves one party assuming responsibility for a debt in the event that a primary obligor fails to perform. Consequently, the principal debtor cannot stand as surety for (p. 531) his own obligations,4 nor can the creditor stand as the guarantor for the moneys owing to him.5

26.07  But what are the other characteristics of a guarantee? The classification of the obligation may be important for, as will be seen, a guarantee is only enforceable if it has been reduced to writing,6 and a guarantor may be able to avail himself of defences which are peculiar to the contract of guarantee.7 Whether or not a contract falls to be characterized as a guarantee does not depend solely upon the use of terminology,8 it depends upon the substance of the obligations which the parties intended to undertake.9 It would thus appear that a contract should be classified as a guarantee if it is apparent from its terms that, in favour of the creditor, the obligor intended to assume responsibility for the performance of an obligation of the principal debtor in the event of a default.10

26.08  It should also be appreciated that an arrangement may be a guarantee if the party concerned provides assets by way of third-party security, where the lender’s recourse is limited to the security package and the chargor gives no personal undertaking to pay.11

26.09  Various consequences flow from this characterization. A guarantor does not merely undertake to perform an obligation in place of the principal debtor if necessary; in effect, he undertakes to procure that the primary obligor will perform.12 As a result, a guarantor of a principal sum will often have to cover interest flowing from the debtor’s breach, even if the document does not expressly render the guarantor liable for such amounts.13

Formalities

Introduction

26.10  It has already been noted that a guarantee is a form of contract. As a result, an arrangement will only constitute an enforceable guarantee if it satisfies the general requirements (p. 532) for a valid and binding contract. It is not proposed to examine all of these requirements in detail,14 rather, it is intended to deal with those issues which can be of particular difficulty in the context of guarantees given to banks.

26.11  As will be seen, guarantees are subject to additional requirements over and above those applicable to ordinary contracts.

Offer and Acceptance

26.12  The existence of an offer and its acceptance are fundamental to the existence of a contract.

26.13  In the context of a guarantee given to a bank, the executed guarantee will usually be delivered to the bank, thus constituting the offer. The receipt and retention by the bank of the document proffered to it may constitute the acceptance; alternatively, acceptance may occur when funds are advanced in reliance on the guarantee.15

Consideration

26.14  If a guarantee is to be contractually binding, then the bank must give consideration for the guarantor’s promise.16 In most cases, this requirement is satisfied because, in return for the guarantee, the bank will agree to advance funds to the borrower.17 In other cases, a guarantee may be given in consideration of the bank deferring a demand for repayment against a borrower who has run into financial difficulties.18

26.15  As a matter of practice, standard forms of bank guarantee provide for execution as a deed, thus obviating the need to prove consideration in a more positive way.19

(p. 533) Intention to Create Legal Relations

26.16  A guarantee is only legally binding if the parties intended to create a legally enforceable relationship.20 Standard forms of documentation will be used which will make it plain that a formal relationship is contemplated; the loan agreement or facility letter will make it clear that the guarantee is a condition precedent to the obligation to lend, thus emphasizing the importance attached to its legally binding character as a part of the overall transaction.

26.17  Inevitably, however, difficulties may arise where the (alleged) guarantee is given in ‘non-standard’ circumstances. In such a case, it may be necessary to examine carefully the terms of the document and the circumstances surrounding its conclusion. In this respect, ‘letters of comfort’ are sometimes encountered, which do not contain the language usually seen in standard guarantee documentation. Such letters do not explicitly guarantee the payment obligations owing to the bank; they will instead contain obligations of a much more nebulous nature (eg ‘…it is our normal policy to ensure that our subsidiaries have adequate resources to meet their obligations as they arise…’). If a letter of comfort was given in lieu of a guarantee for specific reasons (eg because a full guarantee would have required exchange control approval in the obligor’s jurisdiction), then the court is likely to conclude that the parties did not intend to create a legally binding guarantee.21 Furthermore, where a comfort letter is provided for a particular and limited purpose known to all parties, that may be a relevant factor in deciding whether a binding legal relationship was intended to be created.22 It does, however, remain open to the court to conclude that the parties intended to create a contractual obligation of some form, albeit falling short of a guarantee in its fullest sense. For example, if a parent company undertakes to notify the lending bank of any proposal to dispose of the borrowing subsidiary, it may be liable in damages if it fails to comply with that undertaking, since the lender may have continued to provide funding on a false premise. In other words, the choice does not lie between a fully enforceable guarantee and a void document; a range of legally valid obligations can exist in the area between those two extremes.23

(p. 534) 26.18  In the writer’s experience, letters of comfort in the loose sense described above are less frequently encountered in modern banking practice.24 There may be technical reasons for this state of affairs; for example, if the lending bank wishes to account for the risk-weighted asset by reference to the guarantor’s credit standing, then the guarantee must be an enforceable and unequivocal document.25 But quite apart from that, banks will be disinclined to accept such diluted undertakings in an era of tight credit conditions.

26.19  On a separate but related point, it has occasionally been argued that the guarantors executed the guarantee subject to some form of condition subsequent (ie the legal relationship was in effect ‘suspended’ until the condition was met). For example, it may be asserted that the guarantee was only to become effective once the borrower had executed an agreed form of security. However, the courts are unlikely to imply such a condition subsequent from the surrounding circumstances, and such a condition would thus only have formal effect if clearly communicated to the bank.26

Requirement of Writing

26.20  Most contracts can be made orally and without any requirement for the contract to be reduced to writing; the agreement will remain enforceable provided that its terms can be proved by evidence and the other criteria for the creation of an enforceable contract have been met. In the case of a contract of guarantee, however, this rule is varied by the surviving provisions of the Statute of Frauds 1677. Section 4 provides that:

…no action shall be brought…whereby to charge the defendant upon any special promise to answer for the debt, default or miscarriage of another person…unless the agreement upon which such action shall be brought, or some memorandum or note thereof, shall be in writing and signed by the party to be charged therewith or some other person thereunto by him lawfully authorised. …27

26.21  The Statute does not state that the guarantee is void, but merely provides that it cannot be enforced in the absence of written evidence and a signature by the guarantor or his agent.28 (p. 535) The provision is thus apparently of a procedural character,29 with the result that the principle has been applied by the English courts in cases involving a guarantee governed by a foreign system of law.30 The importance of this point in a cross-border context has, however, been diminished by Rome I, which allows that the existence of a contract can be proved by reference to the laws of various different countries with which the contract has a connection; the matter is thus no longer assigned exclusively to the procedural law of the forum.31

26.22  Nevertheless, the fact that the guarantee may be unenforceable (as opposed to absolutely void) may have practical consequences. For example, if the guarantor is also a depositor with the beneficiary bank, then the bank may be able to exercise a right of set-off. When the guarantor sues for the repayment of the deposit, the bank could plead the obligation under the guarantee by way of defence. This would not offend section 4, since the bank is not ‘bringing an action’ for the purposes of that provision.

26.23  But it remains necessary to ask: what will constitute a sufficient ‘memorandum’ for the purposes of section 4 of the 1677 Act? It seems clear that the requisite signature must be appended to a document which sets out all of the core terms of the guarantee32 so that, as a minimum, the memorandum must identify the principal debtor and the arrangements in respect of which the guarantee is given. It must also make clear the guarantor’s intention to answer for the relevant obligations in the event of the borrower’s default. Extrinsic evidence cannot be admitted to fill in the gaps in an otherwise inadequate memorandum, since this would defeat the objectives of section 4. Nevertheless, such evidence may be admissible to explain the terms of the memorandum against its factual background. Thus, if the section 4 memorandum refers to ‘proposed leasing arrangements’ between the principal debtor and the financier, then other evidence can be admitted to identify the arrangements to which the memorandum was intended to refer.33

(p. 536) Guarantees and Indemnities

Introduction

26.24  Although the issue now arises only occasionally in modern banking practice, it is necessary to make a few observations on the distinction between a guarantee and an indemnity.34 The distinction between the two types of arrangement has been described35 as follows:

An indemnity is a contract by one party to keep the other harmless against loss, but a contract of guarantee is a contract to answer for the debt, default or miscarriage of another…

Distinction between Guarantees and Indemnities

26.25  The above quotation highlights the reason for the peculiar quirk in English law created by section 4 of the Statute of Frauds 1677.36 In order to enforce an indemnity, it is merely necessary for the claimant to show that he has suffered a loss falling within the scope of the indemnity agreement. It is unnecessary to attribute that loss to the default of a third party and section 4 accordingly has no application to such an arrangement. An oral indemnity is thus enforceable on the same footing as any other contract.37 A guarantee is, however, necessarily a secondary obligation, and its enforcement depends upon the existence of an unsatisfied obligation on the part of the primary debtor. Accordingly:

  1. (a)  as already noted, a guarantee is only enforceable if reduced to writing and signed by or on behalf of the guarantor;

  2. (b)  the obligations created by a guarantee (strictly so called) can only be enforceable if the guaranteed party has indeed been guilty of a default in respect of the underlying obligation concerned. Consequently, if that obligation is not enforceable, then there is no ‘default’ to which the guarantee can apply or which can justify a call under it,38 a debtor cannot default on an obligation which does not legally exist. Equally, if the underlying obligation has been fully discharged by the primary debtor in accordance (p. 537) with its terms, then the guarantor will likewise be fully discharged without further act or payment on his part;39 and

  3. (c)  the distinction can be of further importance in that the special defences available to a guarantor40 are not generally available in relation to a contract of indemnity.

26.26  Standard forms of bank guarantee will attempt to create both a guarantee and an indemnity, and will confirm that the guarantor assumes the role of principal debtor and thus remains liable notwithstanding the unenforceability of the underlying debt obligation.41 In principle, such provisions should be enforceable because the character of the agreement—ie whether it should be classified as a guarantee or indemnity or as a primary or secondary obligation—depends on the true construction of the words used.42 Nevertheless, banks should remain astute to ensure that guarantees comply with section 4 of the 1677 Act,43 because a court may hold that ‘principal debtor’ and ‘indemnity’ language are merely subsidiary clauses in a document whose overall effect is intended to be that of a contract of guarantee.44 It is thus important that the document should make clear that a full indemnity against loss is intended.45

26.27  The durability of this antiquated section has recently been confirmed by various recent decisions. In particular, the House of Lords has decided that the principle of estoppel cannot be invoked against a guarantor so as to prevent him from relying on the protection intended to be afforded to him by this provision.46 Attempts to enforce guarantees have also failed in various cases as a result of the section.47

26.28  The procedural nature of the provision does give rise to some potentially difficult questions, because the offending guarantee remains a valid obligation, even though it is not enforceable by action. Consequently, if the guarantor happened to have an account with the lending bank, the lender may be able to make demand and to debit the account with amounts owing under the guarantee even though it does not comply with section 4. If the guarantor sued for repayment of his deposit, then the bank may plead its right of set-off by (p. 538) way of defence. This would not seem to offend section 4, since the proceedings have not been instituted by the bank.48

26.29  Counter-intuitive though this may appear, it has occasionally been in the interests of an obligor to argue that the document he has signed does indeed amount to a guarantee. On that basis, he has then sought to argue that he is not liable to the beneficiary of the document on the basis that the underlying obligations are not enforceable or have been materially varied.49 In Sutherland Professional Funding Ltd v Bakewells,50 the defendant law firm had entered into arrangements under which Sutherland would provide loans to the firm’s clients to enable them to pursue personal injury claims. The loan agreements proved to be unenforceable as a result of non-compliance with various requirements of the Consumer Credit Act 1974.51 Under the arrangements between the law firm and Sutherlands, the law firm agreed to make the required repayments to Sutherlands ‘in the event of any breach of the Loan Agreement by the Borrower or in the event that the Loan Agreement is unenforceable against the Borrower’. The court held that this language did not create a guarantee because the law firm undertook to pay Sutherlands if the underlying agreement was unenforceable. This was inconsistent with the very nature of a guarantee and—although the court did not use the expression—the language reproduced above thus took effect as an indemnity against loss. The payment obligation was thus enforceable against the law firm.

Interpretation and Liability

Introduction

26.30  It has been noted earlier that, historically, the courts have tended to be protective of guarantors. It has also been shown that standard forms of bank guarantee will seek to deprive the guarantor of that protection in many cases. This state of affairs gives rise to various issues, namely, (i) how will the court approach the interpretation of guarantees, (ii) the nature and extent of the guaranteed liabilities, (iii) the essential validity of a guarantee, and (iv) the nature of the guarantor’s liability.

Interpretation

26.31  A guarantee is a form of contract and is thus subject to the ordinary rules applicable to the interpretation of commercial agreements. The document must therefore be construed as a whole, having regard to the circumstances known to the parties at the time of its conclusion.52 The key question will usually be: what is the nature and extent of the indebtedness which is covered by the guarantee? Two points may be briefly noted:

(p. 539)

  1. (a)  standard forms of bank guarantee will often provide for the guarantor to cover all of the obligations from time to time owing by the primary debtor.53 It should be made clear that the guarantee extends to obligations owed jointly with others and (if such be the intention) that it extends to obligations which the primary obligor himself owes as surety for the debts of another;54 and

  2. (b)  if the guarantee relates to the indebtedness of the primary obligor in respect of ‘banking facilities’, it is submitted that this should include obligations in respect of bonds, guarantees, bills of exchange, and similar instruments issued or accepted by the bank, as well as overdrafts and other advances.55

26.32  This straightforward approach to contractual interpretation must nevertheless be treated with care in the context of guarantees given to banks. There are two, related reasons for this cautionary statement. First of all, the court’s approach to questions of interpretation will inevitably be coloured by the traditionally protective attitude towards guarantors. Secondly, bank guarantees are almost invariably provided on the bank’s own standard form, with the result that any ambiguities in the meaning of the document should usually be resolved in favour of the guarantor.56 But in spite of these considerations, courts have admitted evidence to clarify both the scope of the liabilities intended to be covered by a guarantee, and the existence of any preconditions to the enforcement of the document.57 Importantly for the bank, and in the absence of an express term, the bank can usually make a demand as soon as a default occurs, and the court will not generally imply any pre-conditions to payment (eg such as an obligation on the bank to enforce other security before having recourse to the guarantee).58

26.33  It must be said that—in commenting on the correct approach to the interpretation of guarantees—there is an obvious tension between the assertion that ordinary contractual principles of interpretation apply and the court’s defensive approach to the position of a guarantor. There are, however, signs that the courts are seeking to place the contract of guarantee on the same footing as any other commercial contract, and are moving away from the broader desire to protect a guarantor. In the broader commercial context, the courts will now look to ascertain the common aim or intention of the parties against the background of the information available to the parties at the time the agreement was made.59 Thus, where a company director gave a guarantee covering ‘the whole debt’ of his company, the natural (p. 540) meaning of this language to a person familiar with the background would have extended to both past and future indebtedness, and would not have been restricted to liabilities arising from future transactions only.60

The Guaranteed Liabilities

26.34  It will also be necessary to determine precisely the nature and extent of the obligations which the guarantor has agreed to cover. This will not usually cause any great difficulty where—as is commonly the case—the guarantee relates to ‘…all sums from time to time owing by the principal debtor on any account whatsoever…’.61

26.35  But the point will not always be so straightforward, and banks need to exercise some care in this field. The problem is well illustrated by the decision in Triodos Bank NV v Dobbs.62 The bank had entered into two loan agreements in 1996 with a company called Acorn Televillages Limited. Mr Dobbs was a director of Acorn and gave a guarantee of certain monies owing ‘…under or pursuant to…’ those loan agreements. The bank subsequently entered into new loan agreements (described as ‘replacements’) with Acorn in 1998. The agreements were further replaced in 1999 and the overall amount available for utilization was significantly increased. Unfortunately, the bank omitted to take fresh guarantees from Mr Dobbs. The Court of Appeal seems to have taken the view that the 1996 guarantee would have extended to any ‘amendments or variations’ to the original facility agreements. However, the court then went on to observe:63

The question is then whether what is said to be an amendment or variation is correctly so called. To my mind, an agreement which truly ‘replaces’ the original loan agreement would not rightly be called an amendment or variation to the original agreement, since it will be a new agreement. This will be particularly true in the context of a guarantee which obliges the guarantor to pay sums falling due ‘under or pursuant to’ an earlier agreement. For this purpose, it does not matter whether the old agreement is discharged in the sense of the loan being fully repaid and a new agreement then made (in the technical sense of their being a novation) or whether there is a replacement agreement which is, for the future, treated as governing the parties’ relationships. The new governing agreement is not the agreement ‘under or pursuant to’ which there falls due the money which the guarantor has guaranteed to pay…

26.36  It is also necessary to emphasize that (i) the identity of the intending guarantor must be clear and (ii) the guaranteed liabilities must be the liabilities of the person identified in the guarantee as the principal or primary debtor. Again, these questions of identification may appear to be obvious point but confusion can occur, especially in relation to groups of companies which may have very similar names.64 A problem of misnomer (p. 541) arose in Dumford Trading AG v OAO Alantrybflot.65 In that case, ZAO Alantrybflot was a subsidiary of OAO Alantrybflot.66 The guarantee at issue had named one entity as the guarantor but then referred to the registered office of the other company. As a result of this confusion, it was unclear which entity was intended to be the guarantor. That issue had to be tried on the facts and the claimant was thus unable to obtain summary judgment. Needless to say, difficulties of this kind can result in delays in enforcement which, in turn may often lead to a lower recovery.

26.37  It may be added that, in an effort to prevent disputes over calculations and other matters, the guarantee will frequently include a clause to the effect that the lender’s certificate as to the amounts owing by the primary borrower—and, hence, by the guarantor—will be conclusive and binding on the guarantor in the absence of manifest error. Although these provisions may appear to be somewhat unreasonable, their validity has generally been upheld by the courts.67 For these purposes, an error will be ‘manifest’ if it is an obvious error or is easily demonstrable without extensive investigation.68

26.38  It might be thought that a ‘conclusive certificate’ clause excludes defences that would otherwise be available to the guarantor and that, as a consequence, such a clause might be amenable to challenge under the Unfair Contract Terms Act 1977.69 However, such clauses have passed the ‘reasonableness’ test prescribed by the 1977 Act on the basis that they include the ‘manifest error’ proviso.70

Essential Validity

26.39  Like any other contract, the essential validity of a guarantee can be attacked on a variety of grounds, including fraud, mistake, and undue influence.71 There is, however, one particular point which will generally be specific to a guarantee.

26.40  If it is sought to set aside the guarantee on the basis that the bank has misled the guarantor as to the financial status of the main borrower, then that action can only be maintained if the representation72 was reduced to writing. Section 6 of the Statute of Frauds Amendment Act 182673 reads as follows:

No action shall be brought whereby to charge any person upon or by reason of any representation or assurance made or given concerning or relating to the character, conduct, credit, ability, trade or dealings of any other person, to the intent or purpose that such other person (p. 542) may obtain credit, money or goods, unless such representation or assurance be made in writing, signed by the party to be charged therewith.

26.41  The essential validity of a guarantee can of course be attacked on a number of other grounds, quite apart from the ‘undue influence’ cases discussed at a later stage.74 For example, in the case of a joint and several guarantee, it is implicit in the arrangements that all of the guarantors will be properly bound by the terms of the guarantee, so that rights of contribution will arise as between them. If the bank fails to ensure that all guarantors execute the guarantee, then it may not be binding on any of them.75 From the bank’s perspective, the matter can be dealt with by means of an express statement in the guarantee to the effect that every guarantor is intended to be individually bound, even though other intended guarantors may not sign or may not be bound for some other reason.76

26.42  In a similar vein, guarantors have occasionally asserted that they have been induced to enter into the guarantee as a result of misrepresentation by the bank’s staff and that—as would be the case with any other type of contract—they are entitled to rescind the contract as a consequence. Although courts will obviously view such arguments with scepticism, they have rejected applications for summary judgment even in cases where the prospects of establishing the defence appear remote.77

Nature of the Guarantor’s Liability

26.43  It is one thing to say that a guarantee is valid and legally binding and has the legal effect contended for by the creditor in a particular case. It is quite another to decide exactly how much is due under the guarantee. Two points may be noted in this regard:

  1. (a)  first of all, and perhaps somewhat strangely, it has been held that a claim under a guarantee is a claim in damages, rather than in debt. This follows from the fact that the guarantor effectively undertakes to ensure that the principal obligor will perform his payment obligations and the creditor’s claim is in the nature of a claim for damages for failing to procure that performance.78 This would mean that the creditor would have to take steps to mitigate his loss so as to minimize his claim under the guarantee. Yet it seems to be accepted that the claim in damages must equate to the amounts which have gone unpaid by the primary obligor; and

  2. (b)  the bank must prove the amount owing under the guarantee in support of its claim. The guarantee is a separate contract from the underlying agreement and the lender thus cannot rely on a judgment against the borrower as evidence of the liability of the guarantor.79 (p. 543) In practice, the guarantor should be joined into the main proceedings against the primary obligor, wherever possible. In addition, the standard guarantee clause to the effect that the records maintained by the bank as to the level of the borrower’s indebtedness will be conclusive as against the guarantor will usually be valid and binding, at least in the absence of manifest error.80

26.44  Where a guarantee has been given by two or more persons, the extent of their individual liability will be a matter of the construction of the guarantee. However, most standard form guarantees will provide for the guarantors to be liable on a joint and several basis.81

Unfair Contract Terms

Introduction

26.45  As noted elsewhere,82 the relationship between a bank and its customer may be significantly affected by both the Unfair Contract Terms Act 1977 and the Unfair Terms in Consumer Contracts Regulations 1999.83

26.46  It is not proposed to repeat that discussion here, but it is appropriate briefly to consider the implications of that legislation in the specific context of guarantees taken by banks to cover the obligations of their customers.

26.47  It has already been noted84 that a guarantee is a species of contract. Consequently, guarantees are in principle within the scope of both the 1977 Act and the 1999 Regulations. What are the practical implications of this position?

Unfair Contract Terms Act 1977

26.48  As noted elsewhere,85 the primary effect of the 1977 Act in the context of the banker- customer relationship is to prevent the bank from excluding or restricting liability for its own breach where the customer is dealing as a consumer or where the bank is dealing on its own standard terms of business. This position is qualified, in the sense that such terms will remain enforceable if they satisfy a ‘reasonableness’ test. As a matter of principle, the 1977 Act will apply to guarantees given to a bank—even if given by corporate entities—on the footing that they will generally be given on the bank’s own standard form. Nevertheless, it must be borne in mind that a guarantee is essentially a unilateral undertaking by the guarantor to answer for the default of the principal debtor. The bank will not normally undertake any obligations to the guarantor under the terms of the document and, in the absence of any such obligations, the possibility of clauses restricting the bank’s liability for its own breach of contract will not generally arise. For example, standard form guarantees will seek to preserve the guarantor’s liability notwithstanding variations to the principal (p. 544) agreement, time given to the debtor or other matters.86 But provisions of this kind do not exclude or restrict a liability to which the bank would otherwise be subject. So, viewed from this perspective, it is difficult to see how the provisions of the 1977 Act can in practice apply to a standard form of bank guarantee.

26.49  Yet the 1977 Act does apply in other respects. Any provision which restricts the exercise of the guarantor’s rights under the guarantee may also be amenable to attack under the 1977 Act.87 By way of example, guarantors have occasionally asserted that they have a claim or counterclaim against the bank—for example, on the footing that the bank has a liability in damages to the guarantor in respect of the transaction. Guarantees will invariably contain provisions requiring guarantors to make payment on demand and free of any set-off or counterclaim,88 and guarantors have argued that this provision should not be enforceable under the 1977 Act because it deprives the guarantor of defences or procedures which would otherwise be available to him. This defence has been rejected, on the basis that the bank has a legitimate commercial interest in receiving immediate payment without waiting for the cross-claim to be litigated.89

26.50  Guarantors have also sought to argue that the ‘no set-off’ clause is unreasonable in the sense that it may require the guarantor to pay even though it asserts that it has a claim in damages for misrepresentation made by the bank with a view to inducing the guarantor to execute the document in the first instance. The reasonableness (or otherwise) of such a provision must be tested with respect to the circumstances as at the time of execution of the contract, and not with reference to the particular circumstances which subsequently arose. On this basis, and although written in very wide terms, a ‘no set-off’ clause was held to be reasonable in Skipskredittforeningen v Emperor Navigation,90 and the lender was able to obtain summary judgment notwithstanding an alleged claim in respect of misrepresentations made by the bank. The same result followed in Continental Illinois National Bank and Trust Co of Chicago v Papanicolaou,91 where the court held that, in a commercial case, a guarantee of (p. 545) this kind was intended to be equivalent to a letter of credit and—except in cases of fraud or other exceptional circumstances—should not be subjected to counterclaims or similar defences.

Unfair Terms in Consumer Contracts Regulations 1999

26.51  The Unfair Terms in Consumer Contracts Regulations 1999 (‘the 1999 Regulations’)92 approach the issue from a slightly different perspective. The following points may be noted:

  1. (a)  the scope of the 1999 Regulations is in some respects wider than the 1977 Act. The 1999 Regulations are not restricted to exclusion clauses. Instead, the regulations provide that standard form contractual terms are not binding on a consumer93 to the extent to which they are ‘unfair’. A term is ‘unfair’ if, contrary to the principle of good faith, there is an imbalance in the rights and obligations of the parties, to the disadvantage of the consumer;94

  2. (b)  a term which is deemed to be ‘unfair’ is not binding on the consumer, although the remainder of the contract may remain in force;95

  3. (c)  however, provided that they are written in plain and intelligible language, the court cannot undertake a ‘fairness’ assessment in relation to (i) the main subject matter of the contract or (ii) the adequacy of the remuneration as against the services supplied in exchange. Thus, the court cannot review the primary guarantee provisions, nor can it enquire as to the adequacy of the consideration received by the guarantor. This is perhaps a fortunate position, in that the guarantor will not generally receive any payment for the giving of the guarantee and, even if he does, he will not receive it from the bank.96 As a result—subject to the ‘plain intelligible language’ requirement—an inquiry into the fairness of the terms of the principal terms of a guarantee will generally be foreclosed;

  4. (d)  yet this is not the end of the matter and further issues may arise in relation to ancillary clauses which are designed to support the validity of the guarantee. For example, as will be seen,97 the bank owes various duties to the guarantor, and it is common practice to exclude those duties by means of the express terms of the standard form guarantee itself. It seems clear that such provisions would be amenable to challenge under the 1999 Regulations, to the extent to which they are applicable to the guarantee;

  5. (e)  this, in turn, begs a further question which flows from the secondary nature of a guarantee. Do the 1999 Regulations apply merely because the guarantor is acting outside the course of his trade or business? Or must the primary obligor likewise be incurred as a consumer if the regulations are to apply to the guarantee? Article 4(1) (p. 546) of the 1999 Regulations states that they are to apply ‘…in relation to unfair terms in contracts concluded between a seller or a supplier and a consumer…’. It had previously been decided that the 1999 Regulations should therefore not apply to a guarantee at all, because the bank is not selling or supplying services to the guarantor; it is merely receiving the benefit of a unilateral undertaking from him.98 However, in Barclays Bank plc v Kufner,99 this line of argument was rejected but it was also held that the 1999 Regulations apply only where the underlying facility is itself entered into by a consumer. It is submitted that Kufner is consistent with the scheme of the legislation and is to be preferred to the earlier authorities. It has been followed on subsequent occasions. For example, in United Trust Bank Ltd v Dohill,100 the defendant had entered into a guarantee in his capacity as a shareholder and director of his own property development company. Under these circumstances, the defendant had executed the guarantee as part of his property business and not in his capacity as a consumer. It followed that the 1999 Regulations could not apply to the guarantee;

  6. (f)  even apart from the restrictive approach correctly adopted in Kufner, it should be remembered that a guarantor—even though a private individual—will frequently not himself be a ‘consumer’ for the purposes of the 1999 Regulations in any event. A director/shareholder who guarantees his company’s overdraft will frequently be acting in the course of a business carried on by him, with the result that the 1999 Regulations cannot apply in any event.101 But marginal cases may arise. For example, if a husband guarantees a loan to his wife to acquire a residence for them, then both are acting as consumers and the 1999 Regulations will apply to the husband’s guarantee. Matters become more marginal if the loan is to be used by the wife to purchase shares or similar assets. Assuming that these are intended to be personal investments and are not acquired as part of a trade or business carried on by the wife, then both she and her husband will be acting as consumers and the 1999 Regulations will apply to the husband’s guarantee.102

Capacity to Guarantee

Introduction

26.52  This section will consider the special defences which may be available to individuals, companies, and other entities which provide a guarantee in respect of the obligations of another person. It should be emphasized that some of the defences about to be discussed may be of general application and may thus be available in a number of other contexts. However, guarantees pose special problems because they are unilateral instruments and it (p. 547) will frequently be obvious to the recipient lender that the guarantor derives no immediate or obvious benefit from the arrangement.

Individuals

26.53  An individual who has attained the age of 18 enjoys contractual capacity103 and is thus able to provide a guarantee to a bank.

26.54  The courts have, however, traditionally regarded the giving of a guarantee as an onerous obligation, especially where private individuals are involved. There is always the danger that such a guarantee has been procured as a result of undue influence applied by the intending borrower; and that danger naturally increases where the guarantee is given by the borrower’s wife or in any other case in which the borrower and guarantor are involved in a non-commercial relationship.104 In cases of this kind, the bank is put on inquiry and is effectively required to assume that the borrower has brought improper influence to bear, unless it has taken adequate steps to ensure that the guarantor has received adequate and independent legal advice on the effect of the guarantee.

26.55  In practice, this type of issue has tended to arise in the context of an agreement by a wife or partner to provide security over the matrimonial home to support facilities provided to the husband’s business. As a result, this subject is considered in more depth in the context of real estate security.105 But it should be borne in mind that identical principles will apply where a spouse, partner, or other family member is asked to provide a guarantee, whether with or without security.

26.56  The guarantor must have the requisite mental capacity to enter into a guarantee. However, as far as the bank is concerned, the guarantor will remain bound by the guarantee unless the bank knew, or should have appreciated, that the guarantor was suffering from a mental incapacity.106

Companies

26.57  The contractual capacity of a company to provide a guarantee is governed by the terms of its memorandum of association. However, the giving of guarantees will be treated as one of the objects of the company, unless its ability to do so is expressly restricted by the terms of the memorandum.107 The procedural steps required to sanction the execution of a guarantee will in turn be governed by the articles of association.108

26.58  In practical terms, however, any limitations imposed by these documents are now principally of concern as between the directors of the company and its shareholders;109 outsiders—including banks—dealing with a company have now been largely insulated (p. 548) from the effect of these rules by sections 39, 40, and 41 of the Companies Act 2006 (‘the 2006 Act’).110 These provisions accordingly require some explanation.

26.59  First of all, by virtue of section 39 of the Companies Act 2006, the validity of a guarantee cannot be called into question on the ground that the constitution of the company did not confer the necessary capacity to undertake such an obligation. It follows that it is no longer incumbent upon lenders to examine the detailed terms of the memorandum of association to determine whether the proposed guarantee falls within the scope of the express objects of the company or, under more modern circumstances, to determine whether the provision of the guarantee is specifically restricted by that document.111 Banks and practitioners are thus relieved of a process which was frequently both tedious and pointless, and occasionally involved matters of fine interpretation. It should be added that section 39 will apply to protect the lending bank even if it has actual notice that the guarantee is beyond the contractual capacity of the company.112

26.60  Secondly, in favour of a bank dealing with a guarantor company in good faith, the power of the board of directors to bind the company, or to authorize others to do so, is deemed to be free of any limitation under the company’s constitution.113 Once again, the bank is relieved of any obligation to examine the articles of association of the guarantor because it ‘…is not bound to enquire as to any limitation on the powers of the directors to bind the company…’.114 As a result, the bank is not concerned with borrowing limits115 and other internal restrictions on the powers of the board; nor is the bank obliged to ensure that any quorum requirements have been met, although it seems that there must have been at least some attempt—however legally defective—to hold a meeting to sanction the transaction or to authorize someone else to do so.116 The requirement of good faith must, however, be carefully noted—especially in the present context. The bank is presumed to have acted in good faith in accepting a guarantee from the company concerned, and that presumption is not rebutted merely because the bank has actual knowledge of a relevant limitation on the directors’ powers under the terms of its constitution.117 Nevertheless, the presumption may (p. 549) be rebutted on other grounds, and it appears that the bank needs to exercise particular caution in the case of a corporate guarantee. The directors of a company are bound to exercise their powers in good faith for the benefit of the company itself;118 by its very nature, however, a guarantee is given for the benefit of someone other than the company itself, because it is intended to facilitate borrowings by another entity. Under these circumstances, a bank which accepts a corporate guarantee is placed on notice of a possible irregularity, and it may be unable to satisfy the ‘good faith’ requirement unless it takes steps to satisfy itself that the guarantor company does indeed derive a benefit from the transaction at hand, or that it is otherwise consistent with the directors’ fiduciary duties.119 The following points may be noted in this context:

  1. (a)  A parent company has an obvious interest in the commercial success of its subsidiaries and the availability of facilities to fund their activities. Consequently, where a parent provides a guarantee in such a case, the bank must generally be taken to have acted in good faith if it has verified the parent-subsidiary relationship. In the normal course, no further enquiries should be necessary for this purpose and the bank could rely on section 40 of the 2006 Act to hold the parent company to its guarantee.

  2. (b)  The position may, however, be different where a successful subsidiary is requested to provide an ‘upstream’ guarantee in respect of borrowings by its parent company. This may be justifiable where the parent company acts as treasurer to the group as a whole. The subsidiary will have access to the guaranteed funding and the cost of funding will be lower as a result of the provision of group guarantees.

  3. (c)  Yet it is necessary to exercise caution in such cases. For example, a commercially successful subsidiary which does not itself require additional funding may be asked to provide a guarantee in respect of a loan to its struggling parent company. A bank which accepts a subsidiary guarantee under such circumstances cannot necessarily be said to have acted in good faith, for it is on notice of a possible breach of duty by the directors of the guarantor. The bank may thus be unable to rely on section 40 to preserve the validity of the guarantee in such a case.120 Nevertheless, even if the bank had accepted the guarantee without any enquiry, the guarantee would be binding if it was in fact given in the best interests of the company.121

  4. (p. 550) (d)  A guarantee given by a company in respect of the liabilities of an unconnected company necessarily places a duty of enquiry on the bank, and the ‘good faith’ test cannot be satisfied unless that duty is adequately discharged.122 Likewise, if the bank knows that the guarantee is given for an improper corporate purpose, it will not be able to hold the company to the guarantee.123

  5. (e)  The presumption that the bank has acted in good faith is not displaced merely because the bank is aware of a division among the directors as to the intended guarantee.124

  6. (f)  If the bank has acted in good faith in taking the guarantee,125 then a guarantee will be binding on the company so long as it is executed by a director who has actual or ostensible authority to do so.126

26.61  The points outlined above deal with the powers of the directors to bind the company to contracts with third parties. They may therefore conveniently be seen as a branch of the law of agency; the directors have apparent authority to enter into transactions with others, but a third party cannot rely on that authority if he is on notice that the directors are exercising their powers improperly.127

Other Entities

26.62  Care is also required when accepting guarantees from other forms of legal entity or business organization. Possible areas of difficulty include the following:

  1. (a)  as already noted, the statutory protections discussed above may not be available where the company is a charity;128

  2. (b)  a member of a partnership does not have implied authority to execute a guarantee on behalf of a partnership.129 Consequently, the lender should satisfy itself that the signatory has actual authority under or pursuant to the partnership agreement or, alternatively, should procure the signature of all partners;

  3. (c)  the powers of local authorities are prescribed exclusively by statute and the courts have adopted a very restrictive view of their capacity to provide guarantees;130 and

  4. (d)  the powers of treaty organizations to provide guarantees will be governed exclusively by the treaty concerned and the statutes of the organization in question.

(p. 551) Duties of the Bank to the Guarantor

Introduction

26.63  It has been noted above that the courts have tended to regard a guarantee as an onerous contract, and have thus tended to adopt a protective attitude towards the guarantor. It thus becomes necessary to consider whether the bank proposing to accept a guarantee owes any specific duties to the guarantor, for example, to ensure that he understands the effect of the guarantee and the commercial circumstances surrounding it.

26.64  It has already been seen that a bank should ensure that a guarantor in a non-commercial relationship with the borrower should be required to obtain independent legal advice, and that the bank may be required to satisfy itself that the directors of a corporate guarantor are acting in the interests of the company.131 Yet it must be emphasized that these are not positive duties which the bank owes to the guarantor; rather, they are steps designed to ensure the validity of the guarantee. They are thus intended for the protection of the bank itself, not for the protection of the guarantor. Does the bank have any further or wider obligations to the prospective guarantor?

A Duty to Advise?

26.65  At the outset, it should be appreciated that a bank is not under any duty to offer advice to a prospective guarantor about the merits of giving the requested guarantee.132 Apart from other considerations, this would create a direct conflict of interest since the bank will itself be the beneficiary of the arrangement.

26.66  Thus, whilst the bank will obviously make its own credit decision about the merits of the underlying transaction, this will be solely for its own protection. Credit approval for a particular facility will therefore not imply any positive advice or recommendation to the prospective guarantor.133

26.67  More recent case law continues to adhere to the view that, in taking a guarantee, the bank does not assume any form of fiduciary duty or duty of care in tort towards the guarantor.134

A Duty of Good Faith?

26.68  The relationship between the bank and the guarantor is not one of utmost good faith.135 The bank is thus under no general duty to disclose to the guarantor any information in the possession of the bank and which might be relevant to the obligations which the guarantor is about to assume. Consequently, if the guarantor agrees to provide an ‘all moneys’ guarantee, it is not incumbent upon the bank to disclose either the extent of the customer’s present borrowings, his overdraft limit or the existence of any other obligations which might fall (p. 552) within the scope of the ‘all moneys’ guarantee.136 Acceptance of responsibility for such sums is inherent in the nature of a guarantee of this kind. Likewise, the bank is not obliged to disclose the fact that it has reservations about the borrower’s own credit standing.137

A Duty of Disclosure?

26.69  The bank is, however, subject to a more limited duty of disclosure, in that it must advise the guarantor of any particular circumstances which may be regarded as outside the normal course and which may have an impact on the essential nature of the arrangements between the bank and the guarantor. In one case,138 the bank failed to disclose to the sureties that the loan to the principal customer matured on the day on which the loan stock pledged by the sureties was to mature, thus rendering it virtually certain that the bank would have first recourse to the loan stock, to the detriment of the sureties. The security arrangements were set aside in view of the non-disclosure of this vital point which materially affected the fundamental nature of the underlying transaction and which would quite probably have led the guarantors to act differently. Furthermore, if the bank believes that the guarantor may have been misled into offering the guarantee, then the bank must disclose the true state of affairs. It will, otherwise, be unable to enforce the guarantee, for it will have become party to a scheme to defraud the guarantor.139 However, the guarantee will not be set aside where the bank’s non-disclosure involves factors that were known to the guarantor, for the non-disclosure will not have affected his decision to enter into the document.140

26.70  Of course, if the bank does elect to provide information about the borrower’s financial position and the risks which the guarantor is about to assume, then it must take steps to ensure the accuracy of that information; otherwise, the guarantor may be able to rescind the guarantee on grounds of misrepresentation.141

26.71  Once the guarantee has been given, there is no obligation on the bank to advise the guarantor of any irregularities which subsequently come to light, such as fraud on the part of the borrower.142

A Duty to Take Other Security?

26.72  There may be situations in which it is anticipated that the bank will be taking additional guarantees and security in addition to the assurance to be provided by the particular guarantor.

(p. 553) 26.73  If the bank fails to complete the remainder of the anticipated security package, then this may deprive the guarantor of an expected right of subrogation or contribution.143 On the other hand, it has been decided that a bank does not owe an equitable duty to the guarantor to perfect other security which it intended to take from the primary debtor.144

26.74  There may appear to be an element of inconsistency between these two views but, in any event, a standard guarantee will usually explicitly state that it remains effective notwithstanding any failure to take other security, so that defences of this nature will be contractually excluded.

A Duty of Realization?

26.75  A guarantee will often be given as part of a larger package designed to secure the repayment of the facility. For example, the bank will often take a fixed and floating charge over the assets of the primary borrower.

26.76  Generally speaking, standard forms of bank guarantee will allow the bank to take proceedings against the guarantor before it takes any steps to enforce any of the other aspects of its security package. Of course, if the guarantor discharges the entirety of the debt in response to a demand, then it will take over the bank’s security by virtue of its right of subrogation.145 Realization of the security is then for the risk and benefit of the guarantor itself. But what is the position if the guarantor does not or cannot afford to discharge the underlying indebtedness in this way? The bank itself will be left in charge of the process of enforcement. It will be seen146 that the lending bank owes duties to the primary debtor or mortgagor in enforcing its security. Does it owe similar duties to a guarantor of the same facility?

26.77  It was indeed confirmed in Barclays Bank plc v Kingston147 that the lender in such a case does indeed owe an equitable duty of care to ensure that reasonable steps are taken to realize the security at a proper value. Given that the guarantor would have expected its potential liability to be mitigated by the value of the security, the court may perhaps be reluctant to hold this duty has been excluded by the terms of the guarantee itself.148 Nevertheless, the court will require clear evidence to the effect that the sale of the underlying property was indeed mis-priced.149

(p. 554) Discharge of the Guarantor

Introduction

26.78  Once a lending bank has made facilities available to a borrower, the parties are free to vary the terms of the arrangements in any way. For example, the bank may agree to increase or to extend the facilities or to release any security originally provided over the borrower’s assets. It is, however, obvious that any such action may have an impact on the position of any guarantor. An increase in the amount of the facilities clearly increases the guarantor’s exposure;150 the release of security may deprive the guarantor of his right of subrogation to securities held by the bank; and the release of co-guarantors may deprive a guarantor of his rights of contribution.151

Discharge by Payment

26.79  Before moving to the more technical defences which may be available to a guarantor, it is necessary to consider the more obvious and more common mode of discharge—namely, payment by the principal debtor itself. Provided that such a payment is not clawed back in the insolvency of the debtor itself,152 then this must constitute a complete discharge of the guarantor. He has, after all, only agreed to answer for the debtor’s default. Thus, if the primary debtor has exercised contractual rights to terminate his liability under the underlying contract and has complied with any conditions necessary to that end, then the guarantor will himself be discharged even though, as a result of the termination, the beneficiary has not earned his anticipated profit on the deal. The guarantor was not assuring to the beneficiary his expected return; he was merely guaranteeing that the debtor would pay whatever he was obliged to pay.153

26.80  It may not always be easy to determine whether the principal obligation has been discharged for these purposes. For example, payment may occur as a result of an exercise of a right of set-off by the principal debtor, although this may to some extent depend on the terms of the main contract.154 However, the mere fact that the debtor may have a counterclaim for unliquidated damages against the lender will not of itself afford any form of defence to a guarantor.155

Discharge of the Guarantor

26.81  As the above analysis demonstrates, there is a tension between the bank’s desire to deal flexibly with its borrower and the need to ensure that the guarantor is not unfairly (p. 555) prejudiced. How does the law resolve these tensions? What steps can banks take to minimize the risk that guarantees will inadvertently be discharged? A few points may be noted in this context:

  1. (a)  A guarantor may be discharged if the bank agrees to allow to the borrower additional time for payment.156 At first sight, this may seem curious given that a call on the guarantee is thereby likewise deferred. However, it must be borne in mind that the borrower’s financial position might deteriorate further during the extended period, thus devaluing the guarantor’s rights of subrogation. It should also be appreciated that a bank does not agree to give time to the debtor merely because it defers enforcement as against the borrower itself or other security.157

  2. (b)  Material amendments to the terms of the underlying facility may also discharge the guarantor, since they may alter the nature of the risk which the guarantor had agreed to assume.158 Such amendments would not usually affect the validity of an ‘all moneys’ guarantee for, by its very nature, the guarantor has agreed to accept responsibility for every obligation of the borrower to the bank, however they may arise.159 But considerable care may be required where the guarantee is limited to monies due under specified facility agreements. Standard guarantees will always provide that the bank can agree to variations or amendments of those agreements without affecting the liability of the guarantor, but there may be cases in which the underlying deal is varied to such an extent that the original debt is extinguished and replaced by a new obligation which falls outside the scope of the guarantee. Difficult questions of degree will be involved, and the prudent course will be to obtain the explicit consent of the guarantor in each case.160 Even then, however, the bank must take care to ensure that the relevant consent (p. 556) is procured on a proper and fully informed basis, and not as a result of misrepresentation on the part of the bank.161

  3. (c)  The release of any security held for the borrowers’ obligations and the release of any co-guarantor will respectively prejudice the guarantor’s rights of subrogation and contribution, and may thus discharge the guarantor, at least to the extent of the value of the security thereby foregone.162 For the same reasons, the bank’s failure to take any additional guarantees and security contemplated at the time of the transaction may likewise provide a defence to the guarantor.163 Again, the guarantee form will seek to exclude defences of this kind.

  4. (d)  Conduct which amounts to bad faith vis-à-vis the guarantor will likewise discharge the guarantee,164 and clearly no contractual provision could protect the bank against the consequences of its own bad faith. The expression ‘bad faith’ does, however, need to be treated with some care because, as noted earlier, the guarantee is not a contract of utmost good faith. Consequently, a bank does not act in bad faith merely because it holds or releases security of which the guarantor was unaware, or because it seeks to enforce the guarantee in priority to any other remedies which may be open to it.165

26.82  Standard forms of bank guarantee will seek to deprive the guarantor of the benefit of many of the defences which might otherwise be available and will seek to preserve the validity of the guarantee under all circumstances. Subject to legislation dealing with unfair terms and consumer protection where applicable, it seems that the courts will generally uphold provisions of this kind.166

Vitiating Factors

26.83  The possibility that a security arrangement may be impugned in a subsequent insolvency of the grantor is considered in general terms at a later stage.167 However, as in so many other contexts, guarantees raise particular problems and it is necessary to make a few special observations.168 In the event of the insolvency of the guarantor, it may become necessary to consider whether the validity of the guarantee can be challenged by the administrator or liquidator, or by any of the guarantor’s other creditors.

(p. 557) 26.84  In some cases, the guarantee may be challenged on the basis that it was void or voidable from the outset; some of these grounds have already been considered;169 those arguments are available even while the company is a going concern.170 However, the Insolvency Act 1986 provides additional grounds which may be invoked solely because of the insolvency of the guarantor. These grounds may be noted briefly since the relevant statutory provisions are considered in more depth elsewhere in this work.171

Preference

26.85  If a company gives a preference to a creditor during the six month period prior to the commencement of administration or liquidation proceedings, then the transaction may be set aside as a preference.172

26.86  A ‘preference’ is given to a person if:173

  1. (a)  the recipient is one of the company’s creditors; and

  2. (b)  the company does some act which has the effect of putting that creditor in a better position than he would otherwise have enjoyed in the event of the insolvency of the company.

26.87  In the normal course, it is submitted that the ‘preference’ provision cannot be applied to a guarantee which is given by a company in the period leading up to insolvency. This follows from a reading of the requirement described in paragraph 26.86(a) above; the bank is not a creditor at the time the guarantee is given; it only becomes a creditor as a result of the execution of the guarantee.174 This technical point is, however, likely to be of limited practical importance because a guarantee could also be challenged on the alternative ground about to be discussed.

Transactions at an Undervalue

26.88  A guarantee given to a bank may be set aside if it was given during the two year period prior to insolvency and constitutes a ‘transaction at an undervalue’. That term is defined to include any transaction for which the company receives no consideration or for which it receives consideration which is significantly less valuable than the benefit conferred on the other party.175 In the case of a guarantee, this may be a particularly difficult analysis since, as noted elsewhere,176 the guarantor receives the consideration necessary to support a contract in technical terms, but it does not directly receive consideration which can readily be (p. 558) ‘valued’ for the purposes of this provision. However, it is submitted that the guarantor does receive consideration equal to the value of the underlying loan facility where the guarantee is given to support a loan to its subsidiary, at least where the subsidiary is wholly owned. In such a case, the guarantee is given simply because the holding company chooses to carry on its business through subsidiaries (rather than directly) and, in any event, the guarantor receives the full economic benefit of the loan facility concerned.

26.89  If the guarantee cannot be defended on the basis of the sufficiency of the consideration, then it may nevertheless be valid if either (i) the company was solvent when the guarantee was given177 or (ii) the company entered into the transaction in good faith for the purpose of carrying on its business, and there were reasonable grounds for believing that the guarantee would benefit the company.178 The first situation is self-explanatory. The second situation could conceivably arise where, for example, the guarantee is given in an effort to support one of the guarantor’s major customers, in an effort to save it from insolvency and, hence, to preserve the cash flows derived from that source.

Termination by the Guarantor

Introduction

26.90  A person or company that provides a guarantee may not wish to be bound by it in perpetuity. For example, a holding company may dispose of a subsidiary to a third party and it will naturally no longer wish to stand as guarantor for its bank facilities following the sale. The lender will frequently agree to the termination of the guarantee as part of the sale arrangements, or its facilities may be refinanced by the purchaser’s bank. But, in the absence of a solution of this kind, does the guarantor enjoy any unilateral rights of termination?

Express and Implied Termination Rights

26.91  Standard forms of bank guarantee will often confer upon the guarantor a right of termination, subject to an appropriate period of notice. The guarantor will, of course, remain liable for obligations incurred by the borrower before the notice period expires. Where a director or shareholder of a company has given a guarantee in that capacity, the bank is not obliged to assume that the guarantee is to be terminated merely because it is aware that the individual concerned has ceased to have an interest in the borrowing entity.179 It thus remains important to give express notice of termination in such a case.

26.92  In the absence of a specific, contractual right of termination, it seems that the guarantor has an implied right to terminate his obligations under a continuing guarantee with reference to any future borrowings by the principal debtor.180

(p. 559) Rights of the Guarantor following Payment

Rights of the Guarantor

26.93  If the guarantor is compelled to make payment, he will have the right to recover these amounts by way of indemnity from the primary borrower—at least if the guarantee was given at the borrower’s request.181 Likewise, one of multiple guarantors who has discharged the debt will be entitled to a proportionate contribution from his fellow guarantors.182

26.94  Rights of the kind just described usually subsist as between the borrower and the guarantor themselves. They will, therefore, generally be of limited concern from the perspective of the lending bank itself. However, the lender will wish to ensure that the guarantor waives any such right of recovery from the primary debtor until the lender itself has been repaid in full. This will be of particular importance where the borrower has become insolvent because the effect of a proof by the guarantor will be to dilute the assets available to other creditors (including the bank itself). The terms of the guarantee will generally prohibit the submission of such a proof until the bank debt has been fully redeemed. Clauses of this kind are, in principle, valid and binding on the guarantor.183 However, their effect may vary in the competing circumstances of particular cases.184

Obligations of the Bank

26.95  The bank cannot, however, entirely ignore the position of the guarantor after a demand has been made against him. The right of subrogation also implies that the guarantor may ‘step into the shoes’ of the lender and take over its rights in respect of the debt which he has paid.

26.96  The lender must therefore take care to ensure that, in such a case, the security is not released but is instead made available to the guarantor. Of course, the lender will not wish to find itself in competition with the guarantor and, for that reason, standard forms of bank guarantee will defer the exercise of the right of subrogation until the lender has been repaid in full. For that purpose, a guarantee should always cover the entirety of the underlying debt, even if there is to be a financial cap on the guarantor’s total liability. If, instead, the lender merely takes a guarantee of part of the debt, then the guarantor’s right of subrogation will apply when he has paid that amount, even though the balance of the debt remains outstanding. For this reason, a guarantee which is to be subject to any form of financial limit must be prepared with some care.185

(p. 560) Conflict of Law Issues

26.97  In a case involving a cross-border situation, it may be necessary to consider questions of private international law. In particular, where (say) a guarantee is given by a German parent company in respect of the obligations of a French subsidiary to an English bank,186 will the obligations of the German guarantor be determined by reference to German, French, or English law?

26.98  This issue will be governed by the EU regulation on the law applicable to contractual obligations, which is considered in more detail at a later stage.187 However, it seems appropriate to make a few general comments about the system of law which will govern a guarantee in such a case:

  1. (a)  the parties are free to select the system of law which is to govern the contract of guarantee.188 In the normal course, it will not be necessary to pursue the matter further because standard form documents used by the bank will include an express selection of English law as the applicable law;

  2. (b)  there may, however, be occasions when the guarantee is provided by the German guarantor on its own terms and in the format preferred by it, and the bargaining power of the German parent is such that the bank is prepared to accept this arrangement. In such a case, if the guarantee includes an express selection of German law, then no further enquiry will be required from a private international law perspective. The obligations of the guarantor will be governed by German law, as will any question as to whether those obligations have been duly performed or have been terminated or discharged for any reason;189

  3. (c)  matters become a little more difficult if the guarantee contains no express choice of law. As will be discussed at a later stage,190 Article 4(1) of Rome I contains a list of rules dealing with the law applicable to particular categories of contracts. However, contracts of guarantee do not fall within that list. As a result, it is necessary to have recourse to more general rules;

  4. (d)  in such a case, the starting point is that the contract is governed by the law of the country in which the party required to effect the ‘characteristic performance’ of the contract has his habitual residence.191 This test naturally points to German law, since the performance which is ‘characteristic’ of a guarantee is payment by the guarantor. In any event, the bank has no positive obligations under a guarantee and thus is not responsible for ‘performance’ under it at all;

  5. (e)  nevertheless, Article 4(3) of Rome I provides that ‘…where it is clear from all the circumstances of the case that the contract is manifestly more closely connected with a country other than [Germany], the law of that other country shall apply…’;

  6. (p. 561) (f)  in general terms, it is suggested that Article 4(3) should be applied in this type of case. The guarantee is not a ‘stand alone’ or independent contract. It only derives its commercial meaning and substantive effect from the fact that the borrower is raising money from an English bank under English law. Under these circumstances, it is suggested that the German parent guarantee is ‘…manifestly more closely connected…’ with England and hence should be governed by English law.192 In spite of differences of detail with the lower court, the Court of Appeal upheld this view in relation to a guarantee issued by an Egyptian company in relation to an underlying contract governed by English law.193 Nevertheless, it is clear that one should not be overly dogmatic in this context and the court may look both to the connected contract and to the wider circumstances.194 Thus, in a more recent case, where a performance bond was expressed to be governed by Syrian law, both that consideration and a series of other factors led the court to conclude that the customer’s obligations under its counter-indemnity were likewise subject to Syrian law;195

  7. (g)  of course, once it has been determined that a guarantee is governed by a foreign system of law, then the essential validity, meaning and effect of that guarantee falls to be determined by reference to the system of law so identified.196

26.99  Where a guarantee is given with respect to an overseas company, that has entered into an insolvency procedure, it may be relevant to inquire whether the foreign laws affecting the insolvency procedure may have any impact on the bank’s ability to enforce the guarantee in England. This question arose in India Coke and Power Ltd v Shah,197 where an Indian lender had made a loan to a distressed company in India, and had taken a guarantee from Mr Shah. Although all relevant parties were Indian and the documentation (including the guarantee) was expressed to be governed by the laws of India, the guarantor was resident in England. When sued on the guarantee, the defendant sought to resist the claim on the basis of section 22 of the Indian Sick Industrial Companies Act, which stated that, where a company was the subject of a scheme under the Act, ‘no suit for recovery of any money or the enforcement of any security against an industrial company or any guarantee in respect of any loans or advances granted to the industrial company’ could be instituted except with official consent. On its face, this provision would have prevented the proceedings because it formed a part of Indian law, by which the guarantee was governed. However, expert evidence on Indian law demonstrated that the provision was only intended to affect the institution of legal proceedings within India itself—in other words, the section was not intended to have extra-territorial effect. On this basis, the lender was able to obtain judgment against the guarantor in English proceedings.(p. 562)

Footnotes:

1  On this subject, see the discussion of unfunded credit mitigation, at paras 6.46–6.48 above.

2  See Chitty, para 44-001. A similar definition is adopted in Paget, para 18.2. See also the language employed in Statute of Frauds 1677, s 4 (discussed at para 26.20 below).

3  Halsbury’s Laws of England, Guarantee and Indemnity, para 101.

4  Lakeman v Mounstephen (1874) LR 7 HL 17, although see the particular situation which arose in Heisler v Anglo-Dal Ltd [1954] 2 All ER 770.

5  Re Hoyle [1893] 1 Ch 84.

6  See the discussion of Statute of Frauds 1677, s 4 at para 26.20 below.

7  This subject is discussed at para 26.70 below.

8  Indeed, terminology can be positively misleading. For example, in the context of the sale of goods, the expression ‘guarantee’ is frequently used but, in law, a warranty is intended: see Halsbury, Guarantee and Indemnity, para 101.

9  This point is very clearly illustrated by the decision of the House of Lords in Actionstrength Ltd v International Glass Engineering Ltd [2003] 2 All ER 615, where the parties may not even have regarded their arrangement as a guarantee, or even turned their minds to the legal nature or characterization of their arrangement. This case is considered further at para 26.27 below.

10  See Moschi v Lep Air Services Ltd [1973] AC 331 (HL); Paget, para 18.2.

11  Or, alternatively, where the obligation to pay is limited recourse in terms of the assets concerned. On this subject, see Deutsche Bank v Ibrahim [1992] 1 Bank LR 267 and other cases noted by Paget, para 18.23.

12  On this point, see Chitty at para 44-001, citing Moschi v Lep Air Services Ltd [1973] AC 331 (HL); Trafalgar House Construction (Regions) Ltd v General Surety & Guarantee Co Ltd [1996] 1 AC 199 (CA) and Sunbird Plaza Pty Ltd v Maloney (1998) 166 CLR 245 (High Court of Australia). An undertaking to procure payment by the primary debtor constitutes a ‘guarantee’: see Technology Partnership plc v Afro-Asian Satellite Communications (UK) Ltd [1998] EWCA Civ 1520, a case on the Statute of Frauds 1677 (below).

13  ie the interest will represent damages for the guarantor’s failure to procure performance by the primary debtor. The point will usually be theoretical since standard forms of bank guarantees will invariably extend specifically to interest and any other sums owing by the debtor.

14  For full discussion of that subject, see Chitty, chs 2–4.

15  The exact point of time at which acceptance occurs would depend upon the precise factual background. The issue could be of some importance in practice, because the offer can be withdrawn at any time prior to its acceptance.

16  Whilst it is necessary that consideration should exist, it is not necessary that it should be explicitly stated in the guarantee itself: Mercantile Law Amendment Act 1856, s 3.

17  Note that the consideration must move from the bank, but it need not move to the guarantor: see Chitty, para 3-039.

18  If a guarantee is given at the request of the bank in this type of situation, then it may be inferred that the guarantee is given in order to avert an immediate demand: Greenham Ready Mixed Concrete Ltd v CAS (Industrial Developments) Ltd (1965) 109 Sol Jo 209.

19  In such a case, a guarantee given by an individual must comply with the requirements of s 1(3)(a) of the Law of Property (Miscellaneous Provisions) Act 1989. The provision requires the execution of the document by the guarantor, the signature of a witness and delivery as a deed. In the case of a company, the document must be duly executed under the common seal of the company, or it may be executed by two directors, or one director and the secretary. For details of the execution formalities, see Companies Act 2006, ss 43–47. Some care is, however, needed in procuring the execution of a guarantee by way of deed, since it has been stated that the signature and witness attestation must all form a part of the same physical document: R (on the application of Mercury Tax Group and another) v Her Majesty’s Revenue and Customs [2008] EWHC 2721, para 40. This may appear uncontroversial for this requirement will invariably be met in the case of standard form bank guarantees. However, where—as is common practice in the context of international transactions—the guarantor sends a signing page to be attached to the final text, the decision in Mercury suggests that the guarantor should specifically acknowledge the content of the final text. If the execution version is subsequently altered, the guarantee will remain binding if it can be shown that this was to correct an error or the guarantor intended the signing page to be applied to the revised text: Koeningsblatt v Sweet [1923] 2 Ch 314 (CA); New Hart Builders Ltd v Brindley [1975] 2 Ch 342.

20  Thus, for example, if the parties refer in desultory fashion to the giving of a guarantee in the preliminary heads of terms for their transaction but the fully negotiated agreement contains no reference to it, then the court is likely to hold that no guarantee was intended to be given solely as a result of the passing reference to such an arrangement in the heads of terms: see Carlton Communications plc v Granada Media plc [2002] EWHC 1650 (Comm).

21  In Kleinwort Benson Ltd v Malaysia Mining Corporation Berhad [1989] 1 WLR 379 (CA), the comfort letter stated that it was the policy of the Malaysian parent company ‘…to ensure that the business of MMC Metals Limited is at all times in a position to meet its liabilities to you under the above arrangements…’. It was held that this did not create a legally binding obligation, in part because a full guarantee would have required the approval of the central bank under the Malaysian Exchange Control Act. The absence of such consent suggested that no legally binding commitment was intended, since it could not be presumed that the parent intended to act unlawfully with respect to its own, national monetary laws. In Australia, however, very similar wording (‘…we take this opportunity to confirm that it is our practice to ensure that our affiliate will at all times be in a position to meet its financial obligations as they fall due…’) was held to constitute a guarantee: see Banque Bruxelles Lambert SA v Australian National Industries Ltd (1989) 21 NSWLR 502. It is suggested that the absence of exchange control considerations was a key consideration in the latter case, leaving the court free to take a broader view of the parties’ commercial intentions. For an English case in which the court appeared willing to enforce the terms of a comfort letter, see Chemco Leasing SpA v Rediffusion plc [1987] 1 FTLR 201. In the event, however, the court declined enforcement on the basis that the lender had not complied with some of the conditions set out in the comfort letter.

22  See Re Simon Carves Ltd [2013] EWHC 685 (Ch), where the letter in question had been provided to the directors of a subsidiary company to facilitate the preparation of audited financial statements on a ‘going concern’ basis. This negated any intention to create a legally binding obligation.

23  There may even be occasions when the lending institution itself may wish to argue that the arrangement is not a full guarantee but is a more diluted—albeit legally effective—undertaking. This might occur where the arrangement has not been reduced to writing or has not been executed by or on behalf of the party concerned. Such an arrangement would not be legally enforceable as a guarantee in view of its lack of compliance with s 4 of the Statute of Frauds 1677 (on which see para 26.20 below).

24  Although it arose in a non-banking context, it may be noted that an argument that a particular undertaking amounted merely to a letter of comfort (or moral obligation) was rejected in Associated British Ports v Ferryways NV [2009] All ER (D) 198.

25  On risk-weighted assets and credit risk mitigation and associated capital adequacy requirements, see Chapter 6 above.

26  See Byblos Bank SAL v Al-Khudairy [1987] BCLC 232 (CA); National Westminster Bank plc v Alfano [2013] All ER (D) 252 (Dec); [2013] EWCA Civ 1703.

27  The section applies not only to the guarantee itself but also to an agreement under which a party undertakes to provide such a guarantee: Compagnie Générale d’Industrie et de Participation v Myson Group Ltd (1984) 134 NLJ 788.

28  See Maddison v Alderson (1883) 8 App Cas 467. In a development which cannot possibly have been within the contemplation of the 1677 legislature, it has been held that an individual’s name automatically reproduced in his email address is not a ‘signature’ for the purposes of s 4, although a manually typed name is more likely to be sufficient: see Mehta v J Pereira Fernandes SA [2006] EWCA 813 (Ch). An automatically generated name of a bank on a SWIFT message may also be a sufficient signature for these purposes: see WS Tankship II BV v The Kwangju Bank Ltd [2011] All ER (D) 234 (Nov); [2011] EWCA 3103 (Comm). It may be added, somewhat obviously, that s 4 of the 1677 Act only requires signature of the document by or on behalf of the guarantor. The signature of the bank is not required: United Trust Bank v Dohill [2012] 2 All ER (Comm) 765; [2013] EWHC 3302 (QB), para 13.

29  Provisions to the effect that a contract shall be ‘void’ suggest a rule of substantive law which should in principle be applied wherever the contract is governed by English law. Expressions such as ‘unenforceable’ or ‘no action shall be brought’ suggest a rule of procedure, to be applied by the English courts regardless of the law applicable to the contract in issue. However, it is impossible to lay down firm rules in this area, since much will depend on the circumstances, the detailed statutory language and the policy objectives of the legislation concerned.

30  See Leroux v Brown (1852) 12 CB 801 and other cases discussed in Dicey, Morris, and Collins, para 7-018. Notwithstanding the discussion in the text, it should be said that the characterization of s 4 as a procedural provision is by no means certain, and the decision in Leroux v Brown has been doubted.

31  See Art 11 of Rome I and the materials mentioned in the previous footnote. Of course, Rome I only applies if a conflict of law issue arises for the purposes of Art (1) of the regulation. It cannot assist where the guarantee is of a purely domestic nature. If an attempt is made to enforce a foreign law guarantee in an English court under circumstances where the guarantee is valid under its applicable law but would be unenforceable on the basis of s 4, the court would have to decide whether s 4 is intended to be an overriding mandatory provision of the forum which must be given effect in any event in accordance with Art 9(1) of Rome I. It may also be argued that, as a rule of procedure, s 4 is applicable to all court proceedings in England, regardless of the law applicable to the contract. It is not proposed to pre-empt these complex issues.

32  See The Anemone [1987] 1 Lloyds Rep 546 and other authorities cited by Paget, para 18.5.

33  Mercantile Law Amendment Act 1856, s 3; Perrylease Ltd v Imecar AG [1988] 1 WLR 463. For further cases on this principle, see Beckett v Nurse [1948] 1 KB 535 (CA); Elias v George Sakely & Co (Barbados) Ltd [1983] 1 AC 646 (PC).

34  In Yeoman Credit Ltd v Latter [1961] 2 All ER 294, at p 299, the issue was rightly described as ‘…a most barren controversy. It dates back, of course, to the Statute of Frauds 1677, and has raised many hair-splitting distinctions of exactly that kind which brings the law into hatred, ridicule and contempt by the public…’.

35  Yeoman Credit Ltd v Latter [1961] 2 All ER 294, at p 296. In Stadium Finance Co Ltd v Helm (1965) 109 Sol Jo 471 (CA), the distinction was said not to be a pure matter of construction but depended on the ‘whole burden’ of the agreement—was there a primary obligation and a secondary obligation, or were there two primary obligations?

36  The relevant wording of s 4 has been reproduced in para 26.20 above.

37  It should be noted that, since the indemnity is designed to hold the beneficiary harmless against losses flowing from a particular source, it is incumbent on the beneficiary to prove his loss: see The Fanti [1992] AC 1 (HL). To this extent, an indemnity is similar to a guarantee in the sense that the beneficiary’s claim is in damages, rather than debt: compare the discussion of Moschi v Lep Air Services Ltd at para 26.07 above.

38  See Coutts & Co v Browne-Lecky [1946] 2 All ER 207; Yeoman Credit Ltd v Latter [1961] 2 All ER 294 (CA). Both of these cases involved primary debtors who were under the age of majority, and whose obligations under the primary contract were unenforceable. The guarantee in Browne-Lecky was unenforceable because, under s 1 of the Infants Relief Act 1874, a loan made to a minor was void. The position of the guarantor in such a case may now be different, because s 1 of the 1874 Act has been repealed and s 1 of the Minors Contracts Act 1987 now provides that a guarantee is not to be unenforceable solely on the ground that the principal debtor is a minor. On this subject, see Chitty, para 8-045.

39  The Court of Appeal found it necessary to decide this apparently obvious point in Western Credit Ltd v Alberry [1964] 2 All ER 938.

40  See the discussion at para 26.81 below and the decision in Associated British Ports v Ferryways NV [2009] EWCA Civ 189 (CA).

41  It has been held that ‘primary obligor’ wording of this kind is sufficient to render the guarantor liable as principle debtor, so that he cannot raise defences which may be available to the borrower himself: see ILG Capital LLC v Van der Merwe [2008] All ER (D) 297 (May).

42  Moschi v Lep Air Services Ltd [1973] AC 331 (HL); Associated British Ports v Ferryways NV [2009] EWCA Civ 189 (CA).

43  The ‘email signature’ decision in Mehta v J Pereira Fernandes AS [2006] EWHC 813 (Ch) (n 28 above) provides a salutary lesson in this respect.

44  For an illustration of this approach, see State Bank of India v Kaur [1995] NPC 43 (CA).

45  For a recent case that emphasizes this point, see ABN AMRO Commercial Finance plc v McGinn [2014] EWHC 1674 (Comm).

46  Actionstrength Ltd v International Glass Engineering SpA [2003] 2 All ER 615. If the guarantor could be estopped from pleading s 4, then the purpose of the provision would be defeated since a guarantee could be enforced even though it did not comply with the requirements or policy of the section.

47  See, for example, Zabihi v Janzemini [2008] EWHC 2910, para 64 and Masood v Zahoor [2008] EWHC 1034 (Ch), para 251. See also Pitts v Jones [2008] 1 All ER 941 (CA), which includes a discussion of the approach which the court should adopt in seeking to distinguish between a guarantee and an indemnity. In the event, the arrangement at issue in that case was found to constitute a guarantee which could not be enforced for want of compliance with s 4 of the 1677 Act.

48  Section 4 appears to contemplate that it should apply only where the proceedings are instituted by the creditor. It does not appear to prevent the use of the guarantee obligation by way of defence, set-off, or counterclaim.

49  On the consequences of such a material variation for the guarantor, see the discussion at para 26.81 below.

50  [2013] All ER (D) 60 (Sep); [2013] EWHC 2685 (QB).

51  In this context, see the discussion of s 61 of the 1974 Act at para 4.31 above.

52  See Prenn v Simmonds [1971] 1 WLR 1381; Perrylease Ltd v Imecar AG [1988] 1 WLR 463; Bank of Scotland v Wright [1991] BCLC 244; Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896; and other cases cited by Paget at para 18.20. On the rules of contractual interpretation generally, see Chitty, paras 12-041–12-094.

53  In the case of a personal customer, however, banks will now stipulate for a specific financial limit. This practice was originally adopted to comply with para 11 of the Banking Code, on which see Chapter 4 above.

54  See the situation which arose in Bank of Scotland v Wright [1991] BCLC 244.

55  The expression was also held to extend to foreign exchange facilities in Bank of India v Transcontinental Commodity Merchants Ltd [1982] 1 Lloyds Rep 506 (CA).

56  See, for example, Amalgamated Investment and Property Co Ltd v Texas Commerce International Bank Ltd [1982] QB 84; Eastern Counties Building Society v Russell [1947] 2 All ER 734 (CA). In spite of this principle, the court will view a guarantee as a whole with a view to ascertaining its intended scope and extent: Bank of Scotland v Wright [1991] BCLC 244. In attempting to protect the guarantor, the court should not strain to avoid the clear meaning of the guarantee: see Tam Wing Chuan v Bank of Credit and Commerce International Ltd [1996] 2 BCLC 693.

57  See Coghlan v SH Lock (Australia) Ltd [1987] 3 BCC 183; Perrylease Ltd v Imecar AG [1988] 1 WLR 463; Associated Japanese Bank (International) Ltd v Crédit du Nord SA [1988] 3 All ER 902, and other cases cited in the Encyclopaedia of Banking Law, para 2054.

58  See, for example, OJSC Alfa Bank v Trefilov [2014] All ER (D) 117 (Jun); [2014] EWHC 1806 (Comm).

59  ie in accordance with the broader approach endorsed by the House of Lords in Investors Compensation Board Ltd v West Bromwich Building Society [1998] 1 All ER 98.

60  See Static Control Components (Europe) Ltd v Egan [2004] EWHC Civ 392. See also the construction issues which arose in the context of the guarantee in Dumford Trading AG v OAO Alantrybflot [2005] EWHC Civ 24.

61  It should be made clear that the guarantee does extend to ‘all monies’. If the guarantee is issued for a specific purpose, then it may be possible to construe the guarantee as limited to that purpose: see and contrast National Merchant Buying Society Ltd v Mallett [2013] EWCA Civ 452 and Bank of Baroda v Patel [1996] 1 Lloyds Rep 391.

62  [2005] EWCA Civ 630 (CA). For a case in which a bank lost the benefit of a director’s personal guarantee of his company’s borrowings because of apparent confusion between the parties, see Lloyds TSB Bank plc v Hayward [2005] EWCA Civ 466.

63  Triodos Bank, n 62 above, para 9.

64  To avoid this problem and also to minimize confusion which may be caused by later changes of corporate names, it is good practice to include the registered numbers of the various entities involved.

65  [2005] EWHC Civ 24.

66  The relevant entities were incorporated in Russia. According to the judgment, ‘OAO’ denotes a public company, whilst ‘ZAO’ refers to a private company.

67  For a recent example, see ABN Amro Commercial Finance PLC v McGinn [2014] 2 Lloyds Rep 333; [2014] EWHC 1674 (Comm).

68  See, for example, IIG Capital LLC v van der Merwe [2008] 2 All ER (Comm) 1173; [2008] EWCA Civ 542; North Shore Ventures Ltd v Anstead Holdings Inc [2011] 2 Lloyds Rep 45; [2011] EWCA 230.

69  On the 1977 Act, see the discussion at para 26.48 below.

70  See AXA Sun Life Services PLC v Campbell Martin Ltd [2012] Ch 31; [2011] EWCA Civ 133.

71  See the discussion of the decision in Etridge and companion cases at paras 26.53–26.56 below.

72  Although the provision about to be discussed is drawn from the Statute of Frauds Amendment Act 1826, it appears that the provision would apply to any form of representation made by the bank, whether innocent, negligent, or fraudulent.

73  For a decision relating to this section, see UBAF Ltd v European American Banking Corp [1984] 2 All ER 226 (CA).

74  See the discussion at paras 26.53–23.56 below.

75  See Harvey v Dunbar Assets plc [2013] All ER (D) 400 (Jun); [2013] EWCA Civ 952. It is, however, necessary to prove that it was the common intention of all parties that the effect of the guarantee should be conditional on signature by all of the intended guarantors: for a contrasting situation, see Capital Bank Cashflow Finance Ltd v Southall [2004] 2 All ER (Comm) 675; [2004] EWCA Civ 817.

76  For example because, as in the Harvey case, one of the signatures was alleged to be a forgery.

77  See, for example, Bank Leumi (UK) plc v Akrill [2014] All ER (D) 192 (Jul); [2014] EWCA Civ 907.

78  See Moschi v Lep Air Services Ltd [1973] AC 331 (HL). It is submitted that this analysis suffers from an air of unreality. Where the guarantor is a subsidiary of the principal debtor, or is a bank providing a guarantee for a fee, it will not be in a position to ‘ensure’ that the primary debtor does anything. The reality is that the guarantor is accepting liability for the debt of a third party. There is no reason why this should not be treated as a debt of the guarantor, albeit subject to the contingency of a default by the main borrower.

79  See, for example, Sabah Shipyard (Pakistan) Ltd v Islamic Republic of Pakistan [2007] EWHC 2602 (Comm).

80  See Van der Merwe v IIG Capital LLC [2008] EWCA Civ 542.

81  For a case in which this point was disputed, but in which the court ultimately arrived at the view stated in the text, see AIB Group (UK) Ltd v Martin [2002] 1 All ER 353; [2001] UKHL 64.

82  See para 15.41 above.

83  SI 1999/2083.

84  See para 26.04 above.

85  See para 15.41 above.

86  On matters of this kind, see the discussion at para 26.81 below. Note that the 1977 Act applies where (i) one party deals as a consumer or (ii) the parties deal on the bank’s standard terms. The 1977 Act may therefore apply to a bank even in the context of its dealings with corporate customers. This should be contrasted with the1999 Regulations discussed below, which apply only to consumers.

87  See s 13 of the Act, which extends the meaning of ‘exclude or restrict’ a liability to embrace provisions which (i) exclude or restrict any right or remedy in respect of a liability, (ii) render the enforcement of a liability subject to onerous conditions, or (iii) exclude or restrict rules of procedure.

88  On provisions of this type, see the discussion in relation to loan or facility agreements at para 20.50 above.

89  For a decision specifically in relation to a ‘no set-off’ clause in a guarantee, see Barclays Bank plc v Kufner [2008] EWHC 2319 (Comm). In Stuart Gill Ltd v Horatio Myer & Co Ltd [1992] QB 600 (CA), it was held that a clause was unreasonable insofar as it prevented set-off in respect of a claim arising with respect to the goods and services for which the relevant payment was claimed. It would be more difficult to apply this reasoning to a purely financial contract and, in any event, a bank undertakes no obligations to the guarantor under a standard form guarantee. As a result, it is suggested that the decision in Stuart Gill could not be applied in this particular context. This view derives some support from the decision in Bank of Scotland v Reuben Singh (unreported, 17 June 2005).

90  [1997] 2 BCLC 398. In theory, the clause prohibited set-off even in respect of fraud by the bank, but this was held to be immaterial since fraud would have been outside the contemplation of the parties in any event. A ‘no set-off’ clause was similarly found to pass the ‘reasonableness’ test in United Trust Bank v Dohill [2012] 2 All ER (Comm) 765; [2013] EWHC 3302 (QB). For a further case discussing (but not deciding) the extent of a guarantor’s right of set-off under these circumstances, see National Westminster Bank plc v Bowles [2006] All ER (D) 447 (Jul).

91  [1986] 2 Lloyds Rep 441 (CA).

92  SI 1999/2038.

93  ie a person acting outside the scope of his trade, business or profession: art 3(1) of the 1999 Regulations.

94  Article 8 of the 1999 Regulations. Schedule 2 to the regulations sets out a list of factors which must be taken into account in determining whether a term is ‘unfair’ for these purposes. Many of these factors will be inapplicable to guarantees in view of their essentially unilateral nature. Provisions which may potentially be applicable to consumer financial contracts have already been noted at para 15.41 above.

95  Regulation 9 of the 1999 Regulations.

96  As noted at para 26.14 above, the bank provides consideration for the guarantee in the technical sense, but this consideration is not received by the guarantor.

97  See paras 26.63–26.77 below.

98  This view was adopted in Bank of Scotland v Reuben Singh (unreported, 17 June 2005), followed in Williamson v Bank of Scotland [2006] EWHC 1289 (Ch) and Manches v Freer [2006] All ER (D) 428.

99  Kufner, n 89 above, relying on a decision of the European Court of Justice in case C-45/96, Bayerische Hypotheken- und Wechselbank AG v Dietzinger [1998] 1 WLR 1035, albeit decided in a slightly different context.

100  [2013] EWHC 3302 (Ch). See para 66 of the judgment.

101  This alternative line of reasoning was explored in Kufner, n 89 above.

102  Cf Standard Bank Ltd v Apostolakis [2003] IL Pr 766.

103  See Family Law Reform Act 1969, s 1(1). In formal terms, capacity can thereafter only be called into question if the guarantor was of unsound mind, or was insufficiently sober to understand the implications of the transaction at hand; on these aspects of contractual capacity, see Chitty, ch 8.

104  This delicate turn of phrase was employed by Lord Nicholls in Royal Bank of Scotland plc v Etridge (No 2) [2001] UKHL 44 (para 87). The case is considered in more detail, below.

105  See para 32.44 below.

106  Imperial Loan Co v Stone [1892] 1 QB 599; Josife v Summertrot Holdings Ltd [2014] EWHC 996 (Ch).

107  Companies Act 2006, s 31.

108  Companies Act 2006, s 18.

109  The memorandum and articles of association constitute a contract as between the company itself and its members: see Companies Act 2006, s 33.

110  As a matter of detail, it should be noted that some of the provisions about to be discussed will not apply where the company concerned is a charity: see Companies Act 2006, s 42.

111  See Companies Act 2006, s 31, to which reference has already been made.

112  For example whether because it has in fact examined the memorandum or because the directors have advised it of the position.

113  Companies Act 2006, s 40(1). References to limitations deriving from the company’s constitution include any such restrictions as may be found in any resolution of the company or any shareholders’ agreement: s 40(3) of the 2006 Act.

114  Section 40(2)(b)(i) of the 2006 Act. Once again, it is submitted that the bank can hold the company to the transaction even though it knew that the guarantee fell within the scope of some limitation applicable to the exercise of the directors’ power to give guarantees. If the bank is not under a duty to make enquiries in the first place, it should not be disadvantaged by the fact that it had chosen to make such enquiries or had otherwise discovered the relevant limitation.

115  A limit on borrowings will usually include a limit on the level of guarantees which may be given for the benefit of subsidiaries and others. For companies which adopted articles of association in the form of Table A to the Companies Act 1948, a borrowing limit equal to the company’s capital and reserves applied—see art 79 of Table A.

116  Smith v Henniker-Major [2002] BCC 544 (CA). A failure to give adequate notice to all of the directors of the company as a result of a mistaken interpretation of the relevant provisions of the articles of association will thus not affect an outside party dealing with the company in good faith, since the provision constitutes a ‘…limitation on the powers of the directors…’ for these purposes: see Ford v Polymer Vision Ltd [2009] 2 BCLC 160; [2009] EWHC 945 (Ch).

117  Companies Act 2006, s 40(b)(ii) and (iii).

118  For reasons which will become apparent, it is necessary to emphasize that the directors must exercise their powers for the benefit of their particular company, and not for the benefit of the wider group of which the company forms a part. It should be noted that the duties of directors are now to some extent codified by ss 170–181 of the Companies Act 2006.

119  Although the case did not arise in a banking context and the statutory provisions were only briefly noted, the point made in the text is well illustrated by the House of Lords decision in Criterion Properties plc v Stratford Properties LLC [2004] UKHL 28.

120  In this type of situation, it would be necessary to have recourse to more traditional procedures. The bank would have to ensure that company has power to provide the guarantee under the terms of its memorandum, and that all internal procedures required to sanction the transaction under the articles of association had been duly carried out. It would then have to obtain from the holding company a waiver of any breach of fiduciary duty involved in the execution of the guarantee, although it should be noted that any such waiver may only be effective if the subsidiary remains solvent notwithstanding the obligations assumed pursuant to the guarantee: on this subject, see Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246. In other words, if the statutory protections are not available for some reason, then the bank must take steps to satisfy itself that the directors are not in fact acting in breach of their fiduciary duties.

121  In other words, the guarantee can only be impugned if (i) the directors did in fact provide the guarantee in breach of their duties and (ii) the bank was aware of the facts which gave rise to such breach: see, for example, Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62, where a guarantee and security given to cover the liabilities of a fellow group member was upheld.

122  Rolled Steel Products (Holdings) Limited v British Steel Corporation [1986] Ch 246.

123  Re Introductions Ltd [1970] Ch 199.

124  Ford v Polymer Vision Ltd [2009] 2 BCLC 160; [2009] EWHC 945 (Ch), para 92.

125  For example by making such inquiries as may be necessary to satisfy itself that no breach of fiduciary duty is involved.

126  Criterion Properties plc v Stratford Properties LLC [2004] UKHL 28, discussed and applied in Ford v Polymer Vision Ltd [2009] 2 BCLC 160; [2009] EWHC 945.

127  On apparent authority and the position of the third party dealing with the company, see Chitty, paras 31-054–31-081. On the application of the principle in the present context, see Paget, para 6.4. For a recent case in which a claimant sought to rely on the ostensible authority of the chief executive of a Korean company to execute guarantees in respect of a shipbuilding contract, see Rimpacific Navigation Inc v Daehan Shipbuilding Co Ltd [2010] 2 All ER (Comm) 814; [2009] EWHC 2941 (Comm).

128  See Companies Act 2006, s 42.

129  See Alliance Bank Ltd v Kearsley (1871) LR 6 CP 433.

130  Crédit Suisse v Allerdale Borough Council [1996] 2 Lloyds Rep 241 (CA); Crédit Suisse v Waltham Forest London Borough Council [1996] 4 All ER 176 (CA). The guarantees given in each of these cases were held to be void on the basis that they fell beyond the authority’s powers. Note also the vires issues which arose in relation to swap contracts entered into by local authorities: see the discussion at paras 23.29–23.34 above.

131  See the discussion at para 26.57 above.

132  Barclays Bank plc v Khaira [1992] 1 WLR 623; Union Bank of Finland v Lelakis [1995] CLC 27; and other cases noted by Paget, para 13.20.

133  National Commercial Bank (Jamaica) Ltd v Hew [2003] UKPC 51 (PC).

134  Grant Estates Ltd v Royal Bank of Scotland plc [2012] CSOH 133; Barclays Bank plc v Svizera [2014] All ER (D) 65 (Apr); [2014] EWHC 1020 (Comm).

135  The point has most recently been re-affirmed by the House of Lords in Royal Bank of Scotland plc v Etridge (No 2) [2001] UKHL 44, para 185.

136  See, for example, Union Bank of Australia Ltd v Puddy [1949] VLR 242; Goodwin v National Bank of Australasia (1968) 117 CLR 173; Westpac Banking Corporation v Robinson (1993) 30 NSWLR 668; and other cases cited in Paget, para 18.18.

137  Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447. It may be said that such reservations will often be implicit in the request for the guarantee.

138  Levett v Barclays Bank plc [1995] 1 WLR 1260.

139  See Paget, para 18.17, citing Goad v Canadian Imperial Bank of Commerce (1968) 67 DLR (2d) 189 and Crédit Lyonnais Bank Nederland v Export Credits Guarantee Department [1996] 1 Lloyds Rep 200 (CA). In similar vein, see National Westminster Bank plc v Kotonou [2006] All ER (D) 325 (May).

140  North Shore Ventures Ltd v Anstead Holdings Inc [2011] 1 All ER (Comm) 85. The judgment includes a detailed discussion of earlier case law on the bank’s duty of disclosure to a guarantor.

141  See generally the provisions of the Misrepresentation Act 1967; Barton v County NatWest Bank Ltd [1999] Lloyds Rep Bank 408.

142  Paget, para 18.16, and cases there cited.

143  On the rights of subrogation and contribution, see paras 26.93–26.94 below.

144  See Kufner, n 89 above.

145  On the guarantor’s right of subrogation, see paras 26.93–26.94 below.

146  See para 32.30 below.

147  [2006] 1 All ER (Comm) 519.

148  The point was made in the Kingston case, n 147 above. For earlier cases confirming the existence of this equitable duty, see Standard Chartered Bank v Walker [1982] 3 All ER 938; American Express International Bank Corp v Hurley [1985] 3 All ER 564; and Skipton Building Society v Stott [2000] 1 All ER (Comm) 257 (CA). In other cases—for example Barclays Bank Ltd v Thienel (1978) 247 EG 385 and Burgess v Auger [1998] 2 BCLC 478—it had been decided that no such duty was owed to a guarantor who had made no payment. But these decisions cannot stand in the face of the authorities just mentioned.

149  See the situation that arose in Butterfield Bank (UK) Ltd v Philip [2013] EWCA Civ 1770.

150  At any rate, this is the case if the guarantee is given on an ‘all monies’ basis, and is not capped at a particular financial limit.

151  The guarantor’s rights of subrogation and contribution are briefly discussed at paras 26.93–26.94 below.

152  On preferences, see para 39.06 below.

153  For a decision which illustrates this point, see Western Credit Ltd v Alberry [1964] 2 All ER 938 (CA). In discussions with the guarantor, the bank must take care not to give assurances that it will not vary the underlying facility agreement, since this may override the protective contractual clause noted in the text: see Lloyds TSB Bank plc v Haywood [2005] All ER (D) 384 (Apr).

154  Hyundai Shipbuilding and Heavy Industries Ltd v Pournaras [1978] 2 Lloyds Rep 502; The Maistros [1984] 1 Lloyds Rep 646.

155  National Westminster Bank plc v Skelton [1993] 1 All ER 242 and Ashley Guarantee PLC v Zacaria [1993] 1 WLR 62. These cases are noted by McKnight, para 16.10.3.

156  Mahant Singh v U Ba Yi [1939] AC 601; Associated British Ports v Ferryways NV [2009] EWCA Civ 189 (CA).

157  See China and South Sea Bank Ltd v Tan [1990] 1 AC 536.

158  The leading English authority is Holme v Brunskill (1878) 3 QBD 495. For an assessment of the ‘materiality’ of changes to the underlying agreement, see Aviva Insurance Ltd v Hackney Empire Ltd [2012] EWCA Civ 1716. Courts in Australia have formulated this test rather more strictly, holding that ‘…any departure by the creditor from the suretyship contract which is not obviously and without enquiry insubstantial, will discharge the surety from liability, whether it injures him or not…’: Anker Ltd v National Westminster Finance Australia Ltd [1987] 162 CLR 549, at p 588. It is open to a guarantor to agree otherwise, but the wording must be clear and must cover the circumstances which have arisen. Thus, where a clause stated that the guarantor ‘…will not be released from any obligations by reason only of any extension of time granted or any other act or omission by the [lender] favouring the [borrower]…’ this language was not broad enough to cover the lender’s agreement to increase the overall amount of the facilities and the guarantor was discharged accordingly: see Valstar v Silversmith [2009] NSWCA 80 (New South Wales Court of Appeal).

159  Bank of Scotland plc v Makris and O’Sullivan (Ch D, 15 May 2009).

160  The difficulties experienced by the bank in Triodos Bank v Dobbs [2005] EWCA Civ 630 (CA) (see para 26.30 above) provide a salutary reminder of the need to secure the guarantor’s consent for these purposes. See also Silverburn Finance (UK) Ltd v Salt [2001] 2 All ER (Comm) 438 (CA), where the guarantee in question applied to a factoring agreement. It was found to have terminated when the factoring agreement came to an end, and thus could not be invoked in relation to a subsequent factoring agreement between the same parties. Whether or not the guarantors have agreed to a variation in a particular case may be a difficult factual question. Company directors may be taken to have agreed to an extension of their personal guarantees if, in their capacity as directors, they sign a letter agreeing to an increase in the facility and that letter stipulates that the personal guarantees should apply: see Moat Financial Services Ltd v Wilkinson [2005] EWCA Civ 1253. However, a restructuring of the underlying indebtedness will not always discharge the guarantor: see Wittman (UK) Ltd v Willdav Engineering SA [2007] EWCA Civ 824 (CA). Cases of this kind will inevitably tend to be highly fact-sensitive.

161  For a case in which the guarantors unsuccessfully argued that their consent had been obtained in this way, see Close Bros Ltd v Ridsdale [2012] All ER (D) 156 (Nov); [2012] EWHC 3090 (QB).

162  Mercantile Bank of Sydney v Taylor [1893] AC 317 (PC); Liverpool Corn Trade Association Ltd v Hurst [1936] 2 All ER 309; Skipton Building Society v Scott [2001] QB 261; Kufner, n 89 above.

163  See James Graham & Co (Timber) Ltd v Southgate Sands [1986] QB 80 (CA). If the guarantor was not aware of the proposal to take other guarantees and security and had thus not placed any reliance on those arrangements when deciding to execute his own guarantee, then it seems that any subsequent release of those additional securities should not affect the guarantor’s liability—see Mount v Barker Austin [1998] PNLR 493 (CA), noted by Paget, para 18.13.

164  Bank of India v Trans Continental Commodity Merchants Ltd [1983] 2 Lloyds Rep 298 (CA).

165  This seems to follow from the decision in Mount v Barker Austin (n 163 above).

166  For a recent example, see Kufner, n 89 above.

167  See generally Chapter 39 below.

168  The comments about to be made would apply equally to any security given for the obligations of a third party, whether or not supported by a guarantee.

169  See paras 26.53–26.61 above.

170  For example, a shareholder could challenge a guarantee given by the company on the basis that it was, to the knowledge of the lender, given in breach of the directors’ fiduciary duties. A situation of this kind arose in Criterion Properties plc v Stratford Properties LLC [2004] UKHL 28.

171  See Chapter 39 below. Whilst the present discussion is framed by reference to the rules applicable to corporate insolvency, it should be noted that similar provisions apply to individuals: see Insolvency Act 1986, ss 339–343.

172  This is the combined effect of the Insolvency Act 1986, ss 239 and 240. A longer time period applies where there is some group or other connection between the debtor and creditor, but this will not normally arise in the context of an ordinary banking relationship.

173  The following definition is derived from the Insolvency Act 1986, s 239(4).

174  For more detailed discussion of the ‘preference’ provision in a banking context, see Paget, para 20.56.

175  This is the combined effect of the Insolvency Act 1986, ss 238 and 240. See the materials referred to in n 174 above.

176  See para 26.14 above.

177  This follows from the definition of ‘relevant time’ in the Insolvency Act 1986, s 240.

178  Insolvency Act 1986, s 238(5).

179  See, for example, the situation which arose in First National Finance Corporation v Goodman [1983] BCLC 203 (CA).

180  Silverburn Finance (UK) Ltd v Salt [2001] 2 All ER (Comm) 438 (CA). Note, however, that the decision applies to guarantees given on a continuing basis to cover transactions from time to time entered into by the borrower with the financier. The implied right of termination should not apply to a guarantee given in respect of a particular and ascertained facility, since the guarantor will have contracted to cover that facility in full.

181  Subrogation is an equitable right and will generally arise only if the transaction was entered into at the behest of the principal debtor: see Owen v Tate [1976] QB 402.

182  These rights of subrogation and contribution are derived from equitable principles but see also Mercantile Law Amendment Act 1856, s 5.

183  See Re SSSL Realisations (2002) Ltd v AIG Europe (UK) Ltd [2006] Ch 610. The court specifically held that an undertaking of this kind did not contravene s 107 of the Insolvency Act 1986 (dealing with the distribution of a company’s property) or r 4.181 of the Insolvency Rules 1986. There was therefore no basis on which such clauses could be disregarded on public policy grounds.

184  In Cattles plc v Welcome Financial Services Ltd [2009] EWHC 3027, the court held that a clause of the type described in the text was effective to preclude the guarantor from competing with the lenders (see in particular para 55 of the judgment). However, at around the same time (and admittedly on the basis of different documentation) another court reached a different conclusion in Mills and others v HSBC Trustee (CI) Ltd [2009] EWHC 3377 (Ch).

185  This apparently bizarre distinction follows from the decision in Re Sass [1896] 2 QB 12, on which see Goode on Legal Problems of Credit and Security (4th edn, Louise Gullifer, 2008) para 8-18.

186  It is assumed for present purposes that—as would usually be the case, the agreement between the French borrower and the English bank is governed by English law.

187  See Chapter 41 below.

188  See Art 3 of Rome I.

189  On these points, see Art 12 of Rome I.

190  See para 41.09 below.

191  Article 4(2) of Rome I.

192  For an earlier case which adopted this approach under the pre-existing rules of private international law, see Broken Hill Pty Ltd v Xenakis [1982] 2 Lloyds Rep 304.

193  See Land Rover Exports Ltd v Samcrete Egypt Engineers and Contractors SAE [2001] EWCA Civ 2019.

194  See the decision of the European Court of Justice in Case C-133/08, Intercontainer Interfrigio SC v Balkende Oosthuizen BV [2009] ECR-I 9687.

195  British Arab Commercial Bank plc v Bank of Communications [2011] 1 Lloyds Rep 664; [2011] EWHC 281 (Comm).

196  See Art 11, Rome I. For a recent case where a guarantee was found to be governed by Russian law, see VIS Trading Co Ltd v Nazarov [2014] All ER (D) 245 (Mar); [2014] EWCA Civ 313.

197  [2013] All ER (D) 48 (Sep).