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Guarantees - Traps for the UnwaryPaul Anderson | July 2012 | Corporate & Commercial

A recent Supreme Court case raises several important and practical issues involving personal guarantees.

Who does this impact?

Lenders, borrowers and providers of guarantees and their advisers.

What action should be taken?

Care should be taken in drafting guarantees and terms of settlement if proceedings are compromised against one of several guarantors.

The recent Supreme Court decisions of Padstow Corporation Pty Limited v Fleming No.1 & No.2 raise two important and highly practical issues involving personal guarantees.

Proceedings No. 1

Facts

Padstow Corporation Pty Limited (“Padstow”) sued Fleming Senior and Fleming Junior for amounts allegedly owing by them as guarantors of Hamola Crochet Pty Limited (“Hamola”) under a commercial property lease between Padstow and Hamola.

Following the institution of these proceedings in the Supreme Court, Padstow entered into Terms of Settlement with Fleming Senior only as a result of which the legal proceedings against him were discontinued.

In proceedings No. 1, Fleming Junior contended that the Terms of Settlement operated to release his liability as guarantor as well.

Legal Principles

The presiding judge, Gzell, J, found that the relevant legal principles were not in dispute. The correctness of the argument raised turned on the proper construction of the Terms of Settlement. In particular, the question was whether the Terms operated as a covenant not to sue Fleming Senior or as a release of the obligation owed by both guarantors.

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Guarantees - Traps for the UnwaryPaul Anderson | July 2012

The authorities made it clear that the discharge by the principal of a co-guarantor discharges the other co-guarantors. The old authorities expressed the principle as “the guarantee is not or ceases to be that which was guaranteed”

The difficult task is that of construction of the Terms of Settlement in a particular case in determining whether they are intended to operate as a release or as a covenant not to sue.

A number of common threads emerge from the cases, namely:

> Where there is a joint obligation, a covenant which is expressed in terms of a release is usually construed as such. Where the obligation is joint and several, a provision is more likely to be construed as a covenant not to sue.

> If any intention to reserve rights against other co-guarantors is found expressly or impliedly in the document containing the release, then it is most likely that the parties intended a covenant not to sue; and

> The court may have regard to the surrounding circumstances in determining the issue.

Decision

The Judge looked at the following factors;

> The word “release” was not used, which was an indication that the terms were intended to be a covenant not to sue;

> The liability was joint and several;

> In clause 2(a) of the Terms, Padstow expressly covenanted not to sue in respect of the claim specified in clause 6. Clause 6 provided that Padstow would not “make, commence or continue any suit etc” against Fleming Senior;

> Clauses 2(b) and 7 of the Terms expressly reserved the rights of Padstow and Fleming Senior against Fleming Junior;

> Clause 9 dealt with the possibility of Fleming Junior claiming contribution against Fleming Senior by providing for an adjustment between Padstow and Fleming Senior if this was to occur; and

> The fact that proceedings were on foot militated against it being the intent of the parties that Fleming Junior be released. If that was the intention, Fleming Junior could easily have been made a party to the Terms of Settlement.

In the result, the application was dismissed and the proceedings against Fleming Junior proceeded.

Comment

The case highlights the extreme care to be taken when compromising proceedings against one of several guarantors. If such care is not exercised, a release may extend to all of the guarantors, even if that result was not intended.

Proceedings No. 2

Facts

Fleming Junior submitted that he was not bound by the guarantee in the lease because he did not sign it in his personal capacity but only in his capacity as a director of Hamola.

Clause 13 of the lease was a guarantee clause. Clause 13.1 provided that clause 13 applied if a guarantor of the tenant was named in item 10A of the schedule to the lease and had signed or executed the lease. Item 10A contained the names of Fleming Senior and Fleming Junior.

There was provision in the lease for signature by Hamola and Fleming Junior signed as a director of the company. There was no separate provision for execution by the guarantors. There was no evidence of any negotiations with Fleming Junior with respect to a guarantee, although he agreed in cross examination that he thought he might be asked to provide a personal guarantee at some stage.

It was submitted that to bind Fleming Junior he needed to sign a second time in his personal capacity as guarantor.

Legal Principles

The authorities made it clear that the question of whether a person has signed in a personal capacity is to be determined in accordance with

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Guarantees - Traps for the UnwaryPaul Anderson | July 2012

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the construction of the document as a whole and on the basis of admissible surrounding circumstances known to the parties.

A crucial factor was that Fleming Junior had been advised by a solicitor, Mr Minter, prior to signing the document. Mr Minter went through the lease with the parties in detail on the basis that Fleming Junior was a guarantor. Admittedly, Mr Minter was acting for Hamola, Fleming Senior and Fleming Junior so it could not be said that the advice Fleming Junior received was entirely independent.

Another important point was that Fleming Junior was familiar with personal guarantees and had signed them in the past.

In the result, the Judge found that Fleming Junior was a guarantor of the lease. Although Fleming Junior had signed the document only once, his signature operated to bind both Hamola and Fleming Junior personally as guarantor.

Comment

The proceedings ended in a satisfactory manner for the landlord, Padstow. However, the drama could easily have been avoided by providing in the lease for a separate execution clause by the guarantors and insisting they sign in their personal capacity. The successful outcome to the proceedings must have led the landlord’s solicitor (who had drawn the lease) to breathe a sigh of relief because Padstow had joined the solicitor to the proceedings seeking an indemnity if Fleming Junior was held not to be a guarantor or if the proceedings against him failed.

For more information, please contact:

Paul AndersonSpecial CounselT: 02 8257 5742M: 0418 491 395paul.anderson@turkslegal.com.au