Duty of a Creditor to a Guarantor
If you are involved in a contract which is secured by both security and a guarantee then it is important to note that the creditor will owe the guarantor equitable duties on top of any contractual duties.
In the recent case of Webster Investments Pty Ltd v Anderson [2016] VSC 620 a judge of the Victorian Supreme Court has clarified the consequences of failing to adhere to these duties. In that case the guarantor was entirely released from any obligation to guarantee the debt.
While the exact scope of the duties is not yet settled at law, they have been expressed as follows:
- A creditor has a duty to a guarantor to take reasonable care and not act in neglect or default when dealing with security; and
- A creditor has a duty to a guarantor to not diminish or release security.
What will amount to a breach of the duty
In Williams v Frayne (1937) 58 CLR 710 the High Court recognised the right of a guarantor of a secured debt to show that their liability to the secured creditor has been reduced or entirely avoided due to a creditor’s flawed dealings with the security. What amounts to flawed dealings with security will vary in each case and depends upon the circumstances, including the nature of the security taken and the conditions placed on it.
However, creditors and guarantors should be aware that it may include poor conduct in the sale of the security which has meant its true value has not been realised. Another example is where the security is released without the guarantors consent.
For a breach of duty to be actionable, a guarantor must prove that they have suffered loss as a result. An example is provided in Bank of Victoria v Smith (1894) 20 VLR 450 where security in the form of shares was released by a creditor, only to be replaced by other shares. The Court noted that if they were of the same value then no injury would be suffered and the creditor would not have breached their duty to the guarantor.
Consequences
If a creditor breaches the duties owed to a guarantor and a guarantor has suffered loss, it is open to a Court to either reduce the guarantor’s liability by the amount the value of the contractual security is reduced, or alternatively to completely absolve the guarantor of their obligation to guarantee the debt.
In Webster Investments Pty Ltd v Anderson [2016] VSC 620 it was found that, at least in cases where a creditor has acted with gross misconduct or fraud, the guarantor may be released from their contract entirely. In other cases, where the creditor’s actions amount only to negligence or misconduct the appropriate remedy may be to reduce the guarantor’s liability by the same amount of the reduction of the security.
Therefore in cases where a creditor’s breach of duty does not amount to gross misconduct or fraud a guarantor may still owe money to a creditor where the guaranteed debt is greater than the value that the security has been diminished.
Contractual Erosion of Protection
It is also important to note that it is open to the creditor and guarantor to exclude the above duties when they enter into a contract. This means in a contract with a guarantor, a creditor can include a clause which allows it to deal with the security in any way it chooses and excludes liability to the guarantor if the creditor releases or impairs the security to the contract. In the case of Duncombe v ANZ Bank [1970] WD R 202 it was explained that if such a clause is inserted into a contract it will be construed strictly against the creditor. This means that any such clause which tries to exclude liability must be drafted carefully to ensure a Court gives it a full effect.
For more information, contact Thomas Camp at Thomas@mdk.com.au
