High court confirms that a covenant not to sue will not extinguish a guarantor’s right of contribution - Contracts and Commercial Law

BACKGROUND

Ms Lavin and Ms Toppi were directors of Luxe Studios Pty Ltd (Luxe). Luxe had borrowed more than $7 million from its financier (Bank).

Those borrowings were supported by joint and several guarantees provided by:

Ms Lavin and a company controlled by her;
Ms Toppi and her husband.

In 2009, the Bank appointed receivers to Luxe. After asset realisations were completed, a residual debt of $4 million remained owing to the Bank. The Bank commenced proceedings against the guarantors to recover that shortfall.

Ms Lavin and her company counterclaimed against the Bank in those proceedings, and, in September 2010, Ms Lavin, her associated company and the Bank entered into a settlement deed. The key terms of settlement were that $1.35 million would be paid to the Bank (in respect of the guaranteed debt) and, in turn, the Bank would not sue Ms Lavin and her company in respect of the guarantee provided by them.

In 2011, Ms Toppi and her husband paid the Bank the balance of the debt of around $2.9 million. This meant that all amounts owing to the Bank by Luxe and all guarantors had been satisfied.

THE CONTRIBUTION PROCEEDING

In 2012, Ms Toppi and her husband commenced proceedings against Ms Lavin and her associated company seeking contribution in the amount of around $775,000. That amount represented the midpoint between the amount paid by Ms Toppi and her husband to the Bank and the amount paid by Ms Lavin and her company – being the amount recoverable under the well recognised right of contribution.

The trial Judge found in favour of Ms Toppi and her husband. On appeal, the NSW Court of Appeal affirmed that decision.

APPEAL TO THE HIGH COURT

The appeal brought by Ms Lavin and her company in the High Court was based on the grounds that the Court of Appeal erred in holding that the various guarantors shared liabilities of the same nature and extent at the time Ms Toppi and her husband paid the balance of the guaranteed debt. It was argued that:

The liabilities were "qualitatively different" in that the liability of Ms Toppi and her husband was enforceable by the Bank, whereas the liability of Ms Lavin and her company was not.
The discharge of the guarantee by Ms Toppi and her husband provided no real benefit to Ms Lavin and her company, as by the time the guarantee was discharged, the Bank had already provided the covenant not to sue.

DECISION

In rejecting the appeal, the High Court noted that Ms Lavin and her company's arguments were "both novel and unduly technical". The Court made the following findings:

Coordinate liabilities – A covenant not to sue does not result in a 'qualitative alteration' to a co-guarantor's obligations under a guarantee. The Bank's covenant not to sue did not discharge the liability under the guarantee. As the liability remained, all guarantors shared 'coordinate' liabilities, which in turn entitled Ms Toppi and her husband to seek contribution.
Equity – As soon as a creditor calls upon a co-guarantor to pay a guaranteed debt, the right of the co-guarantor to contribution is enlivened and cannot then be defeated by a dealing between the creditor and other co-guarantors, such as a covenant not to sue. Unlike the common law, the equity of contribution can be called upon before actual payment is made or loss sustained, provided that such payment or loss is imminent.

COMMENT

This decision is important as it reinforces the effectiveness of covenants not to sue in dealings between creditors and guarantors. In circumstances where a guarantor makes part payment of a debt, it is common practice for creditors to provide covenants not to sue instead of a release, so as to ensure that the creditor's rights against the remaining guarantors are preserved. This decision makes it emphatically clear that this approach does not prejudice the substantive rights of the guarantor.

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