Australia: When can a guarantor rely on a right of subrogation?

This week's TGIF considers the case of Bowesco Pty Ltd v Westpoint Management Ltd [2015] WASCA 184, which considered whether a guarantor had a right of subrogation enabling it to be repaid in advance of the second ranking creditor.

BACKGROUND

The first lender advanced funds to the company for the purposes of a construction project. Pursuant to the first loan agreement, the first lender received a first-ranking charge over the company's assets and the guarantor guaranteed the obligations of the company to the first lender.

The company also entered into a loan agreement with the second lender secured by a second-ranking charge.

The company subsequently experienced financial difficulty and the guarantor advanced funds to it in order to ensure the completion of the project.

The first lender appointed receivers to the company's assets and the receivers exercised their right of sale in respect of those assets. The amount received from the sale discharged the debt owed to the first lender in full and the surplus proceeds of sale were paid to the second lender.

The guarantor argued that as it had provided funds to the company in its capacity as guarantor under the first loan agreement, it had a right to be subrogated to the position of the first lender. The guarantor contended that this meant it had a right to be repaid in advance of the second lender.

DECISION

In dismissing the appeal, the Court relied on the High Court's decision of Bofinger v Kingsway Group Ltd, in which the High Court emphasised that in order to benefit from the right of subrogation, the guarantor must establish that the funds were advanced pursuant to the guarantee and resulted in the reduction or discharge of the principal debtor's liability to the creditor.

In this case, while the company had an obligation to complete the project, the terms of the guarantee did not require the guarantor itself to perform that obligation or see to it that the company performed its obligations to the first lender. Rather, the guarantee required the guarantor to pay any debt or damages arising from the company defaulting on its obligations.

Accordingly, by advancing funds to the company to enable it to complete the construction project, the guarantor had not acted pursuant to the guarantee and had not, in substance or effect, reduced the company's indebtedness to the first lender at any time. The guarantor was therefore unable to benefit from the right of subrogation and did not have a right to be paid the surplus funds ahead of the second lender.

COMMENT

This case confirms that the right of subrogation in respect of a guarantee is conditional upon the reduction or discharge of the principal debtor's liability to the creditor, by the guarantor.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Most awarded firm and Australian deal of the year Australasian Legal Business Awards	Employer of Choice for Women Equal Opportunity for Women in the Workplace (EOWA)