Guarantors must - pay now, sue later - Charges, Mortgages, Indemnities

This week's TGIF considers Palaniappan v Westpac Banking Corporation [2016] WASCA 72 in which the Court clarified the scope of 'suspension clauses' in guarantee agreements.

BACKGROUND

Suspension clauses are commonly found in loan and security documents and other commercial transactions. Suspension clauses typically provide that the guarantor or borrower agrees not to raise any set-offs, counter-claims or deductions until after the debt has been repaid in full. They therefore 'suspend' any rights of a borrower or guarantor against the lender until after the loan has been repaid.

WHAT HAPPENED?

Westpac Banking Corporation granted overdraft and loan facilities to Murray Riverside to the value of $18 million which were secured by mortgages and a guarantee from Palaniappan (a director of Murray Riverside).

The guarantee agreement contained the following suspension provisions:

as long as any guaranteed money remains unpaid, the guarantor must not reduce its liability under the guarantee by claiming that it or the company has a right of set-off or counterclaim against Westpac; and
the guarantor is required to pay the guaranteed money in full without set-off, counterclaim or deduction.

Murray Riverside defaulted in payment and Westpac appointed receivers. The receivers sold the secured assets for $13.1 million, which was insufficient to cover the entire debt.

Westpac commenced proceedings to enforce the guarantee for payment of the shortfall.

Palaniappan filed a counterclaim and set-off arguing that the receivers, as agents for Westpac, had sold the property at undervalue in breach of their common law and statutory duties to exercise their power of sale in good faith. Further, Palaniappan submitted a claim for set-off on the basis that the receivers had engaged in unconscionable conduct in contravention of the Australian Consumer Law.

At first instance, the Supreme Court found in favour of Westpac, finding that the suspension provisions clearly operated to prevent Palaniappan from deferring payment under the guarantee pending any set-off or counter-claim.

On appeal, Palaniappan argued that:

the suspension provisions did not apply with respect to his statutory defence and set-off claim under the Australian Consumer Law; and
the amount that Westpac was entitled to recover under the guarantee should be reduced to reflect the failure to obtain market value for the assets.

THE ISSUES FOR DETERMINATION

The Court of Appeal was required to consider two key questions:

Did Palaniappan's plea that the receivers engaged in unconscionable conduct constitute a reasonably arguable defence under the Australian Consumer Law?
If so, was this defence able to be maintained despite the suspension provisions in the guarantee?

THE DECISION

The Court of Appeal found in favour of Westpac and in doing so, confirmed the following principles with respect to suspension clauses:

the ordinary and natural meaning of the expression 'a right of set-off' by a party to the contract includes all forms of set-off, including an equitable set-off;
subject to any statutory provision to the contrary, a right of set-off, including a right of equitable set-off, may be excluded by express or implied agreement;
a suspension clause does not oust the jurisdiction of the courts. It suspends but does not reduce the rights of the party bound by the provision; and
the 'suspended party' is entitled to enforce the rights in question provided it conforms with its primary obligation to make payment to the other party.

The Court found that the suspension provisions were broad enough to prevent a guarantor from claiming a statutory set-off or defence, unless the claim concerned the validity or enforceability of the guarantee itself.

In this case, Palaniappan's defence, counter-claim and set-off related to circumstances occurring after the execution of the valid guarantee (ie the sale of the security properties by the receivers).

Accordingly, Palaniappan was not entitled to assert a set-off in law or in equity until Westpac was paid the guaranteed money (at which time Palaniappan may have had a claim for damages for the amount of the set-off).

COMMENT

The decision in Palaniappan provides certainty to lenders. A properly drafted suspension clause will prevent guarantors from deferring payment owed under a guarantee except in limited circumstances. In particular, guarantors will only be permitted to bring a set off claim prior to paying the debt if the claim concerns the validity of the guarantee itself.

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.