Principal loan contract varied, but guarantors fail in seeking to avoid liability to the bank under their guarantees - Charges, Mortgages, Indemnities

This week's TGIF considers a recent case where two individuals challenged their liability under guarantees given by them in respect of monies borrowed by their family trust for property development purposes.

Background

The corporate trustee of the defendants' family trust entered into a Business Finance Agreement dated 30 June 2008 (BFA) pursuant to which the bank agreed to lend monies totaling $16.46M so that the trust could develop certain properties at Currumbin in Queensland.

The BFA provided for the loan monies to be advanced in two tranches ($8.68M for Tranche 1 and $7.78M for Tranche 2). Various special conditions had to be satisfied before the loan monies could be advanced under each tranche.

The defendants executed guarantees in favour of the bank on 9 July 2008 in respect of the trust's indebtedness to the Bank under the BFA.

The trust satisfied the conditions precedent for Tranche 1 and proceeded to draw upon the Tranche 1 funds.

Under the terms of the BFA, the term of the facility was 12 months from the date of the first drawdown (i.e. the facility expired on 24 July 2009). The trust could not satisfy the conditions precedent for Tranche 2 within the 12 month period and accordingly was never able to drawn down on the Tranche 2 funds.

Discussions ensued between the bank and the trust regarding an extension. The bank made an offer to extend the term of the loan by a further year (i.e. until 31 July 2010), but on the condition that the Tranche 2 facility was cancelled and that the trust made a payment of $600,000 in reduction of the Tranche 1 debt. The trust accepted the bank's offer. The defendants also consented to the variation to the BFA as well as a variation to the guarantees, such variation reducing the defendants exposure under the guarantees from $16.46M to $8.08M. The defendants executed the variation to the guarantees prior to the trust executing the variation to the BFA.

The trust was not able to make payment of the $600,000 amount referred to above. The bank then made a fresh offer to extend the term of the loan until 31 July 2010 on the basis that the trust made staged payments of the $600,000 amount. The trust accepted the bank's offer. On the same day, the defendants consented to the variation to the BFA and executed a variation to their guarantees under which their exposure was $8.58M.

The loan expired and the trust was in default. The bank issued letters of demand to both the trust and the defendants in their capacity as guarantors. None of the demands were complied with. The corporate trustee went into liquidation.

The Challenge

The defendants attempted to avoid liability under the guarantees by alleging that:

their obligations under the guarantees were discharged because (i) the BFA had been varied in a manner which was detrimental to their interests as guarantors; and (ii) the bank had not obtained their prior consent to the variations to the BFA; and
they entered into the guarantee in reliance upon misrepresentations made by several of the bank's officers.

The defendants' allegations centered upon the Tranche 2 funds. Those funds were to be used to acquire the property known as "Double D", which the defendants considered to be the "jewel in the crown" of the overall development.

The defendants alleged that the cancellation of Tranche 2 as part of the variation was detrimental to their interests because the trust was no longer able to complete the purchase of "Double D". According to the defendants, the parties were all aware that the development and sale of "Double D" was the only means by which the trust could repay the facility to the Bank and therefore the only means by which the defendants could avoid liability under the guarantees.

The defendants claimed that the bank had represented that it would lend funds to allow the trust to acquire "Double D" when, in fact, it turned out that the bank was only prepared to lend those funds provided that certain conditions precedent were satisfied.

The Court's Decision

The Court dismissed the defendants' claims and ordered them to pay the full amount owing under the guarantees.

The Court found that, as the defendants had consented to the variations to the BFA and guarantees, those variations did not prevent them from being bound by the terms of the guarantees as amended. It did not matter if the variations were detrimental to the defendants' interests as guarantors in light of their consent.

As to the misrepresentation claim, there was no credible evidence that the bank had made the alleged representation that the Tranche 2 funds would be loaned unconditionally. Such representations were inconsistent with the terms of the BFA (which listed the conditions precedent that needed to be satisfied before the Tranche 2 funds would be made available). The defendants had not objected to the conditions precedent and the first defendant also conceded under cross-examination that the bank had not made the representations alleged.

Practice Points

This case serves as a timely reminder that guarantors may have a basis to avoid guarantees if the principal loan contract is varied without obtaining the guarantor's consent. This is particularly the case where variations are material and/or to the detriment of the guarantor.

It also serves a reminder that bank officers should keep detailed and contemporaneous records of their discussions with customers to ensure that accurate evidence is available for the Court in the event that there is any dispute as to what has been discussed / agreed.

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.