UK: Guarantees: Rights Of Subrogation

The High Court has provided further guidance on when a guarantor may use its right of subrogation to recover monies paid under a guarantee, which will be useful to bankers providing and seeking guarantees and to insolvency practitioners interested in their implications.

This case serves as a helpful reminder of the fact that the right of subrogation may be waived by the conduct or the evidence of the intention of the parties and the court held here that, on the facts, such a waiver had occurred. Those providing guarantees should be careful to protect their position by ensuring that nothing in the terms of the original agreement or in their subsequent actions could act as a waiver. Equally, insolvency practitioners should be aware of the possibility that rights of subrogation claimed, whether by the company to which they are appointed or otherwise, may be challenged on the basis of the intentions and actions of the parties.

In this case a failing company had been approached by a potential investor. Following discussions, the directors (who were also the company’s shareholders) and the investor agreed that the investor would receive 50 per cent. of the shares in the company if he invested £200,000 and helped the company achieve certain performance targets.

In the end the performance targets were not met and the shares were not transferred. However, the investor had provided £100,000 to the company’s bank as security for the company’s overdraft of that amount. The bank subsequently enforced its security over, amongst other things, the £100,000.

Upon the bank being repaid in full the company was placed in creditors’ voluntary liquidation and a receivership surplus of £104,345.32 was paid over to the liquidators. Following an inconclusive exchange with the investor’s solicitors, the liquidators applied to court for directions as to the investor’s entitlement to this surplus.

In general, where a debt is discharged by a guarantor, that person will be entitled to ‘step into the shoes’ of the creditor and exercise the creditor’s rights against the debtor: this is the guarantor’s right of subrogation. Therefore, in this case the investor would, having discharged £100,000 of the company’s debt, ordinarily be entitled to claim against the company for this sum and to do so with the benefit of the bank’s fixed charge over the company’s assets.

A right of subrogation can, however, always be excluded by agreement between the principal debtor and the guarantor, and this is what the judge found had occurred. The parties had not intended that the investor’s financial contribution be a loan – rather, it was part of his investment of £200,000 and so a part-payment for the shares and was not repayable. This was borne out by the investor not having demanded repayment. The fact that the investor had contributed by means of a deposit charged as security for the company’s overdraft did not alter the judge’s view: the investor’s commitment could equally well have been fulfilled by simply transferring the money to the company.

Even if there had been an implied obligation to repay if the share transfer did not go ahead, the judge found that this would have been an obligation to repay the money as a simple unsecured loan. This would have prevented the investor from taking the benefit of the bank’s charge. There had been no intention to give rise to a secured debt owed by the company to the investor.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 18/12/2007.