In Beck Interiors Limited v Dr Russo, a guarantee was given to the contractor by the majority shareholder of the employer in the following terms:
"I, Dr Mario L Russo... hereby personally guarantee payment of all monies that are due or will become due to Beck Interiors Limited, under the contract dated 28th October 2008 entered into between The Rejuvenation Spa Limited and Beck Interiors Limited for the aforementioned project..."
The building contract was subsequently terminated and the contractor successfully claimed £413,125 in an adjudication against the employer. Enforcement proceedings were stayed after the employer entered liquidation. The contractor therefore claimed the £413,125 against Dr Russo pursuant to the terms of the guarantee.
Material variations to the principal contract
Any material variation to the terms of the principal contract will discharge the guarantor, unless the guarantor consents to the variation or it is self-evident that the alteration is unsubstantial or cannot be prejudicial to the guarantor. The rationale for this rule is to prevent the potential liability of the guarantor expanding without its consent.
The contractor had agreed to give the employer extra time to pay following the execution of the guarantee. This was a variation to the underlying building contract that was of course intended to benefit the employer and would make it less likely that he would breach the building contract. However, the court concluded (perhaps surprisingly) that it was not self evident that the alteration was unsubstantial or could not be prejudicial to Dr Russo. This was on the basis that the guarantor had the right at any time to pay off the contractor, and then (on giving a proper indemnity for costs) to sue the employer in the contractor's name. Therefore if the contractor binds himself not to sue the employer for however short a time, he interfere with the guarantor's theoretical right to sue in his name during such a period.
On the facts, it was held that Dr Russo (as guarantor) had consented to these variations. However, this emphasises the need to ensure that there is a clause in the guarantee specifying that the guarantor will not be discharged in the event of a variation to the terms of the underlying contract. Otherwise there is a real danger that there will be an inadvertent discharge of the guarantor.
Effect of judgments under the principal
contract
A guarantee must contain very clear words in order to make the
decision of an arbitrator or court against the principal binding
upon the guarantor. The rationale is that the guarantor is not a
party to the proceedings and that the principal debtor may neglect
to defend himself properly, or make admissions or otherwise conduct
the case differently from the guarantor.
The Court held that the same principle would apply to an adjudicator's decision.
Therefore to fully protect the beneficiary, it is advisable to include a clause in the guarantee where the guarantor agrees to be bound by the decision of an adjudicator, arbitrator or the court in respect of any dispute in respect of the underlying contract. Otherwise, as happened in this case, the beneficiary could fight out extensive proceedings under the underlying contract only for the principal to become insolvent following the judgment. Instead of simply being able to enforce the judgment against the guarantor, the beneficiary would have to repeat the proceedings in full against the guarantor. This would lead to a great deal of wasted time and legal costs.
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.