Liquidated debts – Personal Guarantees

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With increasing insolvencies it is of no surprise that creditors are looking to steal a march on fellow creditors by using statutory demands and petitions to recover sums due under personal guarantees. Here we revisit the personal guarantee obligations which create a debt, as opposed to a sum in damages which should be pursued outside of the insolvency regime.

A liquidated debt

As addressed in our article “Liquidated debts – The importance of being liquidated and undisputed”, in order to constitute a liquidated debt, the debt must be for an amount which certain and defined, where either the creditor and debtor are in agreement on its value or, it is capable of being ascertained in accordance with a contractual formula/machinery for calculating the debt owed.

The contractual formula is of particular importance when considering the nature and enforcement of a guarantor’s liability under a personal guarantee.

The leading authority is McGuiness v Norwich and Peterborough Building Society [2011] EWCA Civ 1286, which addressed the four types of liability created by personal guarantees:

a.  a “see to it” obligation; a promise by the guarantor to ensure that the principal debtor performs their obligations under the principal contract;

b.  a "conditional payment obligation"; a promise by the guarantor to pay the obligations of the principal debtor if the principal debtor fails to pay when due;

c.  an "indemnity"; a primary obligation under which the indemnifier promises to pay the indemnified person any damages they may suffer as a result of the principal debtor's failure to perform its obligations under the principal contract;

 d.  a "concurrent liability" for the sums due; a primary obligation where the guarantor promises to pay what is payable by the principal debtor under the principal contract.

In McGuiness the Court of Appeal was clear: that obligations (b) and (d) create a debt, whilst (subject to any terms to the contrary) obligations (a) and (d) gives rise to claims for damages.

The nature of the obligation and debt (whether that be liquidated or unliquidated) created by a personal guarantee, is a matter of construction and is an issue which, if raised by a debtor, is one which a court should resolve, assuming it has before it all the material required.  It is therefore important to consider the terms of any personal guarantee before using a statutory demand/petition to enforce payment. 

Recent cases

Sibner Capital Limited v Neil David Martin Jarvis, Suzan Jane Hughes [2022] concerned a loan facility agreement and the liability of guarantors to that loan agreement.

The loan was to be paid in two parts – instalment A and instalment B. Clause 5 of the loan agreement permitted the lender to accept payment of a sum less than the balance of instalment A plus interest so long as the borrower had paid at least £300,000. The remaining balance of instalment A was treated as part of instalment B. The lender was permitted to do so in its “absolute discretion”.

The parties to the loan agreement also entered into a joint venture agreement which included obligations to co-operate and act in good faith. However, the joint venture agreement stated that nothing in the good faith clause would prejudice or restrict the lender’s rights, including its rights following a default of the loan agreement by the borrower.

The lender subsequently agreed to accept a part payment in respect of instalment A. The part payment was subject to conditions, and the remaining balance was to be settled by a certain date. The borrower defaulted on these conditions and did not settle the remaining balance by the agreed date. As a result, the lender served statutory demands on the guarantors.

The first instance judge held there were substantial grounds for disputing the debt, including: whether the default interest rate in the loan agreement was enforceable, and whether the lender had a duty to act in good faith when exercising the discretion permitted by Clause 5 of the loan agreement. Accordingly, the statutory demands were set aside.

On appeal, the High Court held there had been a serious procedural irregularity, as the first instance judge had not allowed the parties to make submissions on the existence of an implied duty of good faith. Furthermore, the High Court held it was not for the courts to imply restrictions where a contract gave one party absolute rights. The discretion permitted to the lender by Clause 5 of the loan agreement was not qualified, it was absolute. The joint venture agreement also further specified that the lender’s rights following a default by the borrower were not to be affected. It therefore could not be said that the lender had a duty to act in good faith when exercising its discretion.

Accordingly, the guarantors were not able to challenge the principal sum of the debt, nor the basic interest rate, but the default interest rate was held to be unenforceable as this amounted to a penalty. Ultimately, the statutory demands were upheld, albeit at a reduced amount taking account of the unenforceable default interest.

PGH Investments Limited v Sean Ewing [2021] EWHC 533 (Ch) emphasises the importance of drafting and interpretation of clauses on the enforceability of guarantees. In this case, a company presented an application to dismiss a winding-up petition based on a debt that was allegedly owed to the petitioner under a corporate guarantee and indemnity it had provided. The petitioner was claiming that a third party had defaulted on its obligations under a share purchase and loan agreement, acting as a trigger for the company’s liability under the guarantee. The company disputed it was liable to pay the debt.

The corporate guarantee was drafted with three primary obligations:

  1. The company guaranteed the third party’s “punctual performance, observance and discharge… of all Guaranteed Obligations” (defined term in the agreement meaning the purchase price).
  2.  In the event the third party defaulted on the payment of the purchase price by the completion date, the company would pay the petitioner any shortfall as if the company were the third party.
  3. The company, as principal obligor, agreed to indemnify the petitioner in full and on demand in connection with the third party’s failure to perform or discharge the Guaranteed Obligation.

In his Judgment, Judge Passfield held that point 1 above created a “see to it” obligation. However, the primary obligation on the third party to pay the purchase price was conditional and ceased to have effect when the agreement was terminated. The company therefore had no liability under this provision because the purchase price had not fallen due in the first place. 

He was not convinced that it created any freestanding liability on the company which survived termination of the agreement.

Judge Passfield held that point 2 was a “conditional payment obligation” that would only have applied where the third party had “defaulted” on his obligation to pay the purchase price by the completion date. The agreement was drafted in such a way that made this obligation dependent on a condition which also automatically ceased to have effect when the agreement was terminated. As such it could not be said that there was any “default” by the third party and therefore, the company was not liable under the guarantee.

Judge Passfield also held that point 3, on its face, was an indemnity, albeit no liability was triggered given the contractual terms.

The High Court granted the application to dismiss the winding-up petition on the basis, among others, that on a proper construction of the agreement, the company was not liable to pay the alleged debt.

The importance of fully understanding the contractual arrangements between/obligations on the parties was also highlighted in Oceanfill Ltd v Nuffield Health Wellbeing Ltd [2022] where a commercial landlord sought summary judgment against the original tenant (D1) and original guarantor (D2) of a lease.

An original tenant (D1) of commercial premises assigned the lease to a company (C1) and indemnified the commercial landlord against C1’s non-performance of its obligations. D2 had guaranteed D1’s performance under the licence to assign. A restructuring plan took effect to release C1 of its obligation to pay rent under the assigned lease. However, the landlord submitted that the restructuring plan had not released D1 and D2 from their obligations as guarantors and sought payment of the rent due from them directly.

It was held that the restructuring plan had only released C1 from its obligations, leaving the obligations of D1 and D2 untouched. Put simply, the licence to assign was clear that D1 and D2 would not be released from their obligations unless the landlord granted the same. Summary judgment was entered and D1 and D2 were liable to pay the rent that had fallen due under the lease.

Our comment

The above authorities demonstrate that identifying the nature of the obligations arising under a personal guarantee is not the key issue. Rather the whole of the contractual relationship between the principal obligor and creditor, and guarantor and creditor should be fully considered before advancing any recovery proceedings. As stated in our article “Liquidated debts – The importance of being liquidated and undisputed”, a comprehensive review should be conducted at the start of the recovery process, to ensure the debt is liquidated and is not susceptible to challenge.

For more information, please contact Nikki BrastockChloe Waul or another member of our Restructuring & Insolvency team.

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