Securities and guarantees are commonly used in both the private and public sectors in contracts for the provision of goods and services. The Australian National Audit Office's Better Practice Guide for Developing and Managing Contracts, recommends securities and guarantees as useful "where significant amounts of money are involved or where a substantial payment is to be made to the contractor prior to the acceptance of the goods and services".

The recent High Court decision in Lavin v Toppi reinforces the rights of contribution accorded to co-sureties and the effect of a covenant not to sue obtained by one of them–both critical features of a security and guarantee relationship.

Background

The first appellant (Lavin) and first respondent (Toppi) were directors of, and equal shareholders in, Luxe Studios PL (Luxe). Luxe purchased a property in central Sydney with funding via a loan from National Australia Bank (Bank), which was guaranteed jointly and severally by Lavin and Toppi and other parties associated with them. After Luxe went into receivership some years later and asset sales were insufficient to discharge the debt, the Bank commenced proceedings against all guarantors for the outstanding amount.

Lavin and the other appellants later entered into a deed of release with the Bank whereby the Bank agreed not to sue the appellants for the debt provided Lavin paid a settlement sum comprising $1.35 million for the guaranteed debt. This was carried out, and following Ms Toppi's payment of what remained of the guaranteed debt in early 2011, the guarantors' obligations to the Bank were discharged. The respondents then commenced proceedings in the Equity Division of the NSW Supreme Court claiming contribution from the appellants in an amount equal to half the difference between the respective amounts they had each paid in discharging the guarantee.

The appellants resisted the claim on the basis that, at the time the respondents had paid the balance of the guaranteed debt, the appellants were no longer indebted to the Bank because their covenant not to sue from the Bank had been performed.

High Court decides

At first instance, on appeal in the NSW Court of Appeal and ultimately the High Court, the appellants' argument was rejected. The courts' decisions centred around two key findings:

  • far from extinguishing the appellants' liability for the guaranteed debt, the Bank's covenant not to sue, in fact assumed the continuing existence of such a liability, and
  • the respondents' right to contribution from the appellants continued to be recognisable in equity throughout the various payments each party had made and could not be defeated by a separate agreement between the appellants and the Bank.

The High Court emphasised the legal and equitable foundations of the right to contribution as a facet of natural justice whereby those who share a liability to make good a debt must share that burden pro-rata, and went on to characterise the appellants' argument as "both novel and unduly technical" and incapable of defeating the natural justice principle invoked by the doctrine of contribution.

Implications for agencies

This decision highlights the importance courts will give to the principles of equity and natural justice underpinning the rights and obligations of co-sureties under a guarantee, and the inability of external arrangements made by some only of the co-sureties to detract from the operation of these principles.

When considering using security and guarantee clauses in contracts, agencies can be confident that the common obligation of guarantors to contribute equally to discharging a debt they are bound jointly and severally in respect of, will be enforced regardless of any other arrangements the creditor may make with some only of the debtors, such as a covenant not to sue.

We would like to acknowledge the contribution of Megan Peterson to this article.

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.