Australia: Co-guarantors beware: no general discretion for courts to adjust liabilities for guaranteed debt

What you need to know

• The NSW Supreme Court recently considered a case in which one co-guarantor sought to have his liability for a guaranteed debt varied, primarily based upon the conduct of the other co-guarantor.
• The Court found that there was no general discretion to adjust liabilities for guaranteed debts, and even if it did exist, the circumstances and evidence in this case would not have justified any apportionment of liability.
• The decision is a reminder that co-guarantors cannot rely on the fact that they have ceased to be involved in a business to be released from their liability to a creditor under a guarantee.

In a recent decision, the NSW Supreme Court found that even if one co-guarantor appears to have a greater culpability for a guaranteed debt, that does not mean the Court has the power to adjust the monetary obligations of the co-guarantors accordingly.

The decision reinforces the accepted principle that co-guarantors are equally liable for the guaranteed debt, subject to certain exceptions, and the courts cannot subsequently apportion a co-guarantor's liability based upon their conduct.

The facts

The case of AMP Bank Limited v Brown and Kavanagh1 involved two directors of a financial advisory business called Rethink Financial Group Pty Ltd (Rethink). The directors, Mr Brown and Mr Kavanagh, had a shareholding in Rethink of 30:70 respectively. While Mr Brown ceased his directorship in March 2016, his shareholding continued after that date.

The case was heard by Kunc J, who outlined the relevant background as follows:

• In March 2014, AMP Bank Limited (the Bank) provided a loan to Rethink guaranteed by Mr Brown and Mr Kavanagh.
• In November 2015, Mr Brown informed Mr Kavanagh that he intended to leave Rethink to start his own business.
• Mr Brown maintained that the following conduct occurred soon after:
• • he offered to stay on at Rethink for 6-12 months but was locked out of the business
  • staff changes and terminations occurred within Rethink and assets were transferred to other entities, without consultation with Mr Brown
  • Mr Brown received no form of income or entitlements from the business
  • Mr Kavanagh failed to agree to a settlement arrangement with the Bank which would have seen Mr Brown and Mr Kavanagh released from the guarantees, and which would have required Mr Kavanagh to pay $250,000 and Mr Brown to pay $780,000.
• In March 2016, the Bank issued Rethink, Mr Brown and Mr Kavanagh with a default notice referring to changes which would affect Rethink's ability to meet its loan obligations. Demands for payment were subsequently issued to Mr Brown and Mr Kavanagh on 12 August 2016.
• On 22 August 2016, the Bank commenced proceedings against Mr Brown and Mr Kavanagh for the guaranteed debt of over $2.7 million.
• In October 2016, Mr Brown filed a cross claim against Mr Kavanagh alleging that because of Mr Kavanagh's conduct, it would be unconscionable, and not just and equitable, for Mr Brown to bear an equal share of the liability. Mr Brown argued that he should accordingly be indemnified by Mr Kavanagh for a contribution to the debt, in such proportion or amount as the Court saw fit.
• In November 2016, Mr Kavanagh and Mr Brown reached a settlement agreement with the Bank which resulted in the Bank holding a consent judgment for debt from both Mr Kavanagh and Mr Brown in escrow, pending determination of Mr Brown's cross claim.
• In December 2016, receivers of Rethink, appointed by the Bank, entered into an asset sale agreement (ASA) in respect to Rethink's client service rights with a company of which Mr Kavanagh was a director, for a purchase price of over $1.2 million. The ASA involved the release of Mr Kavanagh from his guarantee to the Bank.

The law on co-guarantors – general principle and its exceptions

Before considering whether Mr Brown's liability could and should be adjusted as a result of Mr Kavanagh's conduct, Kunc J began by acknowledging that the doctrine of contribution between guarantors is based in equity, not contract, on the ground of equality of burden and benefit.

His Honour referred to four exceptions to the principle of equality to co-guarantors, being circumstances in which:

1. there is a contract or a common intention to modify a co-guarantor's contribution obligations
2. only one guarantor has the benefit of the guarantee
3. a guarantor is guilty of "fraud, illegality, wilful misconduct or gross negligence"
4. equitable defences, such as clean hands, can be relied upon.

None of these exceptions applied in this case. The question to be determined was whether or not the courts have a general discretion to apportion contribution based on a co-guarantor's responsibility.

Whilst there are no binding decisions on this question, Kunc J carefully considered various authorities which support the view that there is no such general discretion available to the courts. Kunc J noted that leading equity texts also maintain the general proposition that the liability for coordinate obligations cannot be apportioned other than equally. Despite Mr Brown's reliance on select case law to argue otherwise, Kunc J concluded that there is no general discretion to depart from the position of equality as between co-guarantors, unless one of the exceptions clearly applies.

Would the evidence have supported a variation to liability?

Kunc J went on to consider whether, even if he did have general power to modify the co-guarantors' liability, Mr Brown's evidence would have supported an apportionment of liability based on Mr Kavanagh's conduct.

In finding that Mr Brown had failed to provide sufficient evidence, Kunc J pointed to various factors, including:

• Mr Brown maintained that due to being locked out of the Rethink business, there was an adverse impact on the business which reduced its ability to meet the loan repayments to the Bank. However, little evidence was submitted to support this assertion and rather it was suggested that the Court draw an inference in this regard.
• Similarly, Mr Brown submitted that the staffing changes at Rethink without his consultation resulted in financial planners leaving, a reduced ability to therefore service clients, and consequently a reduction in Rethink's ability to service the Bank's loan. However, there was no evidence that the staffing changes were unjustified, that Mr Brown's involvement would have given a different outcome and no suggestion made that Mr Kavanagh acted fraudulently or to deliberately cause the business to fail.
• Mr Brown's complaint that Mr Kavanagh failed to agree to an arrangement with the Bank suffered from a lack of evidence for the Court to conclude that the agreement was a 'reasonable' one which Mr Kavanagh should have accepted. Kunc J also noted that there was no obligation on Mr Kavanagh to settle the matter with the Bank.
• Finally, Mr Brown had complained about the circumstances upon which the ASA was entered from the perspective that he was no longer involved in the Rethink business and there was a lack of transparency around the ASA. This submission was considered to have been solely based in fairness and there was no evidence that Mr Kavanagh had acted improperly.

Kunc J concluded by saying:

Key takeaways

As Kunc J said, this situation "is not novel".

We often see situations in debt recovery where a co-guarantor believes they are no longer liable for a guaranteed debt after departing from a business, or ceasing to be involved in it.

This decision is a reminder to co-guarantors of the risks associated with not obtaining a release from liability to a creditor under a guarantee upon departing or ceasing to be involved in a business.

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories