Rethink again, when will a court adjust the liability of a co-guarantor? - Charges, Mortgages, Indemnities

This week's TGIF considers the recent decision of AMP Bank Limited v Brown and Kavanagh [2017] NSWSC 313, where the court found that unless a limited exception applies, it does not have the power to adjust the liability of a co-guarantor.

BACKGROUND

Brown and Kavanagh were directors and shareholders in a financial advisory business, Rethink Financial Group Pty Ltd (Rethink), holding a 30:70% shareholding respectively.

AMP Bank Limited (AMP) provided a loan to Rethink, personally guaranteed by Brown and Kavanagh.

In November 2015, Brown told Kavanagh that he was going to leave Rethink to start up his own business. Subsequently, Brown alleged that Kavanagh caused him to be locked out of the business.

In March 2016, AMP gave Rethink a default notice under the loan agreement.

AMP also gave Brown and Kavanagh notices requiring them to pay the amounts outstanding of $2.7M.

AMP sued Brown and Kavanagh for amounts outstanding, and a settlement was reached in November 2016.

The decision's focus was a cross-claim by Brown against Kavanagh, which claimed that Kavanagh's conduct warranted an adjustment of their respective obligations as guarantors.

ISSUE FOR DETERMINATION

It was not in dispute that Brown and Kavanagh were liable to AMP and that prima facie, as co-guarantors they were each severally liable to AMP for the entire guaranteed debt and equally liable as between themselves. In other words, if one of them paid more than half of Rethink's debt to AMP, he would be entitled to contribution from the other in the amount of the excess.

The issue was whether, in equity, the Courts have a general discretion to modify liabilities as between co-guarantors, absent any agreement or intention between the parties to do so.

Brown submitted that it would be inequitable and unfair for him to bear more than 20% of the liability to AMP because he had received less benefits than Kavanagh and because Kavanagh's conduct had made him more culpable to the debt.

DECISION

Kunc J found that Brown's cross-claim failed both at law and on the facts.

His Honour referred to the longstanding principle that where two co-guarantors are equally liable to a creditor (for example, because they are jointly and severally liable each for the full amount of the debt), there is a right, as between themselves, to equal contribution.

His Honour noted the four recognised exceptions to this principle:

where a contract or clear intention between the guarantors modifies or excludes rights to contribution;
where the whole of the benefit of the guarantee was obtained by one guarantor;
where one guarantor is guilty of "fraud, illegality, wilful misconduct or gross negligence"; and
where equitable defences such as clean hands apply.

Here none of the exceptions to the principle applied.

There was no suggestion that a contract or clear intention existed between Brown and Kavanagh that modified their obligations as guarantors, and it was accepted that the 30:70% unequal shareholding was insufficient of itself to do so.

Importantly, Brown's complaints about Kavanagh's conduct in locking him out from the business related to actions after the loan was guaranteed.

This was not a case where one guarantor enjoyed the whole of the benefit of the guarantee (as Brown remained a shareholder of Rethink which had received the benefit of the loan) nor was there a suggestion that Kavanagh had acted fraudulently, illegally or with wilful misconduct.

Kunc J further held that even if his view of the law was wrong, on the facts there was no rational basis to depart from a position of equal liability between Brown and Kavanagh.

In particular, Brown's case:

failed to demonstrate that there was a causal connection between Kavanagh's alleged conduct and Rethink's liability (or increased liability) to AMP; and
did not provide sufficient evidence that a different outcome would have occurred had Brown not been excluded from the business.

CORRS COMMENT

This case does not alter the position that where guarantors are jointly and severally liable, each guarantor is independently liable to the bank for the full amount of the debt.

The case does confirm the position that as between themselves, co-guarantors will be equally liable and, unless a recognised exception applies, a court will not subsequently adjust their respective liability based on their conduct. That will be so even where, as in this case, there is conduct by one guarantor that the other considers unfair.

For banks, the decision will be of some comfort in that it may cause guarantors to rethink protracting litigation by raising such claims before the court in future cases.

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.