Canada: Unenforceable Guarantees: Lenders Take Note!

A recent Ontario Superior Court decision in Royal Bank of Canada v. Samson Management & Solutions Ltd. addresses the enforceability of guarantees and drives home the lesson that when increasing the amount or changing conditions under a loan agreement, the lender (a) should not terminate the old loan agreement and replace it with a new one and (b) should always have a new guarantee provided or the old guarantee confirmed.

In this case heard before Justice B.A. Glass in June 2012, Royal Bank of Canada ("RBC") pursued summary judgment on a guarantee from Ms. Cheryl Cusack who advanced her own motion for summary judgment discharging the guarantee as one that was unenforceable. Ms. Cusack is the spouse of the defendant, Jason Brasseur, the principal of the defendant Samson Management and Solutions Ltd. ("Samson"). Justice Glass found that the guarantee made by Ms. Cusack was unenforceable and granted summary judgment in favour of Ms. Cusack. Samson and Mr. Brasseur did not file any material or appear or be represented in court and so summary judgment was granted against them in favour of RBC. As such, the case focused on the enforceability of the guarantee.

FACTS

The facts of this case are relatively straightforward. In 2005, Ms. Cusack signed a continuing guarantee in favour of RBC in an amount of up to $150,000. The guarantee was of the present and future liabilities of Samson to RBC and was not tied to any specific loan between RBC and Samson. Ms. Cusack was provided with independent legal advice before signing the guarantee. In 2006, a new guarantee in the amount of $250,000 was made by Ms. Cusack in favour of RBC, again in respect of the present and future liabilities of Samson to RBC, being a continuing guarantee and not tied to any specific loan between RBC and Samson, with independent legal advice given. At the time of the first guarantee in 2005, the loan agreement between RBC and Samson was for an amount of $150,000 and in 2006, the loan agreement increased to $250,000.

In 2008, the amount available under the loan agreement increased to $500,000 and the loan agreement required a $250,000 guarantee from Ms. Cusack. Justice Glass noted that there was no request made by RBC to obtain a new $250,000 guarantee. In addition, the 2008 loan agreement imposed new conditions on Samson, establishing a borrowing base and mandating certain reporting requirements. In 2009, the amount available under the loan agreement was increased to $750,000. No request was made for a new guarantee from Ms. Cusack.

RBC never had any contact with Ms. Cusack at any time. Rather, the guarantees were provided to Mr. Brasseur who gave them to Ms. Cusack along with the form for independent legal advice. Ms. Cusack stated in her affidavit that she never saw any loan agreement between RBC and Samson and that she provided the guarantees to assist her husband to obtain a business loan.

A representative of RBC acknowledged under cross-examination of his affidavit that when each successive loan agreement was created, the prior one was terminated. As such, each new loan agreement superseded and cancelled the old one. The RBC representative also acknowledged that it may have been more prudent to have obtained new guarantees from Ms. Cusack when the loan agreements for $500,000 and $750,000 were created and the usual practice of RBC was to obtain a new guarantee when terminating one loan agreement and creating a new one.

THE ISSUES

The issues identified by Justice Glass were (i) whether the guarantee was enforceable; (ii) whether there had been a change of risk for Ms. Cusack as the loan agreements changed; (iii) whether there was a duty of RBC to advise Ms. Cusack of a change in the loan liability of Samson and therefore a change in her potential risk position; (iv) whether the guarantee was simply a continuing guarantee for $250,000 with only a change to the total indebtedness of Samson; and (v) whether Ms. Cusack had a responsibility to make inquiries about Samson's indebtedness.

THE OUTCOME

Justice Glass granted summary judgment in favour of Ms. Cusack, finding that the guarantee was unenforceable. In so doing, Justice Glass found that the increase in the debt of Samson as well as the 2008 reporting and borrowing base changes to the loan agreement changed her risk. These changes gave rise to a greater potential for her to have to pay under the guarantee. These were material changes and she was not given notice of them or an opportunity to consent to them. RBC had an obligation to apprise Ms. Cusack of changes to the loan liability so that she would be aware of a change to her risk or prejudice. She did not have to continuously ask RBC if there was any change to the loan facilities between RBC and Samson.

THE COURT'S ANALYSIS

Justice Glass discussed a prior Ontario Superior Court of Justice case which found that a guarantee agreement, which included a guarantee of future liabilities, remained enforceable after additional loan facilities were added to an existing loan agreement. The prior case, in Justice Glass' opinion, dealt with a development contemplated by the parties and was not a material change. However, Justice Glass stated that one might distinguish those facts from the case at hand on the basis that the 2008 loan agreement cancelled and superseded the 2006 loan agreement. Expanding on this opinion of Justice Glass, it appears that the termination of one loan agreement and its replacement with a new loan agreement is not within the ambit of a continuing guarantee for present and future liabilities that is not tied to any specific loan agreement.

In addition, Justice Glass rested some of the analysis on a Supreme Court of Canada case that pointed out that a material change in the terms of the contract between a creditor and the principal debtor without the consent of the guarantor will relieve a guarantor of liability. The Supreme Court of Canada noted in that case that there is no assumption that a party intended to assume a burden and waive rights without clear language to that effect in the document. To an outside observer, in the case at hand, such language appears to have been in the guarantee signed by Ms. Cusack in that it related to present and future liabilities and was not tied to any specific loan agreement.

However, the Supreme Court of Canada also took into account that a principal debtor clause will convert a guarantor into a full-fledged principal debtor. Should that development occur, then failing to notify the guarantor of new terms in a contract will release the person from the obligations because the individual will not be a party to the new terms. The 2006 guarantee signed by Ms. Cusack contained a principal debtor clause, whereby she would become a principal debtor if RBC were not able to recover any sum of money under the guarantee. Based on this, Justice Glass inferred that Ms. Cusack could be a principal debtor and noted she had not been given any notice of material changes. Taking this position to its logical conclusion, if there had not been a principal debtor clause in the guarantee, then perhaps this would have bolstered the enforceability of the guarantee.

Justice Glass concluded that Ms. Cusack did not waive her rights in equity or common law as a principal debtor or guarantor. The increase in the debt of Samson as well as changes in the reporting and borrowing base requirements were material changes such that she was potentially at greater risk of Samson defaulting and with the result that she would become liable to pay money to RBC under the guarantee.

Justice Glass also noted commentary in a scholarly text to the effect that a guarantor does not have an obligation to prove actual or certain prejudice but rather she only needs to show a potential for prejudice with a material change to the principal contract. Based on this commentary, Justice Glass found that if the change in the 2008 loan agreement between RBC and Samson had the potential for prejudice, then RBC had an obligation to obtain the consent of Ms. Cusack to the variation. This was despite the fact that Ms. Cusack's absolute liability did not increase under the guarantee.

LESSONS LEARNED

One may take issue with Justice Glass' analysis and conclusions, perhaps making reference to the old maxim that "hard facts make bad law."

Ms. Cusack clearly presented a very sympathetic case, some facts relating to RBC's position were less than optimal and RBC had already carried the day against Samson and Mr. Brasseur. However, whatever one may say about the facts, the analysis and the outcome, there are some very important lessons that can be taken away from this case as reminders of best practices in respect of loan agreements and guarantees.

Firstly, the decision in this case underlines the importance of having a guarantee confirmed by the signatory when the underlying loan agreement is amended, restated or replaced. Although the language in the guarantee in this case covered present and future liabilities and was not tied to any one loan agreement, it was still overturned as unenforceable, so it is not enough to simply rely on the language in the guarantee.

Secondly, as an ancillary approach in this connection, which shouldn't replace a confirmation of the guarantee, is to have the guarantor be a party (as a guarantor or restricted party) to the loan agreement such that it is required to sign all amendments, restatements or replacements.

Lastly, when implementing new conditions or requirements or raising the available amount of facilities under a loan agreements, this decision highlights the importance of not terminating the loan agreement and replacing it with a new one. Instead, any revision should be drafted as an amendment or an amendment and restatement, with all facilities previously existing being continued under the new documentation.

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