UK: When a creditor can´t rely on a guarantee

Creditors must be careful when seeking to rely on a guarantee if they subsequently agree with a borrower to modify the guaranteed obligation, without obtaining the guarantor’s express consent.

The recent case of Triodos Bank N.V v Dobbs ([2005] All ER (D) 364 (May); [2005] EWCA Civ 630) involving an individual’s obligations to a bank under a limited guarantee provides a reminder that where the obligation guaranteed has been modified, and the change is not within the scope of changes permitted by the guarantee, the bank can no longer rely on the guarantee. This is despite provisions purporting to allow the bank to amend the underlying obligation without prior consent from or consultation with the guarantor.

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Creditors must be careful when seeking to rely on a guarantee if they subsequently agree with a borrower to modify the guaranteed obligation, without obtaining the guarantor's express consent.

The recent case of Triodos Bank N.V v Dobbs ([2005] All ER (D) 364 (May); [2005] EWCA Civ 630)

involving an individual's obligations to a bank under a limited guarantee provides a reminder that where the obligation guaranteed has been modified, and the change is not within the scope of changes permitted by the guarantee, the bank can no longer rely on the guarantee. This is despite provisions purporting to allow the bank to amend the underlying obligation without prior consent from or consultation with the guarantor.

The case concerned an individual, ("D") who, in March 1996, executed a guarantee in favour of a bank (the "Bank"), in support of two loans (dated the same date as the guarantee) made to a company (the "Company") for a building project.

The total amount due to the Bank under the loans was £900,000. D's liability under the guarantee was limited to £50,000. The Company also granted the Bank security by way of a legal mortgage and a floating charge over all of the Company's assets.

The guarantee provided that the Bank might at any time "as it thinks fit and without reference to [D] … grant time for payment or grant any other indulgence or agree to any amendment, variation, waiver or release in respect of an obligation of the Company under the [two 1996 loan agreements]".

The 1996 loan agreements provided that the agreements might be varied (in relation to interest rates and "the loan might be repaid in part at any time. Subsequent repayments [could] be rescheduled under a new loan agreement between the Bank and the Borrower").

The Company required further finance, and in November 1998 entered into two further loan agreements, under which the total indebtedness to the Bank was £1.9m. The agreements provided that they replaced the 1996 loan agreements. The 1998 loan agreements listed the guarantee as part of the security on which the Bank relied.

In September 1999 the 1998 loan agreements themselves were replaced by a single loan agreement under which the amount of the loan was increased to £2.6m. The 1999 facility provided that it was to be used in paying costs associated with the building project. This included sums paid to the building contractors engaged in 1996 under contracts entered into subsequent to that date. The 1999 facility also listed the guarantee as part of the security on which the bank relied.

The Company defaulted under the 1999 facility and the Bank appointed receivers over the Company's assets. After certain assets were sold and distributions were made under the security, the Bank was left with a deficit of £80,633.79 and in 2001 made demand on D under the guarantee to fund part of the shortfall. In July 2001 the Bank started proceedings against D. In May 2002, the Bristol Mercantile Court gave a summary judgment stating that the guarantee extended to borrowing under the 1999 facility and, in any event, D was estopped from denying that the guarantee extended to those debts.

D appealed on the grounds that the 1996 guarantee only applied to sums due "under or pursuant to the 1996 loan agreements" and that once those agreements had been replaced by the 1998 and 1999 agreements, there could be no further liability under the guarantee.

The Court of Appeal (Chadwick, Longmore and Neuberger LJJ) decided against the Bank on the following basis:

It did not necessarily matter that the 1998 and 1999 agreements were termed "replacements". A replacement could be contemplated by the original agreement or might be so similar to the original agreement that it could truly be said to be an amendment. The question was whether or not the original obligation had been amended or varied and, if so, whether such amendments or variations were within the scope (or, as Longmore termed it, the "purview") of the guarantee agreement.

In this case, the 1999 facility was substantially different from the 1996 loan agreements and was not a variation or amendment within the scope of those agreements. D could not be taken to have agreed that his liability under the guarantee would be increased or made more onerous by a subsequent agreement (to which he was not a party) made between the lender and the Company, unless there were clear words in the guarantee to show that he did agree to be bound to a more onerous obligation imposed in the future (and without further reference to him).

It was no answer to say that D's liability under the guarantee was limited to £50,000 – the risk that D would be called upon to pay the £50,000 (in circumstances where the loan was secured by fixed and floating charges over the Company's assets) was substantially greater if the loan was £2.6m than if the loan was £500,000.

The Bank had sought to argue that D was prevented (or estopped) from claiming that the Bank could no longer rely on the guarantee. This was because D knew about both the 1998 and 1999 facilities and had not objected to them (he had, for example, in 1999 and 2000 granted mortgages over successive homes to secure his liability under the guarantee). The court decided that this issue could only be resolved at full trial (rather than in the summary judgment given by the Bristol Mercantile Court in 2002). The point has therefore not been finalised and will not be settled until the Bank's appeal is heard.

The decision provides a reminder that where a creditor is intending to rely on a guarantee, it should make sure that, where the guarantee wording allows the primary obligation to be amended or varied without prior consultation with (or consent from) the guarantor, the amendment is within the scope anticipated or allowed by the guarantee. Alternatively, a creditor could require a guarantor to confirm his consent to the amendments to any primary obligation (for example, it could require them to be a party to the document amending the primary obligation to affirm their consent).

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 07/06/2005.