UK: Recent Developments In Finance Litigation: Guarantees – Primary Or Secondary Liability?

Last Updated: 18 September 2008
Article by Edward Davis and Sue Millar

In IIG Capital LLC v Van Der Merwe & Anor [2008] EWCA Civ 542, the Court of Appeal upheld the decision of the High Court that a director's guarantee was a primary obligation that was payable on demand.

The facts of the case

The Respondents, Mr and Mrs Van Der Merwe ("the Guarantors") were directors of a company called Hurst Parnell Import and Export Limited ("HPIE"). In 2006, HPIE obtained financing from the Appellant, IIG Capital LLC ("IIG"), a New York based company. Various documents were signed between the parties, including a loan agreement and guarantees from each of the Guarantors ("the Guarantees").

The Guarantees were expressed as a condition precedent to the giving of the loan and were given for the "Guaranteed Monies", being "all monies ... which are now or may at any time hereafter be due, owing, payable or expressed to be due, owing or payable to the Lender from the Borrower." The main payment obligation clauses provided that each Guarantor "guarantees to the Lender the due and punctual payment of the Guaranteed Monies and agrees that, if at any time or from time to time any of the Guaranteed Monies are not paid in full on their due date... [the Guarantor] will immediately upon demand unconditionally pay to the Lender the Guaranteed Monies which have not been so paid." The Guarantees also stated that the Guarantors acted "as principal obligor and not merely as surety".

In January 2007, IIG made a demand for payment of over $30,000,000 said to be due under the loan agreement. HPIE failed to make the payment and four days later IIG sought payment from the Guarantors. The Guarantors failed to pay the money due and IIG brought proceedings to enforce the terms of the Guarantees.

IIG applied for summary judgment and the Master found in its favour, holding that the terms of the Guarantees prevented the Guarantors from relying on defences that could have been raised by HPIE in resisting payment to IIG. The Master found that the Guarantors were contractually bound to pay the amount due under the Guarantees without any need for IIG to prove liability under the loan agreement. The Guarantors appealed the decision, arguing that the instruments were true guarantees and therefore their liability was co-extensive with the borrower's liability under the loan and that accordingly they should be entitled to raise any defences to the demand that were available to the borrower.

The High Court decision

The main issue on appeal to the High Court Judge was whether the Guarantees created primary obligations on the part of the Guarantors more akin to a performance bond or on-demand guarantee issued by a bank, or secondary obligations, in which case the Guarantors would be entitled to raise defences at trial that could have been raised by HPIE in resisting a demand under the loan agreement.

The Judge hearing the appeal accepted that where the Court is considering the position of individuals rather than banks, there is a strong presumption against giving the words "on demand" the effect of creating an independent primary obligation. In deciding if the presumption was displaced, the Court should consider "what rights and obligations ... the parties created by the words of the instrument, construed in its factual and commercial context".

The Court found that the presumption had been displaced by the wording of the instruments and that the obligation created was a primary obligation, for the following reasons:

  1. The Judge pointed to the definition of "Guaranteed Monies" as monies "expressed to be due, owing or payable", and not simply as monies actually owed by HPIE. This, he said, pointed to the conclusion that the Guaranteed Monies could extend beyond what was owing by HPIE to IIG, and so the liability of the Guarantors was not necessarily co-extensive with that of HPIE.

  2. The Court took into consideration that a typical contract of suretyship is a promise that the principal debtor will perform his contract, whereas in this case the promise was a promise limited to payment of the Guaranteed Monies, and did not extend to any other obligations under the loan agreement. This was consistent with an obligation to pay as a primary obligation.

  3. The Court also emphasised the description of the Guarantors in the Guarantees as principal obligor rather than mere surety.

  4. Finally, the Court found that a prescribed form of certificate in the Guarantees, to be signed by IIG and certifying the amount due and payable by the Guarantors, clinched the argument in favour of IIG.

All of these matters, read together, were found to displace the presumption that a secondary obligation was owed and accordingly the High Court dismissed the appeal.

The Court of Appeal decision

On 22 May 2008, the Court of Appeal upheld the decision of the High Court and dismissed the appeal by the Guarantors.

Lord Justice Waller said that "the question at the end of the day is what on the true language of these deeds of guarantee did [the Guarantors] agree. I accept there is a presumption against these being demand bonds or guarantees; I also accept that the documents must be looked at as a whole. I accept that clause 3 which would only be necessary if the deeds were or might be undertaking a secondary liability, points in favour of the presumption and that there are other terms which appear in what I would call normal guarantees given to banks in relation to a customer's indebtedness. It will thus only be if clear language has been used in the operative clauses that the presumption will be rebutted". Turning to the operative language of the Guarantees, he held that the definition of Guaranteed Monies obliged the Guarantors to pay moneys "expressed to be due" "upon demand" "unconditionally" as "principal obligor" "not merely as surety", and would indicate that the Guarantors were taking on something more than a secondary obligation. Waller LJ considered that clause 4.2, which provided that "a certificate in writing signed by a duly authorised officer ... stating the amount at any particular time due and payable by the Guarantor ... shall, save for manifest error, be conclusive and binding on the Guarantor for the purposes hereof", put the matter beyond doubt: any presumption was clearly rebutted. Apart from manifest error, the Guarantors had bound themselves to pay on demand as primary obligor the amount stated in a certificate.

Practical implications

This decision shows that the Courts will look at the content, rather than title or form, of agreements. For now, institutions that have the benefit of "on demand" guarantees can take comfort from this decision. However, the Court of Appeal has granted leave to appeal to the House of Lords on the basis that the issues considered in this case are widely used in guarantees throughout the market and that accordingly any decision is likely to have far reaching ramifications.

This article was written for Stephenson Harwood's quarterly publication, Finance Litigation Legal Eye. If you would like to receive this publication, please contact Stephenson Harwood.

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.

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