With the market volatility across Europe following the Brexit vote and recent drops in share prices triggering margin call events in margin facilities, we consider it timely to consider whether guarantors and/or third party security providers under a margin facility should be asked to consent to any concessions, waivers or other indulgences granted to borrowers.
Background
As a general rule, it is clear under English law that where the liabilities of a borrower are varied without the consent of the guarantor, the guarantor is no longer liable under the guarantee unless the variation is "beneficial" to the guarantor or "unsubstantial"1. The same rule generally applies to third party security providers.
In addition to the exceptions of "beneficial" or "unsubstantial", over time and in response to the rigid nature of this rule, guarantees and third party security have evolved to include "indulgence clauses", being clauses contained in a guarantee or third party security under which the guarantor or security provider (as applicable) agrees up front to its liabilities continuing notwithstanding any changes to the underlying arrangements between the debtor and creditor. In the modern business world where arrangements between borrowers and lenders (as well as other arrangements where guarantees apply, such as leases or construction contracts) are constantly changing and being restructured broad indulgence clauses are considered a "must-have".
However, notwithstanding this, the case law is not clear as to the requirements for a successful indulgence clause and the "beneficial" or "unsubstantial" have been judicially interpreted to have little practical benefit for a lender (we consider these in more detail below). Accordingly, we would always recommend that the express consent of the guarantor or third party security provider be obtained to any change, consent or waiver granted under an underlying contract between a lender and borrower.
Unsubstantial or beneficial exceptions
It is the responsibility of the lender seeking to rely on the guarantee to prove that the variation, consent or waiver in question is "unsubstantial" or "beneficial" in order that the lender may obtain the benefit of the exceptions. In terms of proving that a change is "unsubstantial" or "beneficial" to a guarantor or security provider, such a change must be self-evidently unsubstantial or beneficial, without the court having to engage with the particular circumstances of the transaction.2
For example, in a case where a landlord sought to claim under a guarantee, the guarantor sought to avoid its liabilities under the guarantee on the basis that there had been changes to the underlying lease to which it did not consent. These included a change in the purpose to enable the tenant both to sell wine and to use the premises as an off-licence. In that case, as the variations could not clearly be shown to be unsubstantial and / or beneficial to the guarantor, the guarantors were released from their obligations.3
Grant of additional time
In addition to the above, it is accepted in case law that where a time indulgence is granted to a borrower without the consent of the guarantor, this will be sufficient to discharge the guarantor from its liabilities. That is to say, an indulgence of time cannot be considered to be "unsubstantial" or "beneficial" and, indeed, this is the case irrespective of whether the change is, in fact, beneficial to the guarantor or security provider. The reason behind this is that by granting an indulgence of time, this robs the guarantor of its rights to pay out the borrower's debt to the lender and to step into the shoes of the lender and make a claim against the borrower.4
All monies liability
If the guarantee or security is provided on account of "all monies", it is possible that this may extend to an increase in the underlying liabilities, unless the indebtedness initially contemplated was minor and the increase was comparatively substantial.5 Factors relevant to this consideration include whether the increase in indebtedness causes the likelihood of the guarantee being called on to be increased.6
In light of the narrow interpretation of the exceptions of "unsubstantial" or "beneficial" by the courts, the exceptions are unlikely to be helpful to a lender and should not be relied upon when contemplating making changes or granting waivers or indulgences in an underlying contract with a borrower.
Indulgence clauses
Given the rigidity of the rule, the narrowness of the exceptions and the detrimental consequences for a lender having the benefit of a guarantee or third party security, guarantee documents and third party security documents have evolved to include indulgence clauses under which the guarantor or security provider (as applicable) agrees at the outset that any changes made to the underlying arrangements between the borrower and the lender (or any consents or waivers granted to the borrower etc) will not affect the continuing liability of the guarantor or security provider under the guarantee or security (as applicable) for the borrower's indebtedness.
The key question in considering whether an indulgence clause is sufficient to capture the change, consent or waiver is whether the clause is drafted sufficiently broadly so as to cover the circumstances that have arisen, that is to say, are the proposed changes, consent or waivers requested "within the purview" of the indulgence clause?7
Unfortunately, although the concept of indulgence clauses being accepted has itself received some judicial support and there is some case law to draw on in this area when considering the "purview of the guarantee", there are no clear guidelines in the case law available as to how to measure whether a proposed change, consent or waiver goes beyond the general purview of the guarantee.
Conclusion
Where lenders are seeking to:
- change in any way an underlying contract with a borrower;
- consent to an indulgence requested by a borrower; or
- waive a default of a borrower and impose alternative terms or grant a remedy period,
in circumstances where there is a guarantee and/or third party security, we would advise that it would be prudent always to obtain the express consent of the guarantor and/ or security provider (as applicable) to such change, consent or waiver to avoid the guarantor and/ or security provider (as applicable) having any claim against the lender that the liabilities under its guarantee or security (as applicable) have fallen away as a result of the change, consent or waiver.
If this is not possible, then careful consideration needs to be given to whether the change falls comfortably within the scope of an indulgence clause or is clearly beneficial or unsubstantial and, in any case, always keeping in mind the narrow construction given to the exceptions and to indulgence clauses by courts in case law available to date.
Finally, and just to note by way of comparison, that in the US the law has developed in such a way that if a guarantor is considered not to be liable under a guarantee, rather than the whole of the guarantee falling away, the guarantor continues to remain liable but only to the extent it would have been liable but for the variation, consent or waiver. There has been some support in England for this interpretation and we would suggest that it is a much fairer approach to this issue.8
However, until the law develops more definitively in this direction, we would strongly recommend obtaining the express consent of the guarantor or third party security provider (as applicable) to any change, consent or waiver proposed to be granted to a borrower, where the liabilities of that borrower are covered by a guarantee or third party security.
Footnotes
1 Holme v Brunskill 1878 3 QBD 495, CA
2 Marubeni Hong Kong & South China Ltd v Mongolian Government [2004] EWHC 472
3 Howard de Walden Estates Ltd [1995] 22 EG 143
4 Samuel v Howarth (1917) 3 Mer 272
5 Egbert v National Crown Bank [1918] AC 903
6 Corumo Holdings Pty Ltd v C Itoh Ltd (1991) 24 NSWLR 370
7 Tridos Bank v Dobbs [2005] EWCA Civ 630; Hackney Empire Limited v Aviva Insurance UK Limited [2012] EWCA Civ 1716
8 The Mystery of Mercers of the City of London v New Hampshire Insurance Co ([1992] 2 Lloyd's Report 365)
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.
