It is not unusual for business partners, company directors or family members to give joint guarantees of their company's debt.

In these circumstances, most people who act as a co-guarantor might think their only obligation is to the bank. The High Court has confirmed that this is not the case, with a significant obligation also existing between the guarantors.

The High Court recently handed down a decision which said that a co-guarantor who has paid more than his or her share of a guarantee may seek a contribution from his or her co-guarantor, even if the co-guarantor has been released from liability by the creditor.

The importance of the decision is that, if a guarantor enters into a settlement with a bank to pay out less than the amount of the debt owed, the guarantor may still be liable to their co-guarantors for contribution if the co-guarantor pays more than their fair share to the bank.

This may come as a nasty surprise, particularly if the guarantor has released the bank from a valuable counter-claim in order to obtain a good settlement.

Background

The recent decision of Lavin v Toppi [2015] HCA 4 arises from a common business practice; business partners act as co-guarantors to guarantee their company debts. In this case, the company in question went into liquidation and the bank commenced proceeding to recover the money owed by the company from the guarantors.

The appellants did a deal with the bank whereby they agreed to pay a small amount to the bank and in return the bank agreed to forbear on suing the appellants further on the guarantee.

However, the bank continued with its proceedings against the respondents and the respondents eventually sold assets to pay the full amount that remained outstanding under the guarantee.

Following the discharge of the guarantee, the respondents commenced proceedings against the guarantors to recover the money owed by the company.

Contribution

Contribution is an equitable remedy that seeks to ensure that one co-guarantor is not unjustly burdened by obligations arising out of a guarantee. The courts say that the law of equity recognises that people who agree to take on the same risk should share any burdens arising from the assumption of the obligation.

The decision of the High Court

The appellants' argument at first instance, on appeal and in the High Court was that by virtue of the bank's agreement that it would not sue the appellant any further under the guarantee the co-guarantors' liabilities under the guarantee were no longer of the same nature and therefore the claim for contribution should be rejected. This argument was rejected at each hearing.

The High Court returned to first principles in deciding that the actions of the bank did not affect a co-guarantor's right to seek contribution.

The appellant also argued that, because they received no benefit from the respondents paying out the remainder of the guarantee, there was no basis for the respondents to claim a contribution. This argument was also rejected by the High Court. The High Court said that, in discharging the guarantee and releasing both parties from their continued obligation, the respondents inevitably bestowed a benefit on the appellants. In reaching this decision the High Court found that the existence of coordinate liabilities and benefit from payment are not separate and distinct elements of the right to contribution.

This case serves as a valuable reminder that entry into a guarantee defines rights not only between the creditor and guarantors but also between co-guarantors. This should be kept in mind when negotiating a settlement under a guarantee as a creditor's actions alone are not sufficient to completely remove the liability of the co-guarantor.

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