Several Australian cases have considered the ability of a guarantor to challenge its payment obligations under a guarantee. Lenders typically rely on provisions which restrict a guarantor from avoiding payment under the guarantee on the ground of 'set-off' and/or 'counterclaim'. These clauses are commonly known as 'pay now and litigate later' clauses and they effectively require that payment under a guarantee must be made before any 'set-off, counterclaim or other deduction' is claimed by a guarantor. From a lender's perspective, these types of clauses are crucial to protect the recoverability of indebtedness owed to a lender and to ensure that cross claims are not raised by guarantors with the sole purpose of withholding payment and causing delay.

The outcome of a NSW case, O'Brien v Bank of Western Australia Ltd [2013] NSWCA 71 (O'Brien) had caused some concern. In this case, the court found in favour of the guarantor holding that suspension clauses could not prevail over statutory remedies (including defences such as estoppel and misleading or deceptive conduct). This meant that lenders were no longer necessarily entitled to summary judgements for money owing under guarantees and that suspension clauses may not be broad enough to incorporate certain statutory relief claimed by guarantors. 

However, in Palaniappan v Westpac Banking Corp [2016] WASCA 72, the principle of 'pay now, litigate later' was upheld and the judgment confirmed that the guarantor could not delay or withhold payment to the lender under the guarantee as a result of its counterclaim seeking certain statutory remedies. 

The facts 

Westpac Banking Corporation (then known as St George Bank Ltd) (the Bank), provided a loan facility of $18 million to Murray Riverside which was secured by property and a guarantee from Palaniappan (a director of Murray Riverside). The borrower defaulted under the facility and a notice of demand was sent to Palaniappan under the guarantee for approximately $20 million. Receivers appointed by the Bank realised assets for around $11 million (the proceeds of which were insufficient to discharge the indebtedness of Murray Riverside). As such, a notice of demand for the shortfall on the guarantee ($14.5 million) was sent to Palaniappan and finally, following non-payment, recovery proceedings were filed against him by the Bank. 

At first instance, the Supreme Court of Western Australia found in favour of the Bank. Palaniappan had filed a defence, counterclaim and set-off arguing that the receivers had breached their duty in exercising their power of sale in good faith. This was supported by arguments including that the receivers had failed to obtain market valuations, to advertise sufficiently and accepted a sale price under market value, which he argued amounted to unconscionable conduct. His claim was that as a matter of equity the lender was unable to enforce the guarantee or if so, only to the extent of the shortfall minus the amount which reflects the consequences of the breaches by the receivers. Whether or not there was any merit in the above arguments to permit a set off, the propositions were rejected by the court as a basis to reduce the liability under the guarantee as the suspension clauses had been clearly drafted to indicate that the guarantor could not defer payment due under the guarantee pending any litigation/determination of his claim. 

The suspension provisions 

The two relevant clauses which the Bank relied upon were the following: 

Clause 9 (a): 

"As long as any of the guaranteed money remains unpaid, you may not, without our consent: (a) reduce your liability under this guarantee and indemnity by claiming that you or the customer or any other person has a right of set-off or counterclaim against us;" 

Clause 13.1: 

"You must pay us the guaranteed money in full without set-off, counterclaim or deduction." 

The appeal - Key issues and judgement 

On appeal, Palaniappan argued that the court should have found that he was entitled to an arguable claim under a defence that the conduct relating to the sale of the property gave rise to statutory causes of action pursuant to the Competition and Consumer Act. As such, he further argued that the Bank should not have been granted summary judgement and that it would be unconscionable for the Bank to rely on clause 9. 

Given the facts of this case, Palaniappan argued that the alleged unconscionable conduct was in relation to the giving of instructions to the receivers by the Bank in respect of the sale of the estate land. This defence (although potentially plausible) only gives rise to offset the guarantor's liability but it does not put aside or vary the enforceability of the guarantee. The Bank's conduct did not in any way concern the making of the contract of guarantee but actually occurred after a fully valid contract of guarantee was entered into by both parties. As none of the Bank's alleged unconscionable conduct was related or attached to the suspension or deferral imposed by cl 9 of the guarantee, the court held that it was not invalid and should be enforced. In reaching this decision, the court found that the construction and meaning of clause 9 "to a reasonable businessperson", was unambiguous, ensuring immediate repayment without any deduction. 

Distinguished from O'Brien 

In O'Brien, the lender had represented to the borrower and guarantors that it would maintain loan facilities after the repayment date and agreed to advance additional money to enable the borrower to complete a property development. The lender then enforced the securities, and demanded the guarantors repay the balance. This was held to be unconscionable conduct because the lender had known that the guarantors relied on the false representations and as a result the indebtedness was not due and payable. Consequently, the suspension clause could not apply because the guarantor had no liability to which it could attach. This was in contrast to the current case where the unconscionable conduct wasn't directly related to the guarantee/loan facilities which means the debt was always due and payable, triggering the suspension clause. 

Analysis - Good news for lenders 

Since the decision of O'Brien, the general effectiveness of suspension clauses had been thrown into doubt, the key concern being that a suspension clause could not be drafted broadly enough to permit the granting of a summary judgement if a guarantor raised a statutory remedy (particularly relief for misleading or deceptive conduct). 

The impact of the decision of Palaniappan v Westpac (which will be a relief for lenders) is that it has limited the scope of the O'Brien decision, in that a counterclaim by a guarantor under certain statutory regimes (such as the relief claimed by Palaniappan including under section 420A of the Corporations Act 2001 (Cth) or Competition and Consumer Act) to challenge, reduce or set-off its liability under a guarantee are not likely to succeed unless such claim relates to conduct of the bank (or the relevant enforcing party) affecting the enforceability of the guarantee itself. In other words, a counterclaim by a guarantor related primarily to the conduct of the Bank (but not related to the guarantee itself) will not reduce the guarantor's liability under an otherwise enforceable and valid guarantee. 

For now, at least, it seems that absent any conduct by the lender which effectively invalidates the guarantee, courts are likely to continue to tell guarantors to pay out first and complain (or sue) later.