Maddocks has successfully assisted a Guarantor in defending his liability under two guarantees. The Guarantor was absolved from any liability under the first guarantee and found not to have been a guarantor on the other. The decision in Webster Investments Pty Ltd v North Star Developments Pty Ltd & Ors [2016] VSC 620 is a reminder to lenders of the importance of adhering to well-documented processes and what not to do during the enforcement process.

This article, the first of two parts, summarises the Court’s decision that the relevant security property was impaired by the conduct of the lender, resulting in the Guarantor being released from any liability under the guarantee.

Take away points for lenders

Although the facts of this case were unusual, the decision serves as a reminder that a lender must act responsibly to ensure that security provided by a borrower is properly realised. A lender places itself at risk where it fails to engage in adequate marketing and selling processes and in addition, a lender should be careful to objectively assess compromise arrangements that involve the release of only one of a number of co-guarantors. Moreover, a lender will place itself in obvious conflict when selling, as mortgagee in possession, to a purchaser which it is also financing.

In this case, the Court held that the lender impaired the security property because:

  • the lender failed to:
    • formally engage a selling agent
    • undertake a marketing and advertising strategy
    • obtain a contemporaneous valuation
    • consider the impact of a lease of the security property that ultimately impaired the saleability of the property
  • the lender refused to consent to a reasonable contract of sale of the security property (which was entered into by the borrower prior to the lender taking possession and for a purchase price that would have cleared the debt owed to it) and ‘sat on its hands’ while penalty interest continued to accrue on the debt
  • three years after it entered into possession, the lender held private negotiations with a co-guarantor for the purchase of the security property on the basis that the co-guarantor be refinanced (in part) by the lender and released from the relevant proceeding. Importantly, the security property was eventually sold to the co-guarantor at a price less than that obtained under the contract of sale.

By reason of the impairment of the security, the Court held that the Guarantor was released from all liability under the guarantee notwithstanding the usual saving provisions inserted in the guarantee to protect the lender.

Decision

The Court had to consider whether the lender had complied with its duties and obligations as mortgagee in possession and whether the lender took appropriate steps to sell the security property, a historical hotel complex in Ballarat.

In late 2005, shortly after becoming a shareholder and director of the borrower, the Guarantor signed a guarantee and indemnity in favour of the lender (in respect of all loans advanced to the borrower). At that time, the loans were secured by a mortgage over the security property. In March 2007, the guarantor resigned as a director of the borrower and requested that the lender release him from liability under the guarantee. The lender refused to release the Guarantor on the basis it was not receiving any consideration for the release.

After the Guarantor ceased any involvement in the business of the borrower, and unknown to the Guarantor:

  • by September 2010, the borrower was in default under the loan agreements
  • on 28 September 2010, the borrower entered into a contract of sale for the security property with an arm’s length purchaser for an amount in excess of the debt owed to the lender
  • in early October 2010, the lender entered into possession of the security property, (without lodging notice of becoming controller with ASIC contrary to s 427(1)(b) of the Corporations Act 2001)
  • consented to leases of the security property, which tied together the hotel and two adjoining properties that formed part of the security.

The lender refused to abide the contract of sale and took no steps to progress it to settlement. The sale ultimately fell through in 2011.

In addition to criticising the lender’s ‘belligerent’ attitude to the contract of sale, the Court concluded that the lender had ‘sat on its hands’ during the period for which it was in possession of the security property. Relevantly, the Court noted:

  • the directors of the lender were experienced legal practitioners and therefore, ought to have known of their obligations as both mortgagee in possession and as selling mortgagee
  • the directors of the lender had received legal advice setting out the duties of a mortgagee under section 420A of the Corporations Act, including the requirement that the property be advertised widely and sold at public auction
  • nonetheless, the lender did not formally engage any real estate agent to conduct a proper advertising and marketing campaign to sell the security property. Indeed, the lender’s own expert witness agreed that the security property would be expected to sell ’at the culmination of a public marketing campaign’, which would have required a recognised real estate agency
  • at all relevant times, no sale signs were placed outside the security property.

In 2013, the lender entered into a private agreement with one of the co-guarantors for the sale of the security property. The sale was on the basis that the co-guarantor would be financed for part of the purchase price by the lender and that he would be released from further liability as guarantor. Significantly, the lender did not make any attempt to contact the other co-guarantors or invite them to make offers for the purchase of the security property.

In ordering the Guarantor be released from any obligation under the guarantee, the court confirmed that a guarantor holds a special position and is ’a ‘favoured debtor’ and so the courts ‘look upon his interests with a jealous eye’. Relying on the judgment in GE Capital Australia v David (2002) 180 FLR 250, the Court held that a guarantor can be discharged from liability completely where a security is impaired by the conduct of the party seeking to rely on the guarantee. This was a clear case whereby the lender, by its acts and omissions, sacrificed the security, absolving the Guarantor from any liability.

This was notwithstanding the fact that the lender sought to rely on various terms of the guarantee to justify its conduct. These terms were expressed to allow the lender to enforce a guarantee even if:

  • a co-guarantor has been released or the lender has entered into any composition with a co-guarantor
  • the lender has realised security without taking reasonable care
  • the lender has delayed in enforcing any right or security
  • the guarantee is wholly or partially discharged by payment at any time
  • there has been any variation or modification to the terms of the arrangements.

The Court held that a lender cannot contract out of its duties and obligations under s 77 of the Transfer of Land Act 1958 (Vic). Moreover, the lender could not fall back on the contractual provisions in the guarantee given the Courts findings of ‘connivance and fraud’ (in this context meant conduct that was unfair to a guarantor) with respect to the lender’s conduct.

Conclusion

The Court’s decision provides importance guidance on when a lender will be precluded from calling on a guarantee, particularly where the lender’s own conduct has been improper or otherwise unreasonably augmented the overall shortfall.