WHAT HAPPENED?

Rahan Constructions Pty Ltd (Rahan) was contracted to undertake commercial construction and other works in about April 2012.  On or about this date, Rahan entered into a credit account with Asset Flooring Pty Ltd (Asset Flooring).  Rahan’s obligations under this credit account were personally guaranteed by the respondent, Mr North.

On 30 July 2013, Rahan was wound up by order of the court and Asset Flooring sought to enforce the guarantee for the outstanding balance owing under the credit account.

THE TERMS OF THE GUARANTEE

The relevant clauses of the guarantee were as follows:

The guarantors hereby jointly and severally guarantee to the company as follows:

4. That all moneys owing or which may become owing by the customer to the company shall become immediately owing and due and payable by the guarantors without notice or demand...upon the appointment of...a liquidator to the customer...

The guarantors further agree with the company that:

8. All dividends, compositions and payments received by the company from the customer whether in liquidation or otherwise, shall be taken and applied by the company as payments in gross and any guarantor’s rights to be subrogated to the company in respect thereof shall not arise until the company has received the full amount of the company’s claim against the customer and this guarantee and indemnity shall be a security to the company for the payment of any ultimate balance which shall remain due to the company.      

PRIMARY DECISION

At first instance, the operative provision of the guarantee was identified to be clause 8, by which the quantum of the guarantee obligation was said to be limited by the use of the phrase ‘ultimate balance’.  As the ultimate balance could not be identified until the completion of the liquidation, Mr North’s obligation to indemnify the creditor was not, and would not be, enlivened until the ‘ultimate balance’ could be determined.

Asset Flooring appealed and contended that, on its proper construction, the guarantee did not prevent it from obtaining judgment against the guarantor until after the conclusion of the liquidation of Rahan.

APPEAL

Dixon J found that it was wrong to conclude that cl 8 was the operative provision of the guarantee and the phrase ‘ultimate balance’ defined the quantum of the indemnity to be met by the guarantor following the appointment of a liquidator.

In reliance on High Court in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd [2015] HCA 37, his Honour concluded that the relevant test of contractual interpretation to be applied was what a reasonable businessperson would have understood the clauses in the guarantee to mean.  That enquiry required consideration of the language used by the parties in the contract, the circumstances addressed by the contract and the commercial purpose or objects to be secured by the contract.

Against that background, his Honour concluded that the two clauses were intended to apply in different circumstances and to construe clause 4 as subordinate was inconsistent with the express words of the guarantee.

Furthermore, his Honour held that clause 8 had no application in circumstances where Asset Flooring was seeking to enforce the primary obligation of the guarantor under clause 4.  That was because, by its express terms, clause 8 was engaged when Asset Flooring received a dividend, composition or payment whether in liquidation or otherwise.

In this case, no payment had been received by Asset Flooring from the liquidator.  Where no payment was received, clause 8 was dormant.

Although his Honour came to this conclusion through interpreting the terms of the guarantee, he noted that this position was consistent with the common law position that a guarantor who has not paid the principal debt cannot require the creditor to proceed against the principal debtor to enforce any securities held for the debt before having recourse to the guarantor. 

COMMENT

This case reiterates the principles of contractual interpretation that apply in determining the effect of terms of guarantees and confirms that it is the duty of the guarantor, not the creditor, to ensure that a debtor performs the principal obligation. 

While the interpretation of a guarantee will turn on its own terms, Dixon J’s decision suggests that express words will be necessary before creditors are required to exhaust their remedies against debtor companies prior to enforcement of a guarantee.