Where a loan is guaranteed by multiple parties, a lender will often issue demands and then commence proceedings against all guarantors. 

If a guarantor pays more than its equal share of the debt, it will generally have a right to sue the other guarantors to recover the difference between what it did pay and what it would have paid if the guarantors each paid an equal share. This is known as the right to contribution - a right which has been recognised since the 18th century.

The High Court in Lavin v Toppi1 has recently reaffirmed the right to contribution by holding that it is not defeated where one guarantor settles with the lender for an amount less than an equal share of the guaranteed debt.  A copy of the decision is available here.

Background

The first appellant (Lavin) and first respondent (Toppi) were directors and equal shareholders of Luxe Studios Pty Ltd (Luxe) a company that borrowed $7,768,000 from National Australia Bank (Bank). Several parties guaranteed the loan, including Lavin and Toppi. When Luxe fell into receivership, the Bank demanded payment from the guarantors and commenced proceedings against each when they failed to pay.

A property used as security for the guaranteed debt was sold for $4 million and the proceeds paid to the bank.

Lavin (and parties related to her) entered into a deed of release and settlement with the Bank after she had filed a cross-claim in the proceeding seeking a declaration that the guarantee was unenforceable.  In return for the Bank withdrawing its claim and giving a covenant not to sue Lavin, she paid $1,300,000 of the guaranteed debt and $1,730,000 to settle additional personal loans. 

At a later stage, Toppi (and parties related to her) settled with the Bank by paying the remaining balance of $2,900,000. 

Toppi commenced proceedings in the Supreme Court of New South Wales claiming contribution from Lavin amounting to approximately $774,000, being half of the difference between the amounts paid by the Toppi and Lavin parties.

Lavin argued that the Bank’s covenant not to sue her made her liability under the guarantee unenforceable because the parties were not under “co-ordinate liabilities” - that is, liabilities of the same extent and nature, which is required for the right of contribution to apply. Lavin’s arguments were rejected at first instance in the Supreme Court of New South Wales and subsequently in the Court of Appeal. Lavin appealed to the High Court of Australia.

Decision

The High Court summarised the issue on appeal as whether a surety who pays a creditor a disproportionate amount of a guaranteed debt can recover contribution from a co-surety when the creditor has given that co-surety a covenant not to sue for payment of the guaranteed debt.

The Court confirmed that the foundation of the right to contribution is natural justice - that persons who have a common obligation should contribute equally in its satisfaction. The right should not be defeated by unduly technical arguments. Given this foundation, the Court in a unanimous joint judgment dismissed the appeal on two grounds.

It agreed with the Court of Appeal’s reasoning that the Bank’s covenant not to sue merely had the effect of preventing the Bank from enforcing the guarantee against Lavin in legal proceedings.  It did not extinguish Lavin’s liability under the guarantee, which could be enforced by other means and by other parties, such as the claim for contribution by Toppi. 

Secondly, the High Court stated that equity separately prevented a creditor from being at ’liberty to fix one with payment of the whole debt’2 and that the equity applied from at least the time the Bank commenced proceedings. If Lavin could rely on the Bank’s covenant not to sue in order to deny another’s right of contribution, the Bank could effectively choose who  was ultimately responsible the debt.  The Court viewed such an outcome as a significant injustice: 

At the heart of the appellants’ argument is an invitation to accept that it is in "the power of the creditor to select his own victim; and, upon motives of mere caprice or favouritism, to make a common burden a most gross personal oppression."4 That invitation cannot be accepted.

Lavin’s appeal was dismissed and she was ordered to pay costs.

Key Messages

The High Court has demonstrated its willingness to protect the right to contribution between guarantors, both at law and at equity.  Joint and several guarantors are equally liable to pay a guaranteed debt, even if separate settlement arrangements are made with the lender.

While the right to seek contribution is a matter between guarantors, we expect this decision may make it more difficult for lenders to settle with individual guarantors, given a guarantor’s advisor will be mindful of the need to reach a global settlement to protect their client’s position (unless their client is paying more than their share). 

This article was prepared with the assistance of Mark Colautti, Graduate Lawyer