In the following case, the issue arose as to whether, on the wording of a guarantee, the guarantors were obliged to pay the amount demanded by the lender; or whether the guarantors could dispute the underlying debt i.e. rely on defences available to the company (whose obligations they had guaranteed).
The court found that the guarantors were not entitled to dispute the underlying debt. The guarantors were granted leave to appeal to the Court of Appeal on the basis that the guarantee contained common form provisions, so the decision had "ramifications".
ILG Capital Llc v Van Der Mewe and another  All ER (D) 297
The guarantors (husband and wife) were the directors of a company which entered into a loan agreement (governed by New York law) with a lender. The guarantors each entered into identical guarantees (the guarantee) in favour of the lender (governed by English law).
The company failed to pay amounts (approx. US$30 million) due to the lender under the loan agreement and the lender sought payment under the guarantee. The guarantors sought to rely on expert evidence of New York law to the effect that there was an implied covenant of good faith and fair dealing which required the lender to give the company reasonable notice of its demand and since the lender had not given such notice, the company had a complete answer to the claim.
The question therefore was: did the guarantors assume under the guarantee:
- a secondary obligation, which was dependent upon the primary obligation of the company (so that if the obligations under the loan agreement fell away or were unenforceable, the guarantor’s liability would also fall away); or
- a primary obligation which was independent of the liability of the company (so that the guarantors were under an unconditional obligation to pay amounts demanded by the lender)?
The terms of the guarantee
Under the guarantee:
- The guarantors guaranteed "as principal obligor and not merely as surety unconditionally and irrevocably" the punctual payment by the company and agreed that if the company did not do so the guarantors would "immediately upon demand unconditionally" pay the monies which had not been so paid.
- Clause 3 set out a long list of matters which would not discharge the guarantors’ obligations under the guarantee, including "Any other act or circumstance which (apart from this provision) would or might constitute a legal or equitable defence for or discharge of a surety or guarantor".
- There was a "conclusive evidence" clause, stating that a certificate in writing signed by a duly authorised officer of the lender stating the amount payable by the guarantors was, save for manifest error, binding on the guarantors.
- The guarantors were prevented from asserting any set-off against the company.
Construing guarantees: the authorities
The Court of Appeal noted the following principles from the decided cases:
- A security instrument had to be looked at as a whole, without preconceptions as to what it was.
- The context in which the security instrument came into being was important. Thus, performance bonds given by banks were almost invariably construed as imposing a liability on the bank to pay, regardless of any disputes in relation to liability under the underlying contract.
- It could not be assumed that cases relating to banking instruments provided any useful guide when construing guarantees given outside the banking context.
- Even minor variations in language plus a different context could produce different results.
- The absence of language appropriate to a demand bond outside the banking context gave rise to a “strong presumption against” interpreting an instrument as a demand bond.
- It could be argued, in a banking context, that a "conclusive evidence" clause converted a secondary security instrument (which contained no language typically found in a demand bond) into a demand bond. However, in a non-banking context, a "conclusive evidence" clause had to be scrutinised to ascertain whether the guarantee was primary or secondary.
Since personal liability was at stake, the Court of Appeal agreed that it was relevant to consider the what protections there would be (if the guarantee was on demand) for the guarantors in the event that the guarantors were forced to pay the demand as certified but it later transpired that the company did not owe the sum.
- The Court of Appeal concluded:
Where a loan agreement required the giving of guarantees (whether on demand or secondary liability guarantees), a call and payment of what was found to be due from the guarantors would "almost certainly" lead to a right of indemnity from the company if the guarantee had to be paid.
- If the guarantors paid out under the guarantee and it was subsequently determined that they had overpaid, then, if the company refused to seek return of any overpayment, the guarantors would have a right of subrogation by which they could force the lender to pay back sums found to have been overpaid.
However, the Court of Appeal noted that the precise mechanism for repayment was not the most relevant question to consider when construing the guarantee. If the guarantee by its clear language required payment, then it was for the guarantors to protect themselves against that eventuality.
Applying the legal principles
The Court of Appeal concluded:
- There was a presumption against the guarantee being construed as an on demand obligation which would only be rebutted if clear language was used.
- Clause 3 (the clause which set out a long list of matters which would not discharge the guarantors’ obligations under the guarantee) pointed in favour of that presumption (since such a clause was only necessary if the guarantors undertook a secondary liability).
- The language used in the guarantee: "as principal guarantor", "not merely as surety", and "immediately upon demand unconditionally" indicated that the guarantors were taking on something more than a secondary obligation.
- The matter was put beyond doubt by the "conclusive evidence" clause.
The Court of Appeal noted that the guarantors had not run the argument that, even if the guarantee did constitute an on demand guarantee, there should be a stay. Thus this matter was not before the court. However the court commented:
"…even in a case where an on demand obligation is undertaken a question might arise when judgment was given, whether there should be a stay. That would depend on the strength or otherwise of the claim that some money would ultimately have to be reimbursed."
It is interesting to note that clause 3 (which was presumably included in the guarantee as a "belt and braces" provision) was relied upon by the guarantors (rather than the lender) on the basis that it was inconsistent with an on demand guarantee. Draftsmen should be aware of this when considering whether to include such a provision in a guarantee which is clearly intended to be an on demand guarantee.
It was also interesting to note the court’s observations in relation to a stay of proceedings.