In a September 2012 British Columbia Supreme Court decision1, a guarantor was fully relieved from liability under a conditional guarantee which it had granted in favour of a lender due to the lender’s inadvertent breach of the underlying conditions.
The principal of the corporate guarantor was a friend and business associate of the principal of the corporate borrower. The borrower was in the business of road building and the guarantor was a small hauling company.
The borrower applied to its existing lender for an advance of additional sums in the amount of $950,000. The lender agreed to advance the additional loan on the condition that it receive adequate security. The guarantor agreed to guarantee the additional loan at the request of the borrower.
The terms of the guarantee in question provided that the guarantor would guarantee payment of the indebtedness of the borrower to the lender “irrevocably and unconditionally”, but “subject to the terms of [the] [g]uarantee”. Elsewhere in the document, the guarantor agreed that it would execute a mortgage in favour of the lender as security collateral to the guarantee, on the condition that the lender not register the mortgage until 5 days after default by the borrower and demand for repayment by the lender.
The guarantor duly executed and delivered each of the guarantee and the mortgage, but the lender registered the mortgage the same day that the documents were signed. The borrower subsequently defaulted under its loan and the lender initiated legal proceedings against the borrower, the guarantor and related parties.
At issue during the trial was whether the inclusion of the terms relating to delayed registration of the mortgage was attributed to a mistake made by the parties during the negotiation of the guarantee. Based on the evidence, the Court concluded that the guarantee, as signed (including the delayed registration condition), reflected the agreement between the parties. Based on the dealings between the guarantor and the borrower, the Court also concluded that the guarantor was an accommodation surety, for whom in law obligations under guarantees would be strictly construed and any material breach thereunder would discharge such a surety from liability.
In registering the mortgage prior to default and demand, the lender was found in breach of a material term of the guarantee (the condition), even though the guarantor did not prove actual prejudice as a result of early registration. Therefore, the effect of such breach was that the guarantor obtained a release from liability under the guarantee.
As conditions can be easily overlooked or forgotten in the steps leading towards enforcement, lenders should avoid attaching conditions or provisos in guarantees or related documents if at all possible. Whenever conditions are attached, lenders should take great care to satisfy them, as a failure to do so may result in the unfortunate outcome that a guarantor is inadvertently released from liability under its guarantee.