In the case of ABN Amro Commercial Finance PLC v McGinn and  others [2014], the UK High Court has ruled on the nature of conclusive  evidence clauses and has upheld the clauses’ intended purpose – to  circumvent protracted debates as to the validity of the underlying loss  being certified.

The Court also concluded that the deeds of indemnity provided by the  defendants created liability which was primary rather than secondary in  nature. Both determinations signal a clear recognition by the Judiciary  that surety agreements, properly obtained, can and will be enforced.

The Court’s judgment arose from a Summary Judgment Application  brought by the claimant. The claimant was an invoice discounter who  had provided financing to its client. The defendants were all former  directors of the client and had provided deeds of indemnity, which the  claimant now sought to enforce.

The defendants denied liability under their indemnities, arguing inter  alia that their liability was secondary and not primary in nature and  was therefore discharged by what they called material variations to  the underlying agreement. They also argued that the claimant had not  taken proper steps to collect and enforce the debts of the client and, by  doing so, the inclusion within the certified sum of any debt which could  and should have been collected was a manifest error.

The claimant in turn argued that the defendants’ liability was plainly  primary in nature and therefore any variation to the underlying  obligation did not impact their own personal liability. With regards to  the certificate, the claimant relied upon the terms of the defendants’  indemnities which expressly stated that the defendants agreed to  be bound by such certificates which should be treated as conclusive  evidence of their liability, save for manifest error.

Primary or Secondary Liability

The defendants contended that over time there had been a number  of variations to the underlying agreement which they deemed to  be material. They sought to rely on the rule in Holme v Brunskill  (1878) 3 QBD whereby a material alteration in an underlying contract  without notifying a guarantor and seeking their consent can cause the  guarantee to fall away. The variations to the underlying agreement  here were increases to the funding limits on the facility provided by the  claimant.

The defendants also contended that the relevant indemnities did not  create a primary obligation to the claimant, whereby any sums owing  to the claimant must be paid by the defendants on demand, but instead  created a secondary obligation whereby the claimant would need to  establish a breach of the underlying contract by the client, to call upon  the indemnities.

The claimant, in turn, relied upon two arguments:

  1. in the case of the first and second defendants, they were aware  of and had agreed to the relevant variations, which were for the  benefit of the company; and
  2. in any event, and more fundamentally, each of the relevant deeds  of indemnity, unlike a guarantee, formed a primary liability upon  the indemnifier whereby the indemnifier (save in the case of  manifest error on behalf of the claimant) must pay sums owing to  the claimant on demand.

Mr Justice Flaux held that the obligations created by the indemnities  were in each case primary. His reasoning for this was that:

  1. whilst not determinative of itself, the repeated inclusion of wording  within the indemnities, referring to indemnification, was “indicative  of assumption of primary liability”;
  2. wording of clause 3 of the indemnities, whereby “I shall be bound  by any acknowledgement or admission by the Company and by any  judgment in your favour against the Company”. The fact that an  acknowledgment of liability was sufficient, despite the possibility  that a detailed examination may reveal no liability, demonstrated  that the purpose of the indemnity was to create a primary  obligation; and
  3. the wording of clause 3 of the indemnities allowed the claimant  to include estimated contingent liabilities; the specific wording of  the clause was as follows: “in arriving at the amount payable to  you by the Company you shall be entitled to take into account all  liabilities….and to make a reasonable estimate of any contingent  liability.” Mr Justice Flaux found that the establishment of  contingent liability which was not dependent upon any conclusive  determination of liability of the company to the claimant was “a  compelling indication that the defendants’ liability under the deeds  of indemnity is primary rather than secondary.”

Accordingly, Mr Justice Flaux held that the true construction of each of  the indemnities created a primary obligation, thereby thwarting the rule  in Holme v Brunskill and that:

“irrespective of the factual position which seems to demonstrate  clearly that the first and /or second defendants were aware of and  consented to the allegedly material variations, the defendants’  case that they were discharged from liability under the terms of the  indemnity by virtue of those variations has no real prospect of success  at trial and is, bluntly, completely hopeless”.

The Conclusive Evidence Clause

As noted by O’Donovan and Phillips in The Modern Contract of  Guarantee, English Edition, at paragraph 5-107 and observed by the  Court in the case of North Shore, whilst conclusive evidence clauses  may be open to criticism, their validity however is established and  accepted by the courts.

Central to the issue of the enforceability of the claimant’s certificates,  provided in reliance of the conclusive evidence clause contained within  the defendants’ indemnities, was the question of what could amount to  “manifest error”, so as to nullify the certificates.

In this case, Mr Justice Flaux recognised that “manifest error” had  been defined by Lewison J in IIG Capital llc v Van der Merwe [2007]  EWHC 435 para 52, as one which is “obvious or easily demonstrable  without extensive investigation”. Subsequent authorities indicated that  “manifest error” would not necessarily have to be readily apparent at  the time that the certificate was provided. In the case of North Shore,  Sir Andrew Morritt CC stated that “it is quite possible for one person to  certify the existence of some fact at a particular moment in time which  the other person, the recipient of the certificate, cannot verify save  after the occurrence of a subsequent event”.

The defendants’ arguments as to the claimant’s error in including  potentially collectable debts in the sums certified, had been unaffected  by the fact that, at the present time, they were unable to demonstrate  the error immediately and conclusively but instead, would require a  full investigation at trial. The Judge in the present case recognised  the commerciality of the situation and stated that Sir Andrew Morritt’s  comments could not encompass a full blown trial as to which debts  might or might not have led to further recovery if the claimant had  pursued continuing efforts of collection. He therefore rejected the  defendants arguments that the certificate contained a manifest error.

For those who are reliant on surety agreements to reduce the inherent  risks of lending, it is encouraging that the Court found no favour with  the defendants’ arguments. Instead, the effect of this judgment is to  preserve the purpose of conclusive evidence clauses.

Mr Justice Flaux recognised this and stated:

“These disputes about collectability cannot be resolved on a summary  judgment application, which is relied upon by the defendants as a  reason why the court should not shut them out at this stage. However,  what this demonstrates is that to resolve this dispute would require a  full trial. I agree ….that would render the conclusive evidence clause  nugatory”.

Holders of sureties are regularly faced with challenges on  enforceability citing their own purported failure to fully mitigate as a  ground for absolving indemnifiers of any liability. Lenders should be  reassured that this is a judgment which recognises that conclusive  evidence clauses cut through such arguments and also strengthen the  generally accepted position that mitigation plays no part in a claim  under a contract of indemnity.

Whilst this Judgment is particularly helpful for those attempting to  enforce their security, it is important to ensure that all formalities  are correctly followed when security is taken. We also set out briefly  here, a few simply “Lessons to Learn” which should serve as a useful  reminder to you when security is being requested. 

Be Careful

  1. If an agreement is secured by way of guarantee, beware of the  rule in Holme v Brunskill. If (material) amendments are to be made  to the underlying agreement, make sure that you enter into fresh  guarantees to ensure that the security is not discharged by the  subsequent variations.
  2. If an agreement is secured by way of an indemnity, check the  wording. Are you sure that the document creates a primary  liability? The fact that the document is called an indemnity is not  enough of itself. The document should seek to identify a personal  liability of the indemnifier which would allow it to be called upon,  absent any breach by a third party.
  3. Even if the agreement is secured by way of an indemnity, it is best  practice to inform (in writing) the indemnifier when changes to  underlying agreements are made to prevent them from seeking to  challenge the validity of the agreements in the courts.

Conclusion – The Good News

Financial companies should take comfort that the Court will treat  properly drafted indemnities to construe primary liability on the  indemnifier and will uphold conclusive evidence /certification clauses.  As has been seen here, arguments attacking the conclusiveness of  a certificate which rely upon further interrogation to ascertain the  correctness of the sums certified will not be entertained. Accordingly,  indemnifiers should not, as a matter of right, be entitled to challenge  the way in which finance companies seek to make collections from the  client’s sales ledger.