In the case of ABN Amro Commercial Finance PLC v McGinn and others , 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:
- 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
- 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:
- whilst not determinative of itself, the repeated inclusion of wording within the indemnities, referring to indemnification, was “indicative of assumption of primary liability”;
- 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
- 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  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.
- 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.
- 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.
- 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.