This week’s TGIF considers a recent decision in the Victorian Supreme Court in which a Guarantor was released from liability as a consequence of the Lender’s inappropriate conduct in realising the security.

WHAT HAPPENED?

Background

In late 2005 the Lender advanced $120,000 to the Borrower secured against an existing mortgage over hotel/motel complex owned by the Borrower. The loan was also secured by personal guarantees given by the directors of the Borrower.

One of the directors (the Guarantor) sold his interest in the Borrower in 2007 and requested to be released from his guarantee, however, the Lender refused to do so.

By late 2010, the Borrower had defaulted and the Lender issued a notice to pay.

Shortly after receipt of the notice to pay, the Borrower entered into an ‘arms-length’ contract to sell the mortgaged property for $3.5 million; enough to satisfy the debt owing (Borrower’s Contract).

The Lender did not accept the Borrower’s Contract and elected to serve a Notice of Redirection of Rent on the lessees of the mortgaged property, and thereby became mortgagee in possession under its mortgage over the Borrower’s property.

Despite the concern expressed by the Borrower and the clear benefits of the Borrower’s Contract, which would have resulted in payment of the debt owed to the Lender in full, the Lender maintained its position, declaring it would move to have the property sold at a public auction.

Throughout late 2010 and early 2011 the Lender made no moves to have the sale set in motion and by the time a valuation was obtained in late March 2011, the value of the mortgaged property had fallen to $2.5 million. The Lender subsequently attempted to revive the Borrower’s Contract but those attempt proved futile.

In May 2013 the Lender negotiated a private sale at $2.8 million, without the involvement of a real estate agent, any external advertising campaign and without a contemporary valuation (Lender’s Contract). Relevantly, the Lender provided vendor finance and the Purchaser, who was also a co-guarantor and former director of the Borrower, was released from any ongoing liability.

Proceedings were commenced by the Lender against the Guarantor for the shortfall.

The Courts decision

One of the issues to be determined was whether the Lender had complied with its duties and obligations as mortgagee in possession in the absence of a public marketing campaign and where the Lender had instead entered into an ‘unusual, generous and private’ deal in the form of the Lender’s Contract.

The Guarantor contended that, despite terms in the Guarantee which protected the Lender, he should be relieved from liability. The Court agreed and the claim against him for the shortfall was dismissed.

The actions of the Lender in refusing to uphold the Borrower’s Contract were found to have diminished the value of the mortgaged property by at least $700,000 (being the difference between the purchase price under the two contracts).

Comment

This case serves as a timely reminder to lenders that the right to enforce a debt against a guarantor may be lost where the power to sell is not exercised appropriately.

The interests of the guarantor and the debtor in the mortgaged property should not be lightly disregarded. If a lender fails to:

  • implement a marketing and advertising strategy;

  • engage a selling agent to implement the strategy; and

  • obtain current valuations,

but instead enters into sale by private treaty with a party related to the transaction, it does so at its own peril and bears a real risk that it will be held in breach of its duty to act in good faith.

In those circumstances the guarantor of the secured debt may be entitled to show that any liability to the secured creditor should be reduced or even extinguished.