If Peter Morton and Cinitel Corp. had their way, every lender would have a distinct duty to a guarantor to permit the sale of a defaulting borrower’s assets as a going concern. In their view, a lender should be required to maximize its recovery from the borrower and to minimize any claim made on a guarantee. Fulfilling that duty would also obligate a lender to keep funding a borrower while that asset sale was negotiated and completed. It is enough to make any lender cringe.
Fortunately, the Ontario Court of Appeal disagreed with Morton and Cinitel’s view of the lending world.
In O’Brien19, the Court faced a fairly typical fact situation where Fifth Third Bank provided certain credit facilities to MPI Packaging Inc., the indebtedness under which was guaranteed by Morton and Cinitel, both of whom were related to the Borrower20. The Borrower defaulted on its loans, and a court-appointed receiver sold the Borrower’s assets. The Bank sued Cinitel and Morton on their guarantees to recover the multi-million dollar shortfall following realization, and upon a motion obtained summary judgment against the guarantors.
In advancing their appeal, the guarantors specifically argued that (1) the Bank failed to act in a commercially reasonable manner in realizing upon its security by failing to allow the sale of the Borrower’s assets as a going concern, and (2) the Bank and the Borrower made material alterations and variations in the terms of the Borrower’s loan facilities without the consent of Cinitel and Morton21.
Surprisingly, Morton and Cinitel did not allege that the price obtained by the receiver for the assets was commercially unreasonable, but rather that the decision of the Bank to appoint a receiver and pursue a liquidation sale rather than a sale as a going concern was unreasonable. The Bank had a separate and distinct obligation to the guarantors to protect and preserve the Borrower’s assets which had not been fulfilled in their view.
The Court of Appeal disagreed with the guarantors and unanimously concluded that the Bank’s conduct in realizing upon its security was not commercially unreasonable in the circumstances22. It held that (1) the concept of commercial reasonableness should not be extended beyond collateral realization, and (2) the Bank’s reliance upon its strict legal rights in the context of a commercial lending transaction between sophisticated parties who have been represented by counsel could not be regarded as commercially unreasonable. The Court noted that the Bank had not entered into a formal forbearance agreement whereby the Bank had agreed to continue to fund the Borrower while efforts were undertaken to dispose of the Borrower as a going concern. Consequently, there was no requirement in their view for the Bank to continue to extend credit to the Borrower and thereby increase its exposure when its loan agreements had expired.23
Morton and Cinitel’s allegation that material variations had been made to the Borrower’s credit facilities without their consent was also dismissed by the Court of Appeal, which found that all of the changes were authorized by the principal loan agreements and the guarantees. The guarantors had been intimately involved throughout the efforts to resuscitate and sell the Borrower’s business, and were fully aware of the Bank’s contractual arrangements with the Borrower and the terms of their guarantees.24
It is encouraging to see that the Court of Appeal in O’Brien held these sophisticated guarantors to the terms of the business deal they had bargained for. The Court firmly rejected the imposition of new duties upon lenders in making decisions about extending credit or continuing to extend credit, and about realization remedies to pursue. This decision should help to close the door on inventive guarantor defences, at least for a few minutes anyways.