A recent British Columbia Supreme Court decision in Coast Mountain Aviation Inc. v. M. Brooks Enterprises Ltd. held that the guarantor of a loan was released from liability under the guarantee due to the lender’s breach of condition. The case stands as a reminder to lenders to be careful to determine if there are any conditions to the effectiveness of a guarantee which are in favour of the guarantor, whether contained in the guarantee itself or in any related documents, and be sure to comply with those conditions. Otherwise, the guarantor may have an argument that it is released from its guarantee.
In this case,1 heard before Justice Fenlon of the British Columbia Supreme Court, a guarantor provided a lender with a guarantee of a loan and a mortgage on real property of the guarantor. The guarantee provided that the mortgage should not be registered against title to the property until the borrower defaulted and the lender demanded repayment of the loan. The mortgage was registered before default and demand. The guarantor argued that the lender breached a term of the guarantee such that the guarantor should be released from its liability under the guarantee. The Lender argued the breach was trivial and not sufficient to release the Guarantor. The court held the guarantor was released from liability under the guarantee due to the lender’s breach of condition.
Coast Mountain Aviation Inc. (the “Lender”) made a loan to M. Brooks Enterprises Ltd. (the “Borrower”). The loan was guaranteed by A.K.S. Trucking Ltd. (the “Guarantor”). The Guarantor also granted the Lender a mortgage on the Guarantor’s Whistler property. The guarantee contained a proviso that the mortgage not be registered against that property prior to the Borrower’s default and demand by the Lender (the “Subject Condition”). In fact, the mortgage was registered against the property on the day it was signed. The Borrower subsequently failed to pay any monthly instalments. The Lender sent a demand letter to the Borrower and the Guarantor, then commenced an action against them. The Guarantor denied liability under the guarantee.
The officer of the Guarantor who signed the guarantee claimed he did not know he had signed a guarantee (non est factum), even though he had obtained independent legal advice. He also claimed he was not authorized to sign the guarantee on behalf of the Guarantor. Both defences were subsequently abandoned and two new defences were raised: (a) the Lender breached a term of the guarantee (ie, the Subject Condition), thereby releasing the Guarantor from liability under the guarantee and (b) the guarantee was void for uncertainty.2
With respect to argument (a), the Lender argued the breach of term was trivial and not sufficient to release the Guarantor. The Lender also argued that inclusion of the Subject Condition in the guarantee was a result of unilateral mistake and should be rectified.
To rectify the guarantee by removing the Subject Condition, the court found, the party asserting the error would have to show, by “convincing proof”, an inconsistent prior agreement and that permitting the other party to take advantage of the error would amount to a fraud or the equivalent of fraud. In reviewing the evidence, the court held that the Lender did not prove the existence of a prior oral agreement. Accordingly, the Subject Condition remained part of the guarantee.
The guarantee also contained a standard clause which provided that the Lender may take and give up security without prejudice to, or diminishing or discharging the liability of, the Guarantor. The Lender argued this clause permitted the Lender to register the mortgage without notice to the Borrower or Guarantor. However, to interpret the clause in that way, the court held, would render the Subject Condition meaningless.
The Lender argued that the breach of the Subject Condition was not a fundamental breach, contrary to what the Guarantor asserted, and therefore should not release the Guarantor from the guarantee. The court found that analyzing guarantees using the concept of fundamental breach was not appropriate since a guarantor does not always obtain a benefit for providing a guarantee. In most cases, there is no benefit against which to measure the magnitude of the guarantor’s loss. The question was rather whether the Guarantor had established breach of the guarantee by the Lender of a kind that releases the Guarantor from the guarantee. In that regard, the Lender argued that a lender’s breach does not relieve a guarantor from its liability under a guarantee unless the breach undermines or lessens the value of the security provided by the debtor or another guarantor or otherwise increases the risk assumed by the guarantor. The Guarantor argued that a guarantor is relieved of liability for any breach of guarantee no matter how minor.
To address these arguments, the court looked to prior case-law3 which established the distinction between “accommodation sureties” and “compensated sureties”. Accommodation sureties are sureties who enter into guarantees in the expectation of little or no remuneration and for the purpose of accommodating or assisting others. Compensated sureties are generally in the business of guaranteeing payment and performance of an obligation in return for a fee. The court interpreted prior case-law to say that accommodation sureties will be released from liability for material breaches of a guarantee but not for trivial or inconsequential breaches. Compensated sureties, the court found, are held to a higher standard and should be discharged from liability under guarantees less readily than accommodation sureties.
The court noted that the characterization of sureties into these two categories is sometimes problematic since a person may not be in the business of providing guarantees but could still profit from entering into one. The court found that the Guarantor in this case was an accommodation surety, notwithstanding that the parties “did business together”.
Given that the Guarantor was held to be an accommodation surety, such that it would be released from liability for a material breach of the guarantee, but not for a trivial or inconsequential breach, how did the court characterize the breach of the Subject Condition? The court held that the Subject Condition (which as drafted, was a proviso) was a condition and was therefore “presumed” to be material. The Lender argued that proof of substantive prejudice was still required to release the Guarantor, but the court found that proof of substantive prejudice was not required; the breach involved a material term and had a potentially substantial effect. The court concluded that, “ [t]here is a sound policy reason for the law holding lenders to the strict terms of a guarantee contract with an accommodation surety.” As a result, the court held the Guarantor not to be liable under the guarantee.
DISCUSSION AND RECOMMENDATION
Arguably, it was not necessary for the court to have determined that the guarantor in this case was an accommodation surety such that the guarantor would be relieved of its liability under the guarantee as a result of material, but not trivial or inconsequential, breaches. Once the court determined that the Subject Condition was a condition of the guarantee, a breach of the Subject Condition may have been sufficient. As McGuinness says, “…where a guarantee is conditional, the relevant conditions must be satisfied in order to render a surety liable.”4
In any event, the case stands as a reminder to lenders to be careful to determine if there are any conditions to the effectiveness of a guarantee which are in favour of the guarantor, whether contained in the guarantee itself or in any related documents, and be sure to comply with those conditions. Otherwise, the guarantor may have an argument that it is released from its guarantee.