Fishy business: always make demand before serving a statutory demand

Serving a statutory demand for guaranteed amounts without submitting a prior written demand under the related personal guarantee sounds a bit fishy*. The High Court agrees, in the case of Martin v McLaren Construction Ltd [2019] EWHC 2059 (Ch)

Introduction

Guarantees often form a crucial part of a lender’s decision to lend money to a corporate borrower as they provide credit enhancement on a finance transaction, supplementing a lender’s formal security package. 

A guarantee can be provided by a parent company (or other group companies depending on the circumstances) or a director of the borrower or an individual otherwise connected to the borrower (known as a “personal guarantee”).

In a personal guarantee, the guarantor promises to be directly answerable for the payment of a debt owed by the borrower to the lender or the fulfilment of the borrower's contractual obligations owed to the lender in the event of the borrower's default.  This means that the lender can only make a demand under the personal guarantee once the borrower has failed to pay or perform its obligations.  A guarantee’s primary function is to provide surety for performance, particularly where the borrower becomes insolvent.

It is very important for the lender to be in a position to be able to make a demand straight away once the borrower has defaulted. A well drafted personal guarantee will allow the lender to do this by including an “immediate recourse” clause in which the guarantor confirms to the lender that the lender is not obliged before taking steps to enforce any of its rights and remedies under the relevant personal guarantee to make a demand, enforce or seek to enforce any claim, right or remedy against the borrower or any other person.

It goes without saying that personal guarantees bring personal assets into play if the worst happens and a personal guarantee is called.  It is for that reason that lenders will often insist that a personal guarantor takes independent legal advice prior to signing any personal guarantee so that s/he fully understands the nature of his/her obligations and the potential consequences (and to avoid the personal guarantor arguing duress or undue influence).

In this alert we report on a recent case which illustrates the importance of following the correct procedure for claiming on a personal guarantee, even though the path followed by the lender in this case would still have produced the same commercial result for the personal guarantor in relation to the payment of the guaranteed liabilities.

Facts and decision

Ronald Martin (RM) had provided a personal guarantee (the PG) to McLaren Construction (UK) Limited (McLaren) in relation to his own liabilities and the liabilities of his various property development companies to McLaren. Under the terms of the PG, RM agreed that “whenever an Obligor does not punctually pay or discharge any amount of the Guaranteed Liabilities when due … the Guarantor shall immediately on demand pay that amount as if he were the principal obligor".

McLaren served a statutory demand (the Statutory Demand) on RM for approximately £7.1m, being the amount alleged to be owed by RM under the PG.  The Statutory Demand was expressly made under section 268(1)(a) of the Insolvency Act 1986 (IA 1986) (debt for liquidated sum is payable immediately). No prior demand had been made under the PG itself.

RM argued that the Statutory Demand should be set aside pursuant to rule 10.4 of the Insolvency (England and Wales) Rules 2016 (IR 2016) on the basis that the debt was not “payable immediately” because McLaren had not made a formal demand under the terms of the PG before serving the Statutory Demand.

McLaren raised various arguments to convince the judge that the Statutory Demand should not be set aside, including that:

• a formal demand under the PG had been made before the Statutory Demand had been served. This was given short shrift by the judge as it did not sit well with the evidence filed by McLaren…
• the Statutory Demand qualified as a demand under the PG so that the debt claimed thereunder was immediately due and payable upon the Statutory Demand being served or, failing that, that an earlier statutory demand in a different sum and subsequently withdrawn constituted a demand under the PG
• RM was in the end still liable under the PG for the amount claimed in the Statutory Demand, so any failure on the part of McLaren to serve a prior written demand under the PG was purely technical and there was no prejudice or injustice affecting RM which needed to be cured by the setting aside of the Statutory Demand

These and some other contentions fell on deaf ears as, ultimately, the ICC judge preferred RM counsel’s analysis, being:

• a statutory demand is a document with prescribed contents designed for the purposes of bankruptcy proceedings (i.e. to establish the presumption that the relevant debtor is unable to pay his/her debts and thereby entitle the relevant creditor to present a bankruptcy petition)
• a statutory demand is not intended as a means of fulfilling contractual preconditions to making a debt immediately payable
• a debt claimed in a statutory demand served under section 268(1) IA 1986 should already be “payable immediately” by the time that statutory demand is served; otherwise, a demand ought to have been made instead as a contingent debt under section 268(2) IA 1986
• the terms of the PG required a demand in writing to be served on RM under and in accordance with the terms of the PG before any actual (as opposed to contingent) liability arose on the part of RM to make payment of the guaranteed liabilities
• the service of that demand under the PG was a contractual prerequisite of a debt claimed under the PG becoming payable immediately for the purposes of section 268 IA 1986
• no formal written demand was given to RM under and in accordance with the terms of the PG
• accordingly, the debt claimed by McLaren was not payable immediately for the purposes of section 268(1) IA 1986

In light of the above, the ICC judge found that McLaren was not entitled to serve the Statutory Demand under section 268(1), given RM was not liable to make payment under the PG “immediately”.  McLaren had therefore failed to establish that RM was unable to pay his debts (which is the threshold requirement to issue a bankruptcy petition); as a result, its failings were both of form and substance. The ICC judge therefore exercised her discretion to set aside the Statutory Demand under rule 10.5(5) of IR 2016.

Comment

David Steinberg, co-head of Restructuring & Insolvency at Stevens & Bolton, comments that the McLaren case serves as a useful reminder that:

• beneficiaries of guarantees should always serve a notice of demand under a guarantee under and in accordance with the terms of that guarantee before service of any statutory demand under section 268(1) IA 1986 (that is, as a debt which is “payable immediately”)
• a statutory demand will not constitute a demand under a guarantee on its own – this principle was established in TS & S Global Ltd v Fithian-Franks [2007] EWHC 1401 (Ch) and referenced by ICC Judge Barber in her decision
• the court has a discretion under rule 10.5(5) of IR 2016 as to whether a statutory demand should be set aside, but is only likely to do so where the essential preconditions to issuing a bankruptcy petition (including the presumption of insolvency) have not been met

It is perhaps not surprising that ICC Judge Barber set aside the Statutory Demand in this case, notwithstanding the fact that the guarantor remained ‘on the hook’ under his personal guarantee. Bankruptcy is a draconian measure and one which the court will not be quick to impose upon individuals, particularly where the fundamental presumption of insolvency has not been raised.

Whilst such commercial considerations may be relevant in the context of winding up proceedings, the requirement to serve a statutory demand in bankruptcy proceedings is (almost) absolute. Therefore, the court will be slow to exercise its discretion to enable a creditor to pursue bankruptcy proceedings where a statutory demand has been pre-emptively and improperly made.

* Our more technically minded readers will know that fish are chordates whereas shrimp are arthropods of the crustacean subphylum.  Fish have an internal skeleton that includes ribs and a skull among other things.  Shrimp belong to an entirely different group who have exoskeletons.