Lender's failure to protect other security offers no get out of jail free card for guarantors

Lenders failure to protect other security offers no get out of jail free card for guarantors

In a recent appeal against summary judgment, the Court of Appeal, Civil Division, dismissed the guarantor and principal debtor’s appeal and held that any duty of a creditor to preserve or maintain a security cannot be onerous: General Mediterranean Holding SA SPF v QucomHaps Holdings Ltd [2018] EWCA Civ 2416.

Background

In 2005 and 2006, the creditor had advanced $4 million to the borrower to finance the acquisition of the assets of a Czech company. The parties did not enter into a written agreement. However in 2007 the loan was documented and a personal guarantee by the first appellant's managing director was provided to the creditor under English law documents. The creditor agreed to lend a further $2 million. The managing director granted a guarantee to the creditor to secure this loan too and also security was given to the creditor by way of a charge over the assets of the Czech company. The company subsequently went into administration in the Czech Republic. The appellants repeatedly advised the creditor that under Czech law the creditor was required to take certain actions by 30 March 2010 in order to maintain its rights in respect of its security. The creditor did not file a claim as secured creditor in the administration and the charged assets were therefore released to other creditors of the Czech company.

The creditor issued proceedings seeking repayment of the loans pursuant to the guarantees. The appellants argued that (i) there was an implied duty on the claimant to do and not omit to do anything which would prevent them from fulfilling their obligations under the agreements, and (ii) the security had been rendered worthless and/or unenforceable as a result of, among other things, the creditor's failure to take any steps in the company’s administration, and (iii) that it had thereby failed to protect its rights. The creditor applied for summary judgment to be entered in its favour. The master granted that application, having concluded that in equity a creditor is not obliged to take any steps to enforce its security unless it is expressly agreed in the loan or guarantee document.

The borrower and guarantor appealed. The Court dismissed the appeal, having found that the appellants were unable to demonstrate that the creditor had been under an equitable duty to file a claim in the Czech company’s administration.

Arguments

The appellants argued that the creditor owed them an equitable duty to take reasonable steps to protect its security over the Czech company's assets, and it had breached that duty. The creditor contended that its equitable duty was of limited scope, which could be summarised as comprising (i) a duty to perfect the security and (ii) a duty, when exercising a power of sale, to take reasonable steps to obtain a proper sale price for the security but (iii) no other duty to take positive steps which have not been expressly stipulated by the debtor or the surety and (iv) no duty to preserve or maintain the security.

The Court of Appeal clarified the extent of a creditor’s obligations to a surety and a debtor under English law. It was held that in the absence of express terms, there is no broad equitable duty to “take reasonable steps to protect the security”.

It is established law that a creditor's release of other security or its failure to perfect security may discharge a guarantor. In Wulff v Jay (1872) L.R. 7 Q.B. 756, one of the main authorities the appellants relied on, a guarantor was partially discharged because of the creditor’s failure to perfect a bill of sale and failure to take possession of premises assigned as security. It was noted that a mortgagee is under a duty to take any necessary steps to perfect his security but has no duty at any time to exercise his powers as mortgagee to sell, to take possession or to appoint a receiver and preserve the security or its value or to realise his security.   

The Court of Appeal held that, while a creditor's equitable duty might not be limited to taking steps to perfect its security, any duty to preserve or maintain its security could not be onerous. A creditor could not be obliged to incur any sizeable expenditure or to run any significant risk to preserve or maintain its security.

The Court of Appeal concluded that the debtor and guarantor had no real prospect of successfully defending the creditor's claims, and their appeal was dismissed.  

Conclusion

Even though this judgment will provide comfort to lenders as it confirms that they are not obliged to take any steps to enforce or protect their security without express wording in the agreements, a lender should always include a clause in the agreement expressly stating that a guarantor's liability will not be reduced or discharged by any act or omission of the lender in perfecting or enforcing any security or guarantee from the borrower or a third party security provider. This is provided in most market standard documentation and provides certainty to lenders. 

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