Guarantees – We Haven’t Gone Away, You Know…

Case law in relation to personal guarantees will inevitably continue to change over the course of the coming months.  Those with sufficient net worth to offer meaningful guarantees at the height of the market will either be fighting them tooth and nail, or will employ teams of professional advisors to contest the validity of the guarantees, which were normally considered a "bolt-on" to main security, thus leaving gaps in procedure.

Two recent cases have thrown even more queries into the mix for banks and lawyers alike.  The recent case of Investec Bank (UK) Ltd -v- Zulman and another, decided on 18^th May 2010, was based on a very straightforward set of facts and reinforces the fact that a guarantee is a contractual arrangement, and the laws of contract therefore apply.

In the Investec case, the claimant bank purported to rely upon a personal guarantee, which had not been signed by the guarantors.  This would seem a fundamental flaw in any security, however as the "contract of guarantee" is exactly that, a contract, there is no need for the same to be executed as a deed.  Investec argued that the guarantee document itself was merely a written record of the terms of an agreement that had already been reached, and that the execution of the document was not essential for the guarantee to be relied upon. 

This situation could arise much more often than you think - in the property boom, banks often relied upon the fact that a facility letter contains a boilerplate provision stating that acceptance of the funds advanced was deemed acceptance of the terms on which it was advanced, including the details of the security given.  As such, especially in Northern Ireland where deeds are still required in property transactions, no security would have been signed and banks would rely upon numerous solicitors' undertakings to protect the repayment of their money.  Similarly, the absence of a signed guarantee could easily be allowed to pass from "conditions precedent" to "conditions subsequent" and may, as a result, never be completed.

The Statute of Frauds states that a guarantee is not enforceable unless it is in writing or there is a memorandum or note of the agreement signed by the guarantor at its discretion.  The courts in the Investec case considered the mindset of the parties in this particular instance, in particular the fact that the guarantee document contained a recommendation that the guarantees seek legal advice before signing the same.  While this is best practice in the post-Etridge era, it was ultimately this provision, which allowed the defendant directors to avoid the guarantee - if they took legal advice, which would lead to the guarantee remaining incomplete, they must be in a position to walk away.  Therefore no binding agreement had been reached at the time the document was issued for signature, and the bank lost the ability to pursue the directors (the presence of an earlier, signed guarantee did not assist due to certain de minimis thresholds contained within it).

Litigators will, however, be glad to hear that the court declined to rule on whether a guarantee must be in writing/recorded and signed by the guarantor in order to comply with the Statute of Frauds, as they had already dealt with the existence of the guarantee as above.  This does mean that the door remains open for banks to attempt to enforce a guarantee that has not been signed notwithstanding the provisions of this legislation, until such time as a court makes a decision on this point.

Banks can, however, breathe some sigh of relief following the Court of Appeal decision in Cattles PLC -v- Welcome Finance Services Ltd & Anor decided on 13^th May 2010.  In this case, RBS was the facility agent, and one of the syndicated lenders, to the claimant company in the sum of £1.625bn.  This borrowing was guaranteed by a group cross-guarantee entered into by Welcome Finance Services Ltd and others.  Cattles had also secured finance by the issue of bonds, which were not guaranteed and which only Cattles was liable to make payments.  Finally, Cattles itself was creditor for a number of inter-company loans, including one to Welcome.

Cattles defaulted under the loan facilities, the bonds and certain unsecured loan notes and notice was served to accelerate the bonds, although no enforcement action was actually taken.  Further, a standstill agreement was in place while a restructuring of Cattles plc was considered to avoid insolvent liquidation or administration.

As part of the restructuring negotiations, RBS asserted that the terms of the facilities and cross-guarantee prevented Cattles from recovering its inter-company debt until the guarantee had been satisfied in full.  The only assets of Cattles were the inter-company debts, and if RBS were successful the bondholders would have no recovery.

The Court of Appeal agreed with the High Court at first instance, and interpreted provisions in the cross-guarantee so as to increase the realisation made by RBS from the assets of the group in prohibiting claims being made in competition with, or priority to, those of RBS.  Ultimately, the guarantee wording was designed to ensure that any claim against the guarantor companies, not just any claim under a guarantee, was subordinated to the bank as between the parties to the agreement, and Cattles ultimately had no recourse against Welcome until the guarantee obligations had been complied with.

This case revolved around very specific wording in the guarantee document, which exists in the vast majority of bank precedent cross-guarantees, and as such follows the common sense conclusion that would be expected.  Please note, however, that at first instance the Cattles case was running in parallel with the case of Mills & ors -v- HSBC Trustee (C.I.) Ltd & ors, which resulted in a completely different decision and is the subject of a "leapfrog" appeal to the Supreme Court, due to be heard in January 2011.

As such, the issue of guarantees, their terms and their effects is one that is likely to be here to stay.  Bankers and guarantors alike, watch this space...

Tom Adair
Partner, Banking and Finance

Graeme McKee
Associate, Banking and Finance

David McAleese
Associate, Banking and Finance