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If your Borrower has Defaulted, Why not Bankrupt its Guarantor?
By Christopher J Sherliker

The Facts

The guarantor provided a guarantee and indemnity to the respondent building society (the creditor) in respect of borrowing by his brother (the borrower).

The guarantee was on the creditor's standard terms. Clause 2.3 provided: 'Any loss claimed under the guarantee is payable by you immediately on demand by us.' Clause 4.2 provided: 'Your obligations under this Guarantee are those of principal, not just as surety. We will not be obliged to make any demand on, or take any steps against, the Borrower or any other person before enforcing this Guarantee.'

The borrower defaulted on the loan, and the creditor demanded payment of £1,223,883.26 pursuant to clause 2.3 of the guarantee.

The creditor issued a bankruptcy petition against the guarantor, and an order was made by the Deputy Registrar in the sum demanded under the guarantee.

The guarantor appealed.

Two points arose concerning the nature of a guarantor's liability to the creditor, and the consequences in terms of the creditor's ability to present a bankruptcy petition.

Firstly, whether the alleged debt was a liability 'for a liquidated sum' within the meaning of s 267(2)(b) of the Insolvency Act 1986, or only a liability to pay unliquidated damages.

Secondly, if it was a liability to pay an unliquidated sum, whether the creditor was disabled from presenting a bankruptcy petition without first obtaining judgment for a specific sum, even in a case where liability was admitted, and the amount of damages could be calculated with mathematical precision.

The Court’s Decision

The High Court, Chancery Division, held that on its true construction, the guarantee did include a debt obligation. The main reason for that conclusion was that, by the principal debtor provision in the first sentence of clause 4.2 of the guarantee, the guarantor thereby made his brother's debts his own.

The creditor had been entitled to demand payment of the very debt which, by clause 4.2, the guarantor had made his own. It was a liquidated sum within the meaning of s 267(2)(b) of the 1986 Act.

The guarantor’s appeal was dismissed accordingly.

What This Means to You

A guarantee that requires a guarantor to discharge its obligations as a principal obligor, rather than simply as a surety, creates a debt in favour of the creditor with the benefit of the guarantee, rather than the right to sue the guarantor for damages.

The decision suggests that, in most cases, it will make sense to follow the standard practice of including an indemnity provision in the guarantee that makes the guarantor liable as a principal debtor. A creditor owed a debt by a guarantor can pursue that debt by way of statutory demand and insolvency proceedings, without having to first obtain a judgment against the guarantor.

Previous High Court decisions suggest that a right to claim damages from a guarantor cannot form the basis of a statutory demand or insolvency proceedings until the creditor has a court judgment in his favour. This judgment casts doubt on those decisions, although it does not directly overrule them. In this case, the court suggested that, if the amount of a damages claim was sufficiently certain, it would be appropriate to regard the claim as being a liquidated claim and so capable of being the subject of a statutory demand.

Whether you are considering enforcing a guarantee, are facing the prospect of being pursued under one, are looking for someone to give you a guarantee or are being asked to give a guarantee, contact us for some initial advice. We would be pleased to help.

Added: 19th May 2011

Christopher J Sherliker is a partner for Silverman Sherliker LLP who provide legal solutions across a spectrum of requirements.  Find out more about Silverman Sherliker LLP.

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