Boilerplate's role in the preservation of guarantors' liability

By Paul Gatward, Leah Chick and Chelsea Piper.

Key Points:
A recent decision of the NSW Court of Appeal is a timely reminder to lenders of the importance of standard (or boilerplate) provisions in guarantee documents.

Last year, the NSW Court of Appeal in Schoenhoff v The Commonwealth Bank of Australia [2004] NSWCA 161 had the opportunity to consider the effect of one typical boilerplate provision of a standard form guarantee used by CBA.

In that case, the guarantors acted as sureties for the obligations of the debtor, under a margin lending facility. The court considered whether the guarantee and/or indemnity was discharged by an advance made to the guarantors by the bank, which would have had the effect of being a variation to the purpose provisions of the facility.

The terms of the documents entered into provided that:

• "the Guarantor guarantees that the Borrower will perform all of the Borrower's obligations on time and in the manner specified in the transaction documents" and "the Guarantor must do or pay anything that the Borrower has failed to do or pay under the transaction documents"; and
• the indemnity covered loss or costs suffered or incurred where "the Borrower does not, is not obliged to, or is unable to, perform the Borrower's obligations in accordance with the transaction documents."

Facts

The central fact considered in the appeal was that before the facility was entered into, the guarantors lent $40,000 to the debtor so that he could purchase shares and once the facility was granted, the debtor directed the bank to debit the guarantors account with $30,000 from drawings made under the facility. The debtor defaulted on his repayment obligations and the guarantors were called on to meet the debt.

Decision

The guarantors' case was that the advance was made by the bank in breach of the purpose provisions of the facility. It was submitted that because the moneys were advanced to the guarantors for a purpose other than as stated in the facility, the effect of this was to vary the facility by applying the funds other than towards buying shares.

The court discussed the High Court's decision in Ankar Pty Limited v National Westminster Finance (Aust) Ltd (1987) 162 CLR 549 which held that a guarantee will be discharged when the creditor's conduct has the effect of altering a surety's rights, unless the alteration is insubstantial and not prejudicial to the surety.

While the court was of the view that the conduct of the bank in lending the debtor the $30,000 for a purpose other than to buy shares had the effect of altering the guarantors’ rights in a substantial manner, it was distinguished from Ankar on the basis that another clause in the facility document, entitled "Rights", authorised variations to the principal contract.

That provision contained an express statement that the bank's right to make demands under the guarantee would not be affected "by any act or omission by [the bank]… or by anything else that might otherwise affect them under law, including the fact that [the bank may]:

1. vary or replace the [debtor's] obligations; or
2. release, lose the benefit of, or not obtain any security."

In relation to the indemnity, the court relied on the equitable principle that an indemnifier will not be discharged by variations to the principal contract unless there is an express or implied term that the indemnity is given the on the basis that the principal contract is not altered.

On this point, the court's view was that no such implied term could be found as the inclusion of the Rights clause was sufficient to express that alterations to the contract would not affect the obligations of the indemnifiers.

Concluding comments

This case provides some comfort that a court will give effect to boilerplate provisions within guarantee documents, particularly where the boilerplate is aimed squarely at ensuring the rights of guarantee and indemnity are not released or diminished.

Having said this, in circumstances where the terms of a principal contact are to be varied or altered in any way, it remains good commercial practice to always have a guarantor and indemnifier consent to and ratify the variations made to all such principal contracts.

For further information, please contact Leah Chick and Paul Gatward.