06 May 2011

Unlimited liability: it's guaranteed

by Sam Cottell, Nick Miller

Guarantees in commercial contracts will need to be carefully reviewed to ensure the guarantor isn't liable for the payment of a non-existing obligation.

Can you guarantee payment of an obligation which doesn’t exist?

The answer, according to the Supreme Court of Victoria, is definitely Yes. In a recent case, it said that a guarantor of a seller’s obligations could be liable even if the seller was no longer subject to the obligations.

The court’s reasoning will require a careful re-examination of the drafting of guarantees in commercial contracts.

Background

It's relatively common for a seller's obligations under a sale agreement to be guaranteed by a parent company. It's also market practice for many of the seller's obligations under the sale agreement to be subject to a range of limitations eg. minimum claim thresholds and time limitations.

It has widely been believed that a buyer could not make a claim against the seller's guarantor if the buyer could not bring that claim against the seller.

The Supreme Court of Victoria has now cast significant doubt on this general proposition.

The facts in Healthscope v Australian Hospital Care

In Healthscope v Australian Hospital Care, the share sale agreement allowed the buyer to make claims against the seller for outgoings and other normally apportioned expenses.

The sale agreement expressly provided that any claim for these expenses/outgoings had to be made within 12 months from the completion date.

The buyer subsequently wanted to make such claim. Unfortunately for the buyer, the 12 month limitation period had expired. The buyer decided to claim under the guarantee instead.

Decision

The court dismissed the buyer's claim on other grounds. However, it considered whether the buyer could have claimed under the guarantee, even though the seller’s obligations under the apportionment clause had expired.

The court thought that this issue was "not free from difficulty". Nevertheless, it believed that the better view was that the time bar did not apply to claims for the same thing under the guarantee.

On this view, therefore, the buyer could claim against the guarantor even after the time limit had expired.

Implications

This will no doubt be a very surprising outcome for most M&A practitioners. The idea that a buyer can essentially override the extensive and usually very closely negotiated limitation provisions seems profoundly contrary to the risk allocation agreed between the parties. For instance, the same rationale would mean that a maximum cap limitation (eg. X% of the purchase price) may not apply to claims made directly by the buyer against the seller's guarantor (ie. liability would be unlimited). Other limitations (eg. warranty claim periods) may also not apply to claims made by a buyer against the seller's guarantor.

In the Healthscope case, the court made specific reference to a term of the guarantee which preserved the guarantor's liability notwithstanding the invalidity or unenforceability of the seller's obligation or liability. With respect, this is a very standard provision included in guarantees for other reasons. It is difficult to conclude that the parties to a commercial contract would have intended this type of provision to preserve liability when it is essentially the buyer's own delay which has resulted in it being unable to claim against the seller.

It remains to be seen whether future cases will follow the court's surprising views on this issue. Nevertheless, prudent guarantors should now be more hesitant to give a seller's guarantee unless it is expressly made subject to the same limitations that apply to the seller's liability.

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