This Commercial Court decision highlights the complex and fact specific nature of guarantees and considers fact specific arguments that may be raised to defend liability under such a contract. The case nevertheless confirms some important principles that may be of use to lenders seeking to enforce guarantees.

The Facts

In this case, the Claimant was a bank that provided loan facilities in accordance with Islamic law and was the victim of a receivables financing fraud.  The Claimant claimed against the second to fourth Defendants, as guarantors, for monies due under a Restructuring Agreement (the “RSA”) after a special purpose vehicle, known as Plantation, defaulted on its obligations under the RSA.

The Defendants advanced various arguments to suggest that they were not liable for the default of Plantation under the RSA. It was for the Court to decide whether:

Rectification of the RSA should be ordered in circumstances where, as argued by the first and second Defendants, before the RSA was entered into, there was an understanding that the value of a lease provided by Plantation as security under the RSA was to be assessed as at the time of transfer to the Claimant as opposed to the later date of sale;
Whether any default of the RSA had been caused by the bank, such that Plantation and the guarantors could not comply with their obligations under the RSA and therefore should not be held liable;
Whether there was an enforcement event entitling the bank to claim under the RSA at all;
Whether the Claimant was in breach of its duty to the Defendants; and
Whether the Claimant was entitled to trace its money into the property of another company’s shares.

The Defences and Decision

The Court ruled that the claim for rectification failed on the facts. In particular, it was a term of the RSA that the Defendants could not rely on anything outside of the RSA to have contractual effect.

Under the RSA, Plantation was required to provide the Claimant with security by way of a first ranking charge by way of conditional assignment of a lease over some land. The Defendants suggested that because the conditional assignment was governed by Dubai law, the effect of giving notice and perfecting the assignment was such that the debt was extinguished. However, it was held that this was unarguable as the debt itself and its recoverability under the RSA was governed under English law.

A further defence considered was whether the Claimant had procured the arrests of some of the Defendants and thereby made it impossible for them to comply with their obligations under the RSA. The Court held that on the evidence this was unsustainable. However, even if it was the case, the Claimant could only be precluded from relying on the event of default if it could be shown, on the balance of probabilities, that because the Claimant had procured the arrests of the Defendants, it was not possible for them to pay the monies due. On the facts, this was not the case. It was the Dubai authorities who had procured the arrests. Further, and in any event, it was held that no term could be implied into the RSA that the Claimant would not report any wrongdoing to the Dubai authorities as to do so would be illegal and contrary to public policy.

The Court held, on a true construction of the RSA, that there was not an enforcement event (entitling it to enforce its security) at the time the Claimant first declared one. However, that position changed when the Claimant served a subsequent notice of acceleration. Importantly, it was not an argument for the Defendants to suggest that because the Claimant declared an enforcement event too early, there was a repudiatory breach of contract. This was because the Court decided that such an error was unlikely to go to the root of the contract and nothing was actually said or done by the second Defendant or Plantation that constituted acceptance of the breach.

Perhaps more interestingly, the Court concluded that once the Claimant took possession of the security, it was under no immediate duty to sell. The Court considered the judgment of The China and South Sea Bank Limited v Tan Soon Gin [1990] 1 AC 536 which held that  it was up to a creditor to decide when to sell, but when it does, any property must be sold for its current market value. In particular, a creditor is not a trustee of the mortgaged security and power of sale for the surety unless and until the creditor is paid in full and the surety, having paid the whole debt, is entitled to a transfer of the mortgaged security.

Finally, in relation to tracing, the Court held that the bank was entitled to a proprietary claim against the Afren shares, which were found to be proceeds of misappropriated money. The Claimant argued first that the Afren Shares represented monies originally subject to a fiduciary duty in favour of the bank which were misapplied in breach of duty. Secondly, the Claimant argued that the first Defendant was liable for dishonest assistance and knowing receipt and was under an obligation to pay equitable compensation to the value of the shares. The Court did not agree with the Defendant’s argument that the RSA prevented such a claim and held that the Claimant had a proprietary interest in the shares and was entitled to trace.

Practical Conclusions

Although this case was largely a decision based on the specific facts and relevant clauses in the RSA, some general principles can be extracted:

Enforcing guarantees is fact specific;
Different agreements can have different governing laws and one agreement governed by one law is unlikely to affect another governed  by a different law;
Claimants may find it difficult to enforce a guarantee/contractual provision if they deliberately take steps to prevent a party from complying with their obligations;
No term can be implied into an agreement that will prevent a party from disclosing wrongdoing, as to do so would be contrary to public policy; and
A creditor is under no immediate obligation to sell its security once in possession. However, when they do, there is an obligation to attempt to obtain the current market value.

For further information, please contact Georgina Squire or the Partner with whom you usually deal.