Guarantee and Indemnity – Rights of a surety against a creditor
Permanent Custodians Ltd v AGB Developments Pty Ltd  NSWSC 540, New South Wales Supreme Court, Davies J, 1 June 2010
Craig Kirrin Gore (the Second Defendant) and John Edward Atkinson (the Third Defendant) were guarantors of a debt owed by AGB Developments Pty Ltd (the First Defendant) to Permanent Custodians Ltd (the Plaintiff). The debt was secured by a mortgage over a property owned by the First Defendant. The Plaintiff agreed with the Second and Third Defendants (the Guarantors) that it would seek to recover first from the proceeds of the sale of the property in return for consent judgments executed by the Guarantors covering any shortfall. When the property was sold and proceeds were insufficient to discharge the debt the Plaintiff moved to enter the consent judgments. The Guarantors resisted, arguing that the property had been sold at undervalue in breach of an implied term in the agreement requiring the Plaintiff to secure the ‘best price obtainable’. The Guarantors also sought leave for a cross-claim based on the alleged sale at undervalue.
Justice Davies found that the agreement contained no implied term of the type alleged by the Plaintiff, ruling that the contract was effective without the implication of such a term. His Honour also declined to grant leave for a cross-claim, finding that the Guarantors had no claim against the Plaintiff under either section 420A of the Corporations Act or a general negligence-based duty. Finally his Honour held that even if there were a relevant claim against the Plaintiff or the First Defendant a stay would not be granted because the terms of guarantee suspended the right to any such claims until the guarantee money had been paid.
The Second and Third Defendants (the Guarantors) had guaranteed a loan given by the Plaintiff to the First Defendant. The loan was secured by a mortgage over a property owned by the First Defendant. The Plaintiff defaulted on 5 January 2009, and by 20 August 2009 the Plaintiff had secured judgment for possession of the mortgaged property and was in the process of making demands on the Guarantors.
On 26 August 2009 the Plaintiff and the Guarantors agreed to an arrangement under which the sale of the mortgaged property would be used to expedite the resolution of the dispute (the Agreement). Under the Agreement the Plaintiff would execute a notice of discontinuance and the Guarantors would execute consent judgments. These documents would then be held in escrow pending the outcome of the sale. If the proceeds were sufficient to clear the mortgage debt the Plaintiff would file the notice of discontinuance, but if the proceeds were insufficient the Plaintiff would be entitled to enter the consent judgments without further notice. The Agreement included a term stating that the Plaintiff reserved its rights generally and including under guarantee.
When the property was sold the proceeds were insufficient to clear the debt, and the Plaintiff moved to enter the consent judgments. The Guarantors resisted the entry of the consent judgment, alleging that the property had been sold at undervalue in breach of an implied term in the Agreement requiring the Plaintiff to have regard to the Guarantors’ interests and do all things reasonably necessary to achieve the ‘best price obtainable’ (the Implied Term). The Guarantors also sought leave to file a cross-claim, arguing that the alleged sale at undervalue constituted a breach of the Plaintiff’s duties under the general law and section 420A of the Corporations Act.
Justice Davies found that there were three matters to be considered. The first was whether there had been a sale at undervalue in breach of the Plaintiff’s duties. The second issue was whether the Implied Term would give rise to a cross-claim that justified preventing the entry of the consent judgment. The final issue was whether, if no cross-claim was permitted in the present proceedings, execution of the consent judgment should be stayed pending the determination of any claims by the Guarantors in fresh proceedings.
(i) Mortgagee’s duties
His Honour found no evidence that the property had been sold at undervalue, but considered whether a sale at undervalue would have breached any duties owed by the Plaintiff to the Guarantors.
His Honour began by considering section 420A of the Corporations Act 2001 (Cth). Section 420A requires a party exercising a power of sale to take all reasonable care to sell the property for market value if applicable, or else the ‘best price that is reasonably obtainable’. His Honour held that there was no evidence that section 420A was intended to confer any protection on guarantors, and that in any case it did not confer a remedy in damages for breach. In discussing section 420A his Honour relied heavily on the judgment of Bryson J in GE Capital Australia v Davis  NSWSC 1146.
His Honour then considered the Guarantor’s claim that mortgagees owe a general law duty of care to guarantors to exercise their power of sale in good faith and with reasonable care to ensure that the property is sold for market price or the best price possible. His Honour dismissed this claim, noting that the notion of a negligence-based duty for mortgagees had been repeatedly rejected in New South Wales.
(ii) Implied terms
His Honour refused to imply the Implied Term for a number of reasons. Firstly, it did not meet the requirements set out in BP Refinery (Westernport) Pty Ltd v Hastings Shire Council (1977) 180 CLR 266. Secondly, it was redundant given the mortgagee’s duties under general law and section 420A of the Corporations Act as claimed by the Guarantors. Thirdly, the term was not capable of clear expression or understanding. Justice Davies concluded that if such a term were to be included in a contract it would have to be by express agreement.
(iii) Stay of execution based on fresh proceedings
The Guarantor’s final submission was that the entry of the judgment and its enforcement should be stayed to allow the Guarantors to bring fresh proceedings alleging a breach of the general law duties of a mortgagee’s exercise of the power of sale or a breach of section 420. In discussing this issue Justice Davies referred again to Bryson J’s decision in Davis, which held that although guarantors have an equitable defence against creditors which stems from the guarantor’s right to be subrogated to the creditor’s rights, this defence is subject to the terms of the contract between the creditor and the guarantor.
Justice Davies found that in this case the Guarantors’ equitable rights had been displaced by the terms of the guarantee, specifically clauses 2.2, 2.5 and 6.6. Clause 2.5 provided that the Plaintiff’s rights against the Guarantors were to continue unaffected unless expressly waived in writing, and clause 6.6 required the Guarantors to pay any amounts owing notwithstanding any deductions or offsets. Justice Davies held that the cumulative effect of these clauses was firstly to require payment regardless of any breach or relevant offset, and secondly to delay the Guarantor’s right to make claims against the Plaintiff until the debt was fully paid.
In an attempt to avoid these clauses the Guarantors submitted that the guarantee had been superseded by the Agreement, but Justice Davies rejected this argument. His Honour pointed to several clauses in the Agreement which referred to the guarantee as if it were still in effect.
(iv) Bankruptcy of the third defendant
The Third Defendant became bankrupt on 27 May 2010, and Justice Davies found that section 58(3) of the Bankruptcy Act 1966 (Cth) prevented the Plaintiff from entering the consent judgment against the Third Defendant until leave of the court was obtained. His Honour therefore only made orders for judgment and costs against the Second Defendant.
Co-authored by Tim Lee.
Published by SAI Global on behalf of Centre for Corporate Law and Securities Regulation, Faculty of Law, the University of Melbourne with the support of the Australian Securities and Investments Commission, the Australian Securities Exchange and the leading law firms.