You're in Trouble. That's a Guarantee!
Guarantees are a very common form of security. Lenders often ask for guarantees from the principals behind a business to whom they are going to extend credit. Landlords will seek them from the principals of a corporate tenant. Suppliers often make them part of a credit application. Typically, guarantees are one of several documents signed as part of a new credit arrangement. Guarantees can be unlimited or limited in amount. After they are signed, everyone tends to forget about them but they remain in the creditors file. Only if things go badly, often years later, does the guarantee resurface. If the business runs into trouble, the creditor will sue for any outstanding debt. Only at this point do the guarantors come to realize the legal consequences of the guarantee they signed so long ago. Naturally enough, they frequently seek to avoid this obligation. A review of a handful of recent guarantee cases illustrates how difficult it is to avoid a guarantee.
One common defence is that the creditor has done something the effect of which at law is to release the guarantors. For example, one principle of guarantee law is that a guarantor who pays the debt is entitled to an assignment from the creditor of all the available security against the debtor. Where the creditor has released or otherwise impaired that security, this can relieve the guarantor of the entire debt. This principle collides with another fundamental tenet of guarantee law: a guarantee is a matter of contract and the parties are free to contract out of the protections the law would otherwise extend to guarantors.
This later principle prevailed in a recent case, Royal Bank of Canada v. Bush, where the creditor held a mortgage and a guarantee as security. The creditor foreclosed on the property and suffered a shortfall. The creditor then sued the guarantor who argued that because the creditor could not assign the mortgage security to him, his guarantee was excused. The court disagreed noting that the language of the guarantee (as is common) provided that its enforceability was unaffected by “the fact any obligation of the debtor to the creditor may be invalid, void, voidable or unenforceable.”
Another frequently tried defence to guarantee claims centres on the verbal discussions between the parties as modifying or excusing the guaranteed debt. This was tried in Lau v. McDonald where Mr. McDonald argued that the written guarantee he gave to Mrs. Lau was, by oral agreement between them, actually an obligation owed to her husband who had originally lent the funds. This had been the subject of discussion between them and the fact that the guarantee was in Mrs. Lau’s name was a “formality” that was “of no significance”. Mr. McDonald lost that fight because the written terms of the guarantee. They included a term that the guarantee could not be amended other than in writing and that it was the “entire agreement” between the parties. The court would not admit oral evidence that contradicted the written terms agreed between the parties. Mr. McDonald had to pay the debt.
The same result occurred in Bank of Montreal v. Bal. The Bals signed a guarantee for the debts of their company. They said they had been induced to move their accounts to BMO by a bank employee who told them their personal guarantees would only be valid for six months. Believing this, they signed the guarantees and did not read them. Several years later, when BMO sued for the unpaid debt, the Bals argued that in the face of a specific and erroneous representation to them, an “entire agreement” clause in the guarantee could not operate to allow its enforcement. The court disagreed and found that evidence of oral discussions could not be used to contradict or overcome the express terms of the guarantee. Those terms were a formal agreement that was intended “to fix the obligations of the parties to prevent such misunderstandings.”
A guarantee can remain enforceable even where the guarantor ceases to have any interest or involvement in the debtor business. In O.K. Tire Stores v. Auto Magic Businesses, Mr. Irving had signed a credit agreement for his business that included a personal guarantee. At the time, he was the owner of the business but later retired. Five years after that, and after the terms of credit had been changed, the supplier sued to recover over $90,000 in unpaid debt. Mr. Irving sought to avoid his guarantee by arguing the modification in credit terms after his retirement absolved him. The court disagreed. The language of the guarantee was broad enough to allow the creditor to modify credit terms without Mr. Irving’s consent or knowledge.
However, sometimes a guarantee defence works, often because of carelessness by the creditor. In one case, Kalsi v. Achary, the “guarantors” were relieved of their obligation because the document they signed did not actually contain any guarantee terms. The Acharys agreed to “guarantee” a loan made to a relative who himself was providing a mortgage as security. A mortgage was draft and a signature line was inserted for the Acharys to sign above the word “guarantor”. However, the mortgage itself contained no guarantee terms. When the loan was not paid, the lender sued. The court held that even though the Acharys were identified as “guarantors” in the mortgage, there was no enforceable guarantee because there were no guarantee terms. Given the wide variety of possible guarantee terms, the court was not prepared to conclude that the use of the word “guarantor” alone created an enforceable obligation.
Another and more complicated case where a guarantee defence work was Coast Mountain Aviation v. M. Brooks Enterprises Ltd. Through his company, A.K.S. Trucking (“AKS”), Mr. Shokar did a lot of business with M. Brookes Enterprises Ltd. (“MBE”). Mr. Shokar and Mr. Brookes, the principal of MBE, were friends. Mr. Brookes arranged to borrow a lot of money from Coast Mountain and persuade Mr. Shokar, through AKS, to provide a mortgage and a guarantee as security. Mr. Brookes’ business failed and both he and MBE went bankrupt. Coast Mountain came after AKS for the outstanding debt. In defending the claim, Mr. Shokar alleged two things. First, he said that when he signed the guarantee on behalf of AKS, he thought he was selling a share of his business, not providing a guarantee. Second, he pointed to the fact that Coast Mountain had agreed not to register the AKS mortgage on title until there had been default under the loan. In fact, Coast Mountain had registered the mortgage well before default.
In dismissing Mr. Shokar’s first argument, the court noted that he “did not pay close attention to what he was signing but must have been aware that he was facilitating MBE’s borrowing”. In other words, failing to read the document or not understanding what it says is not generally going to work as a defence. However, AKS’ second defence did work. The court found that AKS was an “accommodation surety”, as opposed to a “compensated surety”. The law generally holds creditors to a higher standard when dealing with accommodation sureties. Nonetheless, accommodation sureties will not be “relieved of liability for technical or trivial breaches of a guarantee contract”. In this case, the promise not to register the mortgage before default was an express condition of the guarantee. While AKS could not show any “substantive prejudice” from the mortgage being improperly registered, the court found that AKS did not need to because the breach was of a material term and had a “potentially substantial effect”. As Coast Mountain had drafted the guarantee terms, it must live by them (even if Mr. Shokar did not read them). As AKS provided this guarantee with little or no benefit to itself, it could only be held to the terms of that obligation and “nothing more”. The court found that the premature mortgage registration was not trivial. It was a serious enough breach that it relieved AKS of the guarantee debt.
The bottom line is that no one should offer or treat guarantees lightly. Any one being asked to sign a personal guarantee should think carefully before doing so. They should read the guarantee and understand their rights. They should be mindful that the guarantee will likely last indefinitely unless they get the express agreement of the creditor to release it. Too often guarantors only realize the devastating financial consequences of their guarantee at a later date when things are much different. The best time to avoid or limit your exposure is before you sign the guarantee.