Andrew Kirby warns: Lenders Beware – Guarantor Absolved of Liability
Originally published at on Andrew Kirby's LinkedIn linkedin.com/pulse/lenders-beware-guarantor-absolved-liability-andrew-kirby
In the very recent decision of Webster Investments Pty Ltd v Anderson  VSC 620, Justice Croft in the Victorian Supreme Court has held that a guarantor should be absolved from all liability in respect of two guarantees:
- in one case the guarantee was given by mistake as the documents were mistakenly drafted by the lender’s solicitors; and
- in the other case the lender’s conduct sacrificed the mortgaged property to the prejudice of the guarantor.
The case should sound a warning to lenders about their documentation and processes, how and where documents are signed, over reliance by lenders on solicitor’s certificates and the requirements to conduct a proper and public sales process of a mortgaged property.
The guarantor was an accountant who used to hold a small minority interest in a partnership which owned the “North Star” hotel and motel complex in Ballarat. The hotel and motel were being developed with finance obtained from the plaintiff lender, Webster Investments Pty Ltd. The guarantor gave a guarantee to Webster for the loans for the North Star development. Webster held a first ranking mortgage over the hotel and motel complex. The development was being managed by a developer, Anderson.
At the same time, Anderson and some other investors – but not including the guarantor - were also involved in a development at Lal Lal Street, Ballarat. The Lal Lal Street development was also being financed by Webster. The Lal Lal Street development had encountered some difficulties and Webster had asked for additional securities, including a second mortgage over the North Star Hotel and Motel complex.
In the context of these two financings, documentation was drawn up at the same time by Baird and McGregor, who were Webster’s solicitors. Baird and McGregor’s principals were also directors of Webster.
In regard to the Lal Lal documentation, the second ranking mortgage over North Star was drawn up and also included in the mortgage panel a personal guarantee from the guarantor. Justice Croft held that the guarantor’s name on the mortgage panel had been included by mistake, and did not conform with the agreement between Webster and Lal Lal, as set out in Webster’s board minutes, the letter of offer, the letter of instructions from Webster to its solicitors and other contemporaneous documents.
The guarantor gave evidence that he attended one signing meeting with a stack of documents about a foot high. No-one from Webster attended at the signing meeting. The guarantor signed all of the documentation, including his name on the Lal Lal second mortgage. He gave evidence that he was mistaken in signing this document as it was never agreed that he would give a personal mortgage in respect of the Lal Lal facilities, particularly as he had no interest in that project.
A solicitor had signed a solicitor’s certificate on which Webster heavily relied. However, there was some confusion and ambiguity about the terms of the certificate and also whether it applied to the Lal Lal transaction or the North Star transaction. It was acknowledged by Webster that there should have been two certificates – one for each transaction. The solicitor who signed the certificate was also acting for Anderson and other entities involved in the two financings and could not be said to be independent. There was also no evidence that the obligations had been properly explained to the guarantor as the solicitor did not give evidence and Webster had no representative present at the signing. The Judge ultimately found that Webster’s position could not be “saved” by the certificate.
The Judge also considered that post-contractual evidence was admissible and could be considered in relation to whether the guarantor had signed the Lal Lal guarantee by mistake. Two years after signing the guarantees, the guarantor sold his interest in the North Star project and asked if Webster would release him from that guarantee. Webster refused. However, the fact that at this point the guarantor did not also ask to be released from the Lal Lal guarantee was held to be compelling support for his case now. The guarantor said that he did not ask to be released from the Lal Lal guarantee because he did not realise at the time that he had signed a guarantee for the Lal Lal project.
Justice Croft held that there was no contract of guarantee at common law between Webster and East, as the parties had not come to any agreement for him to sign such a guarantee - to use the lawyer’s Latin phrase, the parties were not ad idem. The Judge also held that “Webster, having found his signature on the [guarantee] sought to enforce it and, in doing so, has ignored the true facts. It has been a cavalier approach to a very significant liability which Webster is seeking to impose on [the guarantor]”.
In regard to the North Star guarantee, while it was not in issue that the guarantor agreed to sign the guarantee for the North Star loans, the conduct of Webster as mortgagee in possession and as selling mortgagee was held to have involved egregious and seemingly inexplicable flaws. Most of the directors of Webster were experienced legal practitioners who had a close association with its law firm, Baird and McGregor. They had also received advice Gadens lawyers at the time, which recorded their duties under section 420A of the Corporations Act.
As mortgagee in possession Webster initially refused to abide by a contract of sale of the North Star complex which had been entered into by North Star as borrower once it was in default under the loan. The contract price at the time for that sale would have cleared the North Star debt. However, Webster then proceeded to “sit on” the asset as mortgage in possession for several years. Throughout this whole process the Judge held that the guarantor remained “a forgotten man in Webster’s eyes”.
Years later, Webster sold the North Star complex to a co-guarantor in a private and covert sale negotiated between Webster and the purchaser without any retained agent, nor any normal sales and marketing campaign. Further, the co-guarantor was provided with a notice of discontinuance of the proceeding against him and another co-guarantor and Webster assisted with the finance for the purchase by way of a second mortgage.
In respect of the sale of the North Star complex to the co-guarantor:
- there was no agent retained by Webster
- Webster made a conscious decision not to advertise the properties
- no auction or sale sign was ever erect on the properties by Webster
- the guarantor was never informed of the proposed sale of properties nor the proposed terms of the sale to the co-guarantor
- the offer to the co-guarantor was never provided to the guarantor
- Webster did not have an up-to-date valuation at the time of the transaction.
The Judge also held that there was an obvious conflict in a lender selling as mortgagee to a purchaser which it is financing. It was held not to be an arm’s length transaction. As seller, Webster as mortgagee should have been seeking the highest price possible. However, as an asset-based lender, Webster would have been looking to finance the asset on the most conservative loan to value ratio possible. Arguably, this meant that the lower the price paid by the purchaser, the less finance would be required, hence the possibility of a better loan to value ratio. Moreover, Webster continued to benefit from the secured asset in that it continued to receive interest on a mortgage. This was clearly important and beneficial to Webster as a financier, but it was of no benefit to the guarantor.
The Judge held that the circumstances of the sale of the property to the co-guarantor was very unorthodox and the directors of Webster appeared to be conscious of this and the sensitivity of the issues surrounding the transaction.
On another point, the Judge also held that after the guarantor had signed his guarantee, Webster consented to a lease over the motel part of the complex which included two large freestanding Victorian houses. The lease meant that these houses could not be sold separately unless the motel lease was renegotiated with the tenant. The Judge held that these two freestanding residential properties were more attractive and saleable assets than the rest of the motel properties. The Judge found that by consenting to these arrangements without the consent of the guarantor, Webster as mortgage had impaired the security.
The Judge held that Webster’s overall conduct, in particular the covert sale to the co-guarantor, involved “gross misconduct or fraud” within the language used in the relevant cases. “Fraud” in this context has been defined as conduct which is unfair to the guarantor. The Judge therefore held that the guarantor should not be burdened with the detriment caused by Webster’s conduct and therefore he should be absolved from all liability under the North Star guarantee.
There was also discussion in regard to the terms of the guarantee, which used an old-fashioned form of drafting. It was held that the terms of the guarantee could not “rescue” Webster from its conduct. Further, in accordance with previous authorities such as MBF Investments Pty Ltd v Nolan (2011) 37 VR 116 a lender selling a security property cannot contract out of its duties and obligations to act in good faith under section 77(1) of the Transfer of Land Act.