Get consent for security
SOURCE: SCOTTISH BANKER, OCTOBER / NOVEMBER 2007
When the assets of a borrower are insufficient to cover the loan, and/or to service the interest, a bank would often obtain a guarantee to cover the potential shortfall. In a previous article, I looked at some of the basic provisions that would need to be included in a guarantee to ensure that it is effective. In this article, I will consider how a variation to the underlying contract can have a dramatic effect on the enforceability of a guarantee.
The basic rule is that any variation of the underlying contract (e.g. a facility letter), after the guarantee has been granted, will discharge the guarantor's liability under the guarantee unless:
(a) the guarantor consents to the variation; or
(b) the variation is clearly incapable of adversely affecting the guarantor.
As facility documentation has evolved over the years, it is often subject to amendments and variations, and obtaining the consent of the guarantor on each occasion can be problematic, albeit it would always be recommended as good practice. As a consequence, most bank guarantees contain wording to the effect that the guarantor consents in advance to any future amendments or variations to the facility, without the need for specific consent. These words will provide the bank with some comfort where the consent of the guarantor has not been obtained, but recent English law cases (which would be persuasive in Scotland) have greatly diluted such comfort.
In Triodos Bank NV v Dobbs 2005, it was considered whether a rescheduling of loans covered by a guarantee constituted a variation allowed by the standard form guarantee (which provided that the bank could “agree to any amendment, variation, waiver or release in respect of an obligation of the company under the Loan Agreement”). The original loans were replaced by further agreements with materially different terms, but which the bank described as “rescheduling”.
The Court decided that an agreement which was genuinely rescheduling, and which was envisaged in the original contract, was an amendment or variation of such contract permitted under the standard terms. However, agreements which altered terms relating to ranking of securities, the purpose of the loan and the actual sums due (as was the situation in Triodos), were more than an amendment or variation of the existing agreements (regardless of being tagged as "rescheduling") and therefore outside the scope of the standard term. Accordingly, the guarantor’s liability under the guarantee was discharged. NB It is worth noting that in Triodos the guarantor was aware of the new loan agreements but his specific consent as guarantor had not been obtained.
Banks can take some comfort from a more recent case, Wittman (UK) Limited v Willdav Engineering S.A. 2007 which decided that the variation of an underlying contract to a guarantee to include new obligations without the consent of the guarantor would not automatically discharge a guarantee, although the new obligations would not be covered by the guarantee. The rationale for this decision was that the underlying contract anticipated that it would be changed and that the guarantor had consented to such future changes, and therefore when such changes were made it would not be equitable if the guarantor was released from all obligations.
Therefore, whilst you would be advised to continue to include wording in the guarantee to confirm that the guarantor consents to any variations to the underlying contract, you should always obtain the consent of the guarantor to such variation, and ensure that the guarantor has a copy of the original underlying contract and all such variations, or else your security cover may not be as strong as you (and your credit committee) had originally anticipated.
author: alex innes