By Gerry Neely
The fall in real estate values has made the security held by financial institutions of somewhat dubious value with the result that the number of Court actions against guarantors to recover deficits owed by principal borrowers has increased sharply. This is bad news for guarantors since the form of guarantee used by financial institutions contains so many escape clauses in favour of the financial institution that even a Houdini would have difficulty in safely emerging from its maze of small print. However, as the following cases illustrate, a little planning on the part of the guarantor, and a lot of luck because of changed circumstances, may enable the guarantor to avoid liability.
In the first case, the guarantor insisted upon negotiating changes to the bank's form of guarantee to provide for the addition to it of several conditions. One condition was that the bank would notify the guarantor of any default by the principal debtor, within fifteen days of that default occurring. Another condition was that the guarantor would be a party to any negotiations between the bank and the principal debtor involving the loan to the principal debtor. These conditions arose out of the agreement between the principal debtor and the guarantor which contained a number of safeguards to minimize the possibility that the principal debtor would be unable to pay the debt owed to the bank. The bank failed to meet these conditions and, when the principal debtor was unable to pay the amount of $168,821.19, the bank sued the guarantor. The guarantor argued that the two conditions were vital to the guarantor and the failure of the bank to perform those conditions had the effect of discharging the guarantor from liability. The Alberta Court of Appeal accepted this argument and dismissed the bank's claim.1
There are circumstances where the actions of the financial institution prejudice the guarantor so much that the guarantor is discharged from liability. In one instance, a husband and wife who were the principal shareholders of a company indebted to a bank, gave a number of guarantees to the bank over a period of years. When the amount of the loans exceeded the company's authorized limit, a meeting between the guarantors and the bank resulted in an extension of credit to the company. In return for the shareholders agreeing to give additional security and new guarantees to the bank, the bank agreed not to call the loan to the company until two road building projects underway had been completed. After the principal shareholder gave the further guarantee, the bank ceased to honor any cheques issued by the company. This of course put the company in the position where it was unable to continue with its business and therefore unable to repay the loans. The bank sued the guarantors, who argued that the actions of the bank were in breach of the contractual agreement entered into among the bank, the company and its principal shareholders. The bank had impaired the financial position of the company and prejudiced the guarantors. The British Columbia Court of Appeal agreed with this argument and discharged the guarantors from any further liability.2
Another circumstance in which a guarantee was relieved from liability is found in the facts of a foreclosure action. A mortgagor gave a mortgage in which a company and an individual were named as guarantors. The mortgagor sold the property and subsequently the new purchaser obtained from the mortgagee a modification of the mortgage. The modification extended the term for one year and increased the rate of interest from 13 3/4% to 18 1/2%. The purchaser defaulted and the mortgagee sued for personal judgment against the guarantors. They successfully argued that the result of the modification agreement was a new contract with the purchaser which was substituted for the original contract. The effect at law of this substitution was to extinguish the liability of the guarantors. This case is useful for pointing out the significant distinction between a principal debtor and a guarantor. As a guarantor you are entitled to rely upon some of the defences put forward in the cases mentioned above. As a principal debtor, however, those defences would not be available to you. In this case, had the guarantor been referred to consistently throughout the mortgage as the "principal debtor" rather than variously being referred to as principal debtor or guarantor, then the guarantor would have been found to be liable.3
So the message is to know what the printed form means, to negotiate changes or additions when you have some room to bargain, and to document the agreement made with the financial institution.
|1.||Bank of British Columbia v. Turbow Resources Ltd. 148 D.L.R. (3d) p.598.|
|2.||Bank of Montreal v. Wilder et al 149 D.L.R. (3d) p.193.|
|3.||Walter E. Heller Financial Corp. v. Timber Rock Enterprises Ltd.,40 B.C.L.R. p.85.|
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