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What is the extent of a secured creditor’s equitable duty to a guarantor?

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11/12/2018

In General Mediterranean Holding SA SPF v Qucomhaps Holdings Ltd [2018] the Court of Appeal had to consider if and when a commercial lender’s acts or omissions in relation to its security will release a guarantor from its obligations. The court found that in the absence of express terms, any equitable duty to take reasonable steps to protect the security cannot be onerous

Background

The case concerned an attempt by General Mediterranean Holding SA (GMH) to recover multi-million dollar loans that it had advanced to Qucomhaps Holdings Ltd (QHL), a company specialising in digital broadcast services. The repayment of the loans was secured by a charge over the assets of a subsidiary of QHL and guaranteed by a director of QHL, Mr Harkin.

GMH obtained summary judgment and the decision was upheld on appeal to the High Court. However, QHL and Mr Harkin obtained permission for a second appeal to the Court of Appeal on the grounds that the case raised an important point of principle. They argued that GMH owed them an equitable duty to take reasonable steps to protect the security it had been granted. When the subsidiary company had gone into administration, they argued that GMH failed to take reasonable steps to protect the security and it had therefore been rendered worthless and/or unenforceable. They argued that GMH had breached its duty to them, thereby releasing Mr Harkin from his guarantee.

Lawyers for Mr Harkin further contended that the lender had the opportunity to include an express provision in the guarantee stating that the surety’s liability “would not be reduced by the lender’s failure to perfect, take up or enforce any rights against, or security over assets of the debtor”. The fact that such an express exclusion had been omitted from the guarantee meant that the equitable duty to take reasonable steps to protect the security should be implied.

GMH, on the other hand, argued that previous authorities made it clear that the creditor’s equitable duty is very limited in scope and could be summarised as: (i) a duty to perfect the security; and (ii) a duty to take reasonable steps to obtain a suitable sale price for the security when exercising a power of sale.

What did the court decide?

The Court of Appeal dismissed the appeal and in its judgment clarified the extent of a creditor’s obligations to a surety and debtor under English law. It held that in the absence of express terms, any equitable duty to “take reasonable steps to protect the security” cannot be an onerous one. Furthermore, there could be no question of a creditor having an absolute duty to ensure that a guarantor could have recourse to the security. A creditor could not be obliged to incur any sizeable expenditure or to run any significant risk to preserve or maintain security.

WM comment

Although the guarantor was unsuccessful in its arguments, the case is a reminder that guarantees can be vulnerable. To make sure that the guarantee is watertight, it is good practice to include a clause stating that the guarantor’s liability will not be reduced or discharged by any act or omission of the creditor in taking up, perfecting or enforcing the security or guarantee.

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