A creditor will often take security for a debt in addition to a guarantee. In those circumstances, the creditor will need to deal with its security in a reasonable and prudent way, as failure to do so could result in the guarantor's liability under the guarantee being discharged in whole or in part. In a recent decision, the Court of Appeal considered the extent of a creditor's duties to a guarantor in preserving security granted by a third party: General Mediterranean Holding SA SPF v. QucomHaps Holdings Limited and others [2018] EWCA Civ 2416.

Facts

General Mediterranean Holding (the creditor) made loans to QucomHaps Holdings (the debtor) to finance the purchase of a Czech aircraft manufacturer. Repayment was secured by a pledge of the shares of the debtor's wholly-owned subsidiary (the company) and a personal guarantee from its managing director, William Harkin (the guarantor). The company also granted the creditor a charge over its assets.

The company went into administration, allegedly as a result of a "tunnelling fraud", whereby its ex-manager fraudulently obtained security over the company's assets, forcing it into insolvency, and then bought the assets out of the administration at a fraction of their value.

Claim

The creditor brought proceedings to recover the loans under the personal guarantee. The defence alleged that the security had been rendered worthless and/or unenforceable as a result of the creditor's failure to take steps in the administration to preserve its rights and the rights of the debtor and guarantor in relation to the security, so that neither was liable to the creditor.

The creditor successfully applied to strike out the defence and was granted summary judgment, and an appeal from that decision was dismissed. The debtor and guarantor appealed.

Issues on appeal

On appeal, the debtor and guarantor argued that the creditor owed them an equitable duty to take reasonable steps to protect its security over the company's assets, and it was arguable that it had breached that duty, thereby releasing their liability to the creditor. The issue was one that should therefore be decided at trial. The creditor contended that its equitable duty was of limited scope, and did not include a duty to preserve or maintain the security.

It is established law that a creditor's release of other security, or its failure to perfect security, may discharge a guarantor. This is because a guarantor who has paid a creditor under a guarantee has a right to step into its shoes and obtain the benefit of any security in relation to the debt (subrogation rights). In Wulff v Jay ¹, a case the appellants relied on, a guarantor was partially discharged because the creditor failed to perfect a bill of sale by registering it and did not enter and take possession of premises assigned as security.

In this case, the Court of Appeal held that, while a creditor's equitable duty might not be limited to taking steps to perfect its security, any duty to preserve or maintain its security could not be onerous. There could be no question of a creditor having an absolute duty to ensure that a guarantor could have recourse to that security. A creditor could not be obliged to incur any sizeable expenditure or to run any significant risk to preserve or maintain its security. The court further held that it was doubtful whether a creditor could ever have an equitable duty to the principal debtor (as opposed to the guarantor) to take steps to preserve or maintain a security granted by a third party.

On that basis, the court concluded that the debtor and guarantor had no real prospect of successfully defending the creditor's claims, and their appeal was dismissed.

Comment

In this case the guarantor failed to convince the court that the creditor's equitable duty to preserve its security extended to it taking steps in the company's administration, which might have exposed it to unacceptable risk and expenditure. There may be other circumstances where a creditor's failure to act to preserve the value of its security might result in the guarantor being discharged in full or in part from its liabilities under the guarantee. A creditor can protect itself against such risks by including a clause in the guarantee whereby the guarantor acknowledges that the guarantee will not be discharged by any act or omission by the creditor in taking up, perfecting or enforcing any security. Alternatively, the parties can agree to exclude or postpone a guarantor's rights of subrogation, although clear words will be needed.