I’ll Pay – Guaranteed

The law reports are replete with cases dealing with guarantors attempting to cast off their obligations. Although, almost inevitably, the guarantors are unsuccessful, sometimes they beat the odds. Of course, each time financial institutions see a successful defence, they simply change their guarantee forms to draft around it. They do so because, although there are several common law defences to an action on a guarantee, the courts recognise that contracting parties can, in their contract, avoid the application of those defences. One defence relates to increased risk. If the financial institution changes the risk to which the guarantor is exposed without the guarantor’s consent, the institution thereby completely releases the guarantor from the guarantee.

Different Loan

In Royal Bank of Canada v. Bruce Industrial Sales Limited (1998), 40 O.R. (3d) 307 (C.A.), the guarantors guaranteed two loans of the bank’s customer: a revolving operating loan at prime plus 1.5%, not to exceed $125,000; and a $100,000 term loan at prime plus 2.25%. The guarantors ultimately notified the bank that they would no longer guarantee the continuing operations of the customer. At that time, the liability under the revolving loan was $95,000. Without the knowledge of the guarantors, the bank then converted the revolving loan to a fixed loan at prime plus 2% and increased the interest rate on the term loan to prime plus 2.5% 

Conversion of Loan

Clause 1 of the guarantee allowed the bank to “… otherwise deal with the customer and others and with all securities as the Bank may see fit …” Clause 4 of the guarantee allowed the guarantors by notice to determine their liability but “notwithstanding receipt of any such notice the bank may fulfil any requirement of the customer based on agreements expressed or implied made prior to the receipt of such notice and any resulting liabilities shall be covered by this guarantee.”

The court first reviewed clause 1. It determined that if clause 1 was meant to provide the bank with an unqualified right to make material changes to the principal loan agreement with the customer, it could have been drafted to say this in simple and precise terms. The court noted that the customer was not in financial difficulties at the time of the loan and guarantee. There was therefore no conceivable reason why the customer or the guarantors “would have felt obliged to cloak the bank with the extraordinary power of being able to change the principal loan agreement in whatever fashion and to whatever extent it deemed fit.”

As to clause 4, the bank tried to justify its action by arguing that it had an implied duty to its customer to renegotiate the terms of the loans. The Court stated that not only was there no evidence to support this contention, but that under the terms of the loan agreement, the determination of the guarantee was itself an event of default.

Accordingly, the guarantors were not liable on their guarantee of the revolving loan.

Term Loan

Had the term loan been renegotiated at the same or a lesser interest rate, the guarantors would have remained liable. Since clause 1 did not specifically state that the loan could be renegotiated at an increased rate, the court held that the risk had changed and that the guarantors were discharged from liability.

Increased Lending

In CIBC v. Shire, an unreported 1999 B.C. Supreme Court decision, two men and their spouses owned the bank’s customer. The spouses were not involved with the customer’s day-to-day business. Each family had given unlimited guarantees supported by collateral mortgages. In order to facilitate the sale of the home of family #1, the bank discharged its mortgage. Family #1 had promised to replace the mortgage on its new home but never did.

The guarantees were executed in July 1991 before any monies were advanced and were guarantees of past and future indebtedness of the customer. The first advance was made in September 1992, at which time the bank approved a $200,000 line of credit for the customer. It was at this time that the bank had taken the collateral security from each family.

In 1993, the bank was pressuring family #2 to repay part of the customer’s loan. By the end of January 1994, the loan stood at $245,000. In April 1994, Family #2 paid down $111,000 of the loan but never demanded and never received a discharge of their collateral mortgage. The customer ceased carrying on business in April 1994 and, in 1996, the bank called the loan and requested payment from both families.

Release of Security

Family #2 argued that when the bank released the security of family #1 without the knowledge of family #2, that changed the nature of the agreement among the parties and discharged family #2. This argument did not succeed. The guarantee agreement was very specific in that regard. It allowed the bank to discharge any security it wished to discharge.

Increase of Loan

The guarantors then argued that by permitting the customer to increase its indebtedness, the bank unilaterally and materially varied a term of the principal contract. The judge agreed and discharged the liability of family #2 under the guarantee.

Although the guarantee was executed at a time when no monies had been loaned to the customer, the judge felt that the real contract to which the guarantee applied was a loan not to exceed $200,000. The judge could see “no distinction between a unilateral increase in interest rates and unilaterally permitting the debtor to exceed an agreed cap on indebtedness. Both actions increase the risk assumed by the guarantors.”

Contrast

The Royal Bank case makes some sense to us regarding the original revolving loan; it makes less sense regarding the term loan. We cannot fully understand why the bank should lose its entire guarantee because of a 0.25% interest rate increase; it should lose the increase but not the entire guarantee.

The CIBC case makes almost no sense. At least in the Royal Bank case, the guarantors had no knowledge of the customer renegotiating the revolving loan with the bank. In CIBC, if the customer renegotiated the loan, it did so through the auspices of the two male shareholders. Each family knew of the increased loan; they had to have implicitly consented to it. The bank is being penalised for the total amount of the loan because it provided more funds than it had originally agreed to lend. Does this mean that if the bank advances $1.00 more than the maximum, all guarantees are discharged? Further, the guarantees pre-dated the customer’s loan agreement. If the guarantees applied to that agreement, why should they not apply equally to the renegotiated agreement? The CIBC case makes almost no sense to us.