Beware of the suspension clause – a possible new defence to the guarantee

Suspension clauses are commonly found in loan documents where a lender and obligor agree that as long as any of the guaranteed moneys remain unpaid, the obligor will not claim any right of set off, counterclaim or deduction to reduce the amount owed to the lender.

Earlier this year, the New South Wales Supreme Court of Appeal in O’Brien v Bank of Western Australia [2013] NSWCA 71 (O’Brien) confirmed the existence of a defence available to guarantors that could hinder the operation of suspension clauses.

Background

On any summary judgment application, a principal issue is whether there is an underlying cause of action or defence that has a prospect of success.¹  The decision in O’Brien follows the entry of summary judgment (and other orders) by the Bank of Western Australia (Bank) against Mr O’Brien and Bakota Holdings Pty Ltd (a company of which Mr O’Brien is the sole shareholder) (Guarantors).  The Guarantors had granted a guarantee in favour of the Bank, guaranteeing the performance of obligations of another associated company (Borrower) under a facility agreement with the Bank.

The Guarantors defended the summary judgment application alleging that there had been misleading and deceptive conduct on behalf of the Bank.  The Guarantors argued that by reason of representations made to them by the Bank, the debt owed by the Borrower did not become due on the termination date, and that they should be relieved from their liabilities under the guarantees.

The decision at first instance

The Guarantors argued that no amount was due and payable at the date the demand was made by the Bank, because the Bank represented to them, that the Bank would roll-over the facility when the facility expired and would advance further funding to the Borrower.  Despite the Guarantors’ argument, McDougall J granted summary judgment in favour of the Bank.

The issue on appeal

The Guarantors appealed the decision.  The main issue on appeal involved the construction of the suspension clauses under the guarantees.  The relevant suspension clauses in question are as follows:

Clause 5.5 provided:

                     As long as any of the guaranteed money remains unpaid, you may not, without our consent:

  •  

      (a) reduce your liability under this guarantee and indemnity by claiming that you or the debtor or any other person has a right of set-off or counterclaim against us (except to the extent you have a right of set-off granted by law which we cannot exclude by agreement).

      Except to the extent you have a right of set-off granted by law which we cannot exclude by agreement (such as under a Code) you must pay us the guaranteed money in full without set-off, counterclaim or deduction.

  • Clause 8.1 provided:

On appeal, the Guarantors asserted that they were afforded a defence to the Bank’s claim because there was an arguable defence that as a result of the representations made to them and the Borrower by the Bank, the guaranteed sum was not due and payable by the borrower at the date the demand was issued or at the time the facility expired.

The decision on appeal

The Court of Appeal held that at first instance McDougall J erred in entering summary judgment in favour of the Bank, on the basis of the following:

  • By reason of an arrangement reached between the Bank, the Borrower and the Guarantors, money was not due and payable by the Borrower when the facility expired (the termination date).  As a result, the suspension clause in question was not operative, as no debt was due and payable at the relevant time.

  • The Court highlighted that suspension clauses similar to the relevant suspension clauses in O’Brien do not protect a lender against such a defence.

  • In particular, Ward JA noted that suspension clauses may be inapplicable in similar circumstances if they are expressed to operate only when the guaranteed money “remains unpaid”.

Lavan Legal comment

This decision is of significance to lenders as it highlights the importance of the construction of suspension clauses, as well as the conduct of the lender.  However it is important to note that the decision of O’Brien was made at a summary level only, where the threshold of proving a defence is much lower.  Lavan Legal will continue to monitor the O’Brien case and its impact on lenders’ rights.