Dear Everyone
I wish to discuss the law concerning guarantees, independent advice, undue influence and unconscionable conduct.
- In our previous newsletter we explained why a person should be extremely cautious before signing a guarantee. This newsletter considers the legal principles which may, in exceptional circumstances, permit a guarantee to be set aside or prevent a creditor from enforcing it. A guarantee is a contractual undertaking by which one person agrees to answer for the obligations of another. The principal parties will generally be:
- - the creditor
- - the principal debtor and
- - the guarantor
The principal debtor may be an individual, company or trustee. A guarantee can be relatively straightforward, such as guaranteeing a particular loan. It can also be extraordinarily broad. It is a serious contractual commitment which are usually enforced by the courts when entered into voluntarily by a person. A person cannot ordinarily escape a guarantee simply because:
- the borrower subsequently defaults
- the transaction becomes financially disadvantageous
- the guarantor did not expect the borrower to fail
- the guarantor did not read the document carefully or
- the guarantor later regrets signing it.
This is why independent legal advice should be obtained before signing. When assisting a prospective guarantor, I review the documents which may include all or some of the following:
- the loan agreement
- mortgage
- facility agreement
- lease
- security documents
- indemnity
- guarantees given by other parties
- variations to the underlying agreement
- prior guarantees
- company documents; and
- correspondence concerning the transaction.
Then assess the extent of guarantor’s liability based upon the contractual documents and the applicable law. Where the transaction falls within the consumer credit regime, the National Consumer Credit Protection Act 2009 and the National Credit Code impose particular requirements concerning guarantees.
The legislation provides that a guarantee must generally be in writing and signed by the guarantor. It also imposes disclosure requirements before the guarantee is signed, including provision of the relevant credit contract and prescribed information concerning the guarantor’s rights and obligations.
There are also requirements concerning copies of the guarantee and credit contract being provided to the guarantor. A commercial loan, company borrowing or other business transaction usually falls outside the consumer credit regime. Consequently, a guarantor should not assume that the protections applying to consumer guarantees apply to every guarantee.
The Guarantees Act 1900 is another piece of legislation which may be relevant to particular guarantees in New South Wales. Whether the Act applies, and its precise effect, depends upon the nature of the transaction and the document.
The fact that legislation concerning guarantees exists does not mean that a person can safely sign a guarantee and subsequently rely upon legislation to avoid liability. A creditor may require a guarantor to obtain independent legal advice which does not necessarily make a guarantee enforceable in every circumstance.
Nor does the existence of a certificate stating that legal advice was received necessarily answer every question about the circumstances in which the guarantee was obtained.
The High Court’s decision in Stubbings v Jams 2 Pty Ltd [2022] HCA 6 is particularly important in this respect. In that case, the guarantor had signed documents recording that he had received independent financial and legal advice.
Nevertheless, the High Court considered the circumstances surrounding the transaction and found unconscionable conduct. The court found that a certificate of independent advice is not a substitute for genuine independent advice.
One of the most important Australian cases concerning guarantees is the case Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447. This case involved an elderly couple who had guaranteed the debts of their son’s business. The High Court ultimately set aside the relevant transaction on the basis of unconscionable dealing as the parents could not understand English and found that they were under a special disadvantage and the bank was guilty of unconscionable conduct.
The Amadios had limited English proficiency, little business experience, and relied on their son's misleading assurances that their liability was capped at $50,000 for six months (the actual guarantee was unlimited) whilst the Commercial Bank of Australia knew the company was in severe financial peril and that the parents were misinformed, yet the bank manager had them sign the documents at their home without explanation or advice to seek independent legal counsel.
The case is particularly instructive because it demonstrates that the court can look beyond the fact that a document has been signed and consider the circumstances surrounding the transaction.
Special disadvantage is determined when considering the following factors:
- lack of education
- lack of commercial experience
- limited understanding of English
- age
- illness
- intellectual or cognitive impairment
- serious financial distress
- emotional dependence
- lack of understanding of the transaction or
- other circumstances affecting the person’s ability to make a properly informed decision.
However, the existence of a disadvantage by itself is not necessarily sufficient, the circumstances and the other party’s knowledge of them are critical. Another extremely important authority is Garcia v National Australia Bank Ltd [1998] HCA 48; (1998) 194 CLR 395. In this case a wife guaranteed debts associated with her husband’s business.
The High Court considered the earlier decision in Yerkey v Jones (1939) 63 CLR 649 and explained the circumstances in which equitable principles may protect a wife who has guaranteed her husband’s obligations without understanding the effect of the transaction.
The case is frequently referred to in discussions concerning guarantees given within marriages and other close relationships. It again emphasises that the circumstances surrounding the guarantee must be carefully examined.
The issue becomes more complicated where there is evidence that the guarantor was subjected to undue influence:
- did not understand the nature or effect of the transaction;
- was subjected to pressure
- was emotionally or financially dependent upon another person;
- was improperly influenced
- suffered a special disadvantage; or
- was unconscionably taken advantage of.
Whilst law does not prohibit ordinary persuasion, such matters may result in undue influence where a person’s decision was the product of another person’s influence rather than the person’s free exercise of independent judgment.
The circumstances must be sufficiently serious to demonstrate that the person’s free will was overborne or that the transaction resulted from improper influence. The Court emphasised that the surrounding circumstances and the person’s vulnerability can be critical.
The principles of undue influence are therefore relevant to understanding why a person should not sign a significant financial document merely because someone in a position of influence insists upon it. The court considers matters such as:
- What the lender knew;
- what its agents knew;
- what the guarantor understood;
- the guarantor’s financial circumstances;
- the purpose of the loan;
- the nature of the security;
- whether the transaction was commercially rational; and
- whether the guarantor’s vulnerability was exploited.
- It needs to be noted that a transaction does not become unconscionable merely because:
- it was a bad bargain;
- the guarantor received no benefit;
- the borrower subsequently failed;
- the guarantor did not expect to have to pay; or
- the guarantor considers the result unfair.
The law of unconscionable conduct has specific requirements. Generally, there must be circumstances amounting to a special disadvantage or other recognised basis for equitable or statutory relief, together with conduct which satisfies the applicable legal test.
Before signing, every guarantor should ask themselves “If the borrower completely fails, what is the maximum amount I could personally lose?” Such relief as described above is rarely afforded to guarantors. It is extremely important that a prospective guarantor knows exactly to what they are committing themselves and I believe that legal advice is paramount in that assessment. That question should include consideration of:
- the principal debt
- interest
- default interest
- legal costs
- enforcement costs
- indemnity obligations
- mortgages
- guarantees of other obligations
- increases in the underlying debt and
-future transactions covered by a continuing guarantee.
If the answer is unclear, do not sign until the position has been clarified. In my advice I consider whether there are any circumstances which could affect the validity or enforceability of the transaction, including undue influence, duress, unconscionable conduct or other equitable principles.
The cases reveal it is in only in very exceptional circumstances that courts will set aside a guarantee. It is essential that anyone providing a guarantee for another consider their position in a clear unemotional light.
The most important question you should ask is “Would I be prepared to pay this debt myself if the borrower does not?” and the answer is “no”, you should think very carefully before becoming a guarantor. That said, I have assisted many clients in providing independent legal advice to enable my clients to proceed in full knowledge of their commitment.
If either you or someone else you know requires independent advice regarding a loan or guarantee, please have them contact me
Wishing you a wonderful day,
Jeffrey Choy
JCL Legal
0419 233 670
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Liability limited by a scheme approved under Professional Standards Legislation
Legal Disclaimer: This guide is for informational purposes only and does not constitute legal advice.
