Personal Guarantees and Directors Liabilities on Insovlency: What Scope for Houdini?

Posted On: 30 October 2009

Author: Richard Aird

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By Richard Aird, Advocate

The Structure

X = Creditor, Y = Principal Debtor, Z = Cautioner

"The obligation of a cautioner is not an independent obligation, but is essentially conditional in its nature, being properly exigible only on the failure of the principle debtor to pay at the maturity of his obligation"

Lord Ross: City of Glasgow District Council v Excess Insurance (1986 SLT 585)

Similar transactions?  
An insurance or indemnity contract does not depend on a principal contract- so not a guarantee.  

The concept is getting wider – cautionary obligations may arise "in the broad sense" where X grants a Standard Security of the debts of Y (Hewitt v Williamson 1998 SCLR 601) "In security of the whole obligations to pay all sums…due by W"

"The concept of cautioner and cautionary may be invoked in relation to any circumstance in which A exposes himself or his property in security of the debts of B to C"  Braithwaite v Bank of Scotland 1999 SLT 25

Quasi cautionary obligations involve the duty of Good Faith but do not give rise to obligations of the cautionary to become personally liable for the principal debtors obligations beyond the Standard Security. This obligation owed by cautioners "in the narrow sense" does not involve the special rules such as the release of the cautionary by an alteration in the principal obligation.
Any Special Form for Cautionary Obligations?

No general requirement for writing

1) A gratuitous unilateral obligation not undertaken in the course of business Requirements of Writing (Scotland) Act 1995 S 1(2) a ii requiresWriting and Subscription of the Cautioner

2) Consumer Credit Act 1974 – in the case of a Regulated Agreement 
Guarantee in Writing + Executed.   Also copies & statutory requirements

Main Defences
1) Acts or Omissions by Creditor
Normal Contractual Defences                                        
a)  Induced by Creditor's Misrepresentation
The mis representation must be material AND induce the cautioner to contract
- A cautioner who knows of the truth cannot claim misrepresentation         

Not a contract Uberimae Fides – but not quite the normal situation either.

If the circumstances are unusual between the Debtor and Creditor       
and not to be reasonably expected there is a duty to disclose.
Lots of cases which suggest that if Creditor is aware that cautioner is under a misapprehension he must disclose his true position – Answer any questions truthfully and fully but no general duty to volunteer information. Perhaps there is a duty to answer any question which is specifically put.

b) Undue Influence
c) Force and Fear
d) Facility and Circumvention
e) Essential Error

2)  Acts and Ommissioners by Debtor

The developing Law

The traditional Scots Law position was that the debtor's misrepresentation, undue influence etc has no effect.
- the contract is between the Creditor and Cautionary unless the creditor uses the debtor as his agent or is aware of the misrepresentation etc. (Young v Clydesdale Bank (1899)17R 231)  But this is steadily being eroded by case law and is may now be doubtful.

Can the Creditor enforce the Guarantee where the debtor has been fraudulent and Creditor has grounds to suspect fraud?
         Where no reasonable suspicion of fraud on the part of the Debtor, the Creditor would require to have given valuable consideration to enforce the guarantee.

Where the misrepresentation is fraudulent the creditor cannot enforce the guarantee where a reasonable person would have expected that fraud had occurred. (see Smith v Bank of Scotland 1997 SLT 1061: Owen and Gutch v Homan (1853) 4 HLC 997.)      
          Also, where force or fear was involved there can be no consent and the transaction is void (see Trustee Savings Bank v Balloch 1983 SLT 240).

The present Position
All the above restrictions on the rights of Creditors to enforce apply but the position has been extended and rationalised by The Duty of Good Faith developed by Lord Clyde in Smith v Bank of Scotland 1997 SLT 1061 – which followed the English case Barclays Bank v O'Brian. So where the duty arises the Creditor must act in good faith to the Cautioner as well.


changes are confined to where a reasonable man might conclude that because of the personal relationship between the Cautioner and Principal Debtor,  the Cautioner's consent might not be freely given.


an "actionable wrong" must have taken place before the guarantee may be impinged (Royal Bank of Scotland v Wilson 2004 SC 153).


in the great majority of cases where a Director guarantees the debts of a Company no change has been made.   

"The concept of good faith is used in the sense that a party may not be entitled to enforce his apparent rights because he is aware of or is put on inquiry to discover some prior vitiating factor. The existence in fact of such a factor is a prerequisite to the applicability of that concept." 

Lord Hamilton Braithwaite v Bank of Scotland 1999 SLT 25

Looking at the new rules in practice

The new regime only applies "a close personal relationship"
- Parent child wife husband lover etc.
- Including technically different situations like family companies
The requirement disappears where obligation is also for Cautioners benefit
- Husband and wife jointly agree to guarantee a loan to them both (Ahmed v Clydesdale Bank 2001 SLT 423
- Mother also has interest in company managed by son (Wright v Cotias Investments 2000 SCLR 324. A co-extensive obligation from the Principal Debtor meant that the guarantee was not gratuitous (RBS v Wilson supra)

Has there been an Actionable Wrong by the Debtor?

Where misrepresentation or undue influence or anything which in the general law could amount to an actionable wrong - the courts now examine the situation to determine whether there has been a failure by creditor to observe duties of Good faith towards the Debtor.   
eg. The Creditor must not mislead by omission
      Correct manifest misapprehensions 
      Rectify Misapprehensions by Cautioner which are known
     Require Cautioner to obtain legal advice                                           

The Lack of Good Faith must result in lack of consent by cautioner      
The consent of the Cautioner must have been compromised – the standard may be that the circumstances are sufficient to amount to a defence were the if action by Debtor    Cautioner must be able to say "but for this Cautioner would not have entered into the transaction"

USUALLY the "Good Faith" requirement is fulfilled because a Banks Standard Procedure is to require Cautioners to obtain Independent Legal Advice.

So in practice since Smith Financial Institutions require separate advice for guarantors and make the loan on conditions which satisfy Good Faith Requirements.

(Continued. For full notes please click on the link at the top of the page.)