Guarantees and variations to the underlying contract
November 2007
The principal case stating the law in this area is 130 years old but a couple of recent cases have revisited this area of the law.
The rule in Holme –v- Brunskill [1877] 3 QBD 495 provides that any amendments to the primary underlying contract, after the giving of the guarantee, will discharge the guarantor's liability under the guarantee unless either (i) the guarantor consents to the variation; or (ii) the variation is clearly insubstantial or incapable of adversely affecting the guarantor. Accordingly, if the underlying contract is to be varied in any way, it is prudent to obtain the guarantor’s consent.
In 2005 the case of Triodos Bank NV v Dobbs [2005] EWCA Civ 630 (“Triodos”), prompted many a guarantee to be looked at afresh after the Court of Appeal held that even if a guarantee contains a clause agreeing that the underlying contract can be amended without the consent of the guarantor, the guarantee may still be discharged if consent was not in fact sought.
In Triodos, the director of a company guaranteed the borrowings of the company of which he was a director. The guarantee contained a provision allowing the Bank, "without reference to the Guarantor", to "agree to any amendment, variation, waiver or release in respect of an obligation of the company under the loan agreements". The original loan agreements contained a provision allowing the obligations under them to be "rescheduled under a new loan agreement" in the future.
The original loan agreements were replaced by new agreements increasing the borrowing and changing the purpose. The new loan agreements referred to the original guarantee and stated that the Bank would continue to have the benefit of it.
The company defaulted and the Bank sought to enforce the guarantee. The Guarantor argued that the guarantee only applied to the original loan agreement.
The Court of Appeal held that a variation was not permitted and clarified that a guarantee would be discharged in circumstances where the underlying contract was replaced or varied where (i) the new agreement provided finance for a different purpose, (ii) the new agreement was for a larger amount, or (iii) the new agreement was substantially different from the original loans and was not within the scope of the variation anticipated by the parties at the outset.
The problem that Triodos and Holme –v- Brunskill presents for lenders is the extent to which the underlying contract can be varied before consent of the guarantor is required.
Whilst offering little by way of practical guidance, the judgment in Triodos does state that consent of the guarantor is not required if (i) the amendments are a genuine variation of an existing obligation and (ii) the terms of the amended contract remain within the general scope of the original guarantee.
In the recent case of Wittman (UK) Ltd v Willdav Engineering S.A. [2007] EWCA Civ 824 the Court of Appeal held that where the original contract underlying the guarantee anticipated that it would be amended during the course of the contract and the guarantor knew of and consented to that future change, the amendment to the underlying contract would not discharge the guarantor notwithstanding that consent to the amendment was not obtained. Any new liabilities incurred as a result of the amendment would not however be covered by the guarantee and the guarantee would only extend to the obligations owed by the guarantor at the time the guarantee was entered into.
The court reached this decision on the basis that that the guarantor knew of and consented to the future amendments of the contract so it would be inequitable for the guarantor to claim that its obligations should be discharged by that variation.
The court did consider whether it was necessary for the guarantor to communicate its consent to the beneficiary of the guarantee. No judgment was made by the court on this issue because the original guarantee included a primary liability (an indemnity). The beneficiary of the guarantee was perhaps lucky to avoid the discharge of the guarantee and the case should not influence lenders not to seek consent from a guarantor where an amendment to the underlying contract is proposed.
It has been and remains the case that the prudent approach for a Lender is to obtain the consent of a guarantor if the underlying contract is to be amended more than by way of minor amendments, regardless of what the guarantee permits.
The rule in Holme –v- Brunskill [1877] 3 QBD 495 provides that any amendments to the primary underlying contract, after the giving of the guarantee, will discharge the guarantor's liability under the guarantee unless either (i) the guarantor consents to the variation; or (ii) the variation is clearly insubstantial or incapable of adversely affecting the guarantor. Accordingly, if the underlying contract is to be varied in any way, it is prudent to obtain the guarantor’s consent.
In 2005 the case of Triodos Bank NV v Dobbs [2005] EWCA Civ 630 (“Triodos”), prompted many a guarantee to be looked at afresh after the Court of Appeal held that even if a guarantee contains a clause agreeing that the underlying contract can be amended without the consent of the guarantor, the guarantee may still be discharged if consent was not in fact sought.
In Triodos, the director of a company guaranteed the borrowings of the company of which he was a director. The guarantee contained a provision allowing the Bank, "without reference to the Guarantor", to "agree to any amendment, variation, waiver or release in respect of an obligation of the company under the loan agreements". The original loan agreements contained a provision allowing the obligations under them to be "rescheduled under a new loan agreement" in the future.
The original loan agreements were replaced by new agreements increasing the borrowing and changing the purpose. The new loan agreements referred to the original guarantee and stated that the Bank would continue to have the benefit of it.
The company defaulted and the Bank sought to enforce the guarantee. The Guarantor argued that the guarantee only applied to the original loan agreement.
The Court of Appeal held that a variation was not permitted and clarified that a guarantee would be discharged in circumstances where the underlying contract was replaced or varied where (i) the new agreement provided finance for a different purpose, (ii) the new agreement was for a larger amount, or (iii) the new agreement was substantially different from the original loans and was not within the scope of the variation anticipated by the parties at the outset.
The problem that Triodos and Holme –v- Brunskill presents for lenders is the extent to which the underlying contract can be varied before consent of the guarantor is required.
Whilst offering little by way of practical guidance, the judgment in Triodos does state that consent of the guarantor is not required if (i) the amendments are a genuine variation of an existing obligation and (ii) the terms of the amended contract remain within the general scope of the original guarantee.
In the recent case of Wittman (UK) Ltd v Willdav Engineering S.A. [2007] EWCA Civ 824 the Court of Appeal held that where the original contract underlying the guarantee anticipated that it would be amended during the course of the contract and the guarantor knew of and consented to that future change, the amendment to the underlying contract would not discharge the guarantor notwithstanding that consent to the amendment was not obtained. Any new liabilities incurred as a result of the amendment would not however be covered by the guarantee and the guarantee would only extend to the obligations owed by the guarantor at the time the guarantee was entered into.
The court reached this decision on the basis that that the guarantor knew of and consented to the future amendments of the contract so it would be inequitable for the guarantor to claim that its obligations should be discharged by that variation.
The court did consider whether it was necessary for the guarantor to communicate its consent to the beneficiary of the guarantee. No judgment was made by the court on this issue because the original guarantee included a primary liability (an indemnity). The beneficiary of the guarantee was perhaps lucky to avoid the discharge of the guarantee and the case should not influence lenders not to seek consent from a guarantor where an amendment to the underlying contract is proposed.
It has been and remains the case that the prudent approach for a Lender is to obtain the consent of a guarantor if the underlying contract is to be amended more than by way of minor amendments, regardless of what the guarantee permits.
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