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Jersey & Guernsey Law Review – October 2007

LEGALITY, VALIDITY AND ENFORCEABILITY OF GUARANTEES – CAUTIONS -  UNDER JERSEY LAW[1]

Anthony Dessain,   Michael Wilkins and Deborah Gregory

1       Guarantees, traditionally called "cautions", play an important role in supporting banking, financial, corporate and personal arrangements.  Whilst many may never be called upon, when they are called, it is possible that the principal debtor will be unable to pay,  and the guarantor may seek to test the legality, validity or enforceability of the guarantee.  Accordingly, an understanding of the nature and requirements of a guarantee or surety is important.   This is particularly important as Jersey law affords guarantors certain rights and construes guarantees strictly and generally in favour of the guarantor.   As a matter of policy, this is understandable as the guarantor’s obligations are, of course, for another’s indebtedness; the terms of the guarantee are usually prepared by the creditor and a guarantor’s rights of subrogation may be impossible to satisfy.

2       The tri-partite relationship of creditor, principal debtor and guarantor, and the rights and obligations of each as regards the others, gives rise to complexities which can be further affected by the insolvency of one or more of the parties.

3       Some of the circumstances in which it is appropriate and usual to have a guarantee governed by Jersey law are where -

 (i)     all the parties are in Jersey;

(ii)      a guarantor is incorporated or resident in Jersey;

(iii)     the guarantor’s assets are situate in Jersey;

(iv)     the principal obligation or related guarantees or documents are governed by Jersey law; or

(v)      a court order requires it: for example, to support an undertaking in damages or costs, or as a condition of granting certain relief.

4       This article attempts to clarify these relationships in different situations, and to highlight relevant differences between Jersey law and English law.  In practice, the legal effects of a Jersey law governed guarantee, can be made similar to an English law guarantee provided that the guarantee document is correctly drafted.  As international commercial agreements are frequently expressed to be subject to English law, it may well be a comfort to have a Jersey law guarantee to provide similar rights, duties or obligations as would apply to an English law guarantee involving multi-jurisdictions.

Nature of a guarantee

5       There is no statutory definition of a guarantee.[2]  There are three types of guarantee or caution, viz. -

(i)      Le cautionnement legal, which arises by operation of law

(ii)      Le cautionnement judiciaire, which arises from a court order;[3] and

(iii)     Le cautionnement conventionnel, which arises by contract.

Unless otherwise indicated, this article refers to cautionnements conventionnels (or contractual guarantees).  The Royal Court has indicated that the nature of a contractual guarantee is in all essential respects similar under the laws of Jersey and England and the Court has applied Jersey and English authorities.[4]  In MAB Investments the Court referred to "the rich veins of our customary law".[5]

6       The similarities between English and Jersey law can however be overstated.  There are some important differences and pitfalls for the unwary.  The Royal Court expects all appropriate authorities to be placed before it – not just English authorities.

7       In MAB Investments the following passage from Le Gros[6] was cited with approval -

“La caution, ou fidéjusseur, est une personne qui s'oblige de répondre de l'exécution d'une obligation contractée par une autre, dans le cas où celle-ci n'y satisferait pas.  Le cautionnement est un contrat, consensual et exprès, c'est à dire qu'il ne se présume point, par lequel une personne s'oblige pour une autre... 

Le cautionnement conventionnel est un contrat unilatéral par lequel une personne s'engage à satisfaire à l'obligation contractée par une autre au cas que cette dernière n'y satisferait pas.  Il constitue un contrat de droit étroit.  Dans le doute, le contrat doit être interpreté dans le sens le plus favourable à la caution … car la dette ou l'obligation dont elle garantit le paiement ou l'exécution n'est pas la sienne.”

This may be translated as -

“The guarantor is a person who is obliged to perform an obligation due by another where that other person fails to satisfy that obligation.  A guarantee is a contract based on consensus and express agreement, that is to say it is not possible to imply an obligation by one person for the benefit of another person… 

The contractual guarantee is an agreement whereby one person is bound to perform an obligation agreed by another where that other does not perform it.  It forms a narrow obligation.  In the event of doubt the agreement must be construed in favour of the guarantor … as the debt or obligation which is guaranteed to be paid or performed is not the guarantor's own debt or obligation.”

8       Pothier[7] states that –

“Le cautionnement est un contrat par lequel quelqu’un s’oblige pour un débiteur envers le créancier, à lui payer en tout ou en partie ce que le débiteur lui doit, en accédant à son obigation.”[8]

9       A good working definition of a guarantee under English law is-

“A guarantee is an accessory contract by which the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promisee must exist or be contemplated.”[9]

10     The primary characteristics of a guarantee under Jersey law are in our view that -

(i)      it is an accessory contract, and it therefore follows that the guarantor's liability and obligations cannot be greater, more onerous or disadvantageous than those of the principal debtor;

(ii)      the primary obligation must subsist;

(iii)     the guarantor cannot be compelled to pay or perform something different from the primary obligation;

(iv)     the guarantor can only be liable in the circumstances where the principal debtor is liable, for example, after certain conditions of liability have been satisfied or a certain time has passed.  This applies in relation to payment or performance; the subject matter of the liability and the time, the place, the conditions and the method of payment or performance;

(v)      the guarantor's liability is always secondary to that of the principal debtor; and

(vi)     the guarantor has no liability unless or until the principal debtor has failed to perform. 

11     A guarantee will generally only extend to the liability as described in the guarantee.  The principal obligation must not only exist but must remain unchanged, unless otherwise stated, throughout the life of the guarantee.  If the principal obligation is performed, released or otherwise determined then so is the guarantee.  Parol evidence is generally not admissible to add to or vary the terms of a written guarantee, see Grindlays Bank (Jersey) Ltd. v Photogenic Publications (Jersey) Ltd.[10]

12     Any variation of the principal obligation needs the consent of the guarantor. Guarantee agreements sometimes provide that any variation in the principal obligation will not affect the validity or enforceability of the guarantee.

13     With regard to enforcement, an English law guarantee (and it is suggested a Jersey law guarantee too) has no implied term that a creditor in enforcing its rights under a guarantee must act reasonably or fairly, or not act oppressively or unconscionably.[11] 

14     An indemnity is an obligation imposed by operation of law or by contract on one person to make good a loss suffered by another.  An indemnity is a primary obligation whereas a guarantee is a secondary obligation dependent for its validity on the underlying primary obligation.  The obligation of an indemnitor will continue whether or not the principal party is bound by the obligations.  Guarantees and indemnities are often combined so that if there is a problem under the guarantee the creditor can still claim under the indemnity.  This article is concerned only with contracts of guarantee. 

Types of guarantee commonly encountered in practice

15  (i)      Specific or general obligations

A guarantee may extend to a series of transactions or may be specific to obligations arising under an identified contract. 

(ii)      “All monies” guarantees

An all monies guarantee is typically required by banks to support overdrafts or revolving credit facilities.  Such guarantees constitute an undertaking by the guarantor that he will be responsible for all indebtedness which the principal debtor may incur from time to time under any transaction with the creditor.  This may also extend to guarantees given by the principal debtor himself. 

(iii)     Performance guarantees

A performance guarantee is very similar to a guarantee of specific obligations and guarantees the performance of all obligations under the underlying contract.  Performance guarantees are often seen in the parent/subsidiary context where a parent company may guarantee the performance by a subsidiary of all obligations under a contract to which the subsidiary is a party. 

(iv)     Demand guarantees - letters of credit and performance bonds

A letter of credit is a written undertaking by a bank given at the request of a customer to a beneficiary to effect a payment up to a stated amount of money against the production of stipulated documents.  They are often used in the context of shipping/cargo transactions. Letters of credit and performance bonds are forms of demand guarantees. The essential difference is that, in the case of a demand guarantee, the guarantor is liable upon the beneficiary's demand for payment and liability is not dependent on the default of the principal debtor.  The contract is autonomous and is not affected by disputes as to the underlying contract.  The guarantor must honour the demand in accordance with its terms and any disputes regarding the underlying contract must be resolved separately.

(v)      Limited guarantees

A guarantee may be limited in either duration (for example one year from the date of the guarantee) or be subject to a monetary limit.  Where guarantees are subject to a monetary limit, it is important to distinguish between a guarantee of all the debtor's obligations with a limit on the amount which can be recovered from the guarantor, and a guarantee of part of the underlying debt. This distinction is important when considering rights of subrogation and the rights to prove in both the debtor's and the guarantor's insolvency.  A guarantee of a fluctuating balance (for example, an overdraft facility) with a monetary limit will prima facie be construed as a guarantee of part of the debt under English law.[12]

(vi)     Secured/unsecured guarantees

As with any other contractual obligation, the obligations of a guarantor under a guarantee may be secured or unsecured.  The existence of security will be relevant in the event of the insolvency of the guarantor.  In the case of Jersey immovable property (including a contract lease of over 9 years) the security may be created by an hypothèque judiciaire or by an hypothèque conventionelle simple or in the case of intangible movable property (other than a lease) under the Security Interests (Jersey) Law 1983, as amended, or by a pledge in the case of a tangible movable. Alternatively, security may be governed by the foreign law of the jurisdiction in which the asset is situate. 

Validity of the guarantee

16     A contract of guarantee, like any other contract, is subject to the usual rules of contractual validity.  The English statutory requirement that a contract of guarantee is enforceable only if it is in writing and signed by the guarantor or with his authority[13] does not apply in Jersey.  Pothier indicated that guarantees were, in his day, given before a notary public, or in a signed written agreement, or verbally if up to a certain financial limit.[14]  A guarantee, like any other contract, may be void or voidable for reason of undue influence, duress, misrepresentation, fraud, etc.  In addition, as a matter of general principle a guarantee given by a company must also be within its corporate powers under the law of the place of its incorporation and as set out in its Memorandum and Articles of Association,[15] and must be executed by an authorised person.

17     Guarantees may also be vulnerable for lack of corporate benefit when granted by a company or for lack of cause[16] which may be particularly relevant when considering whether a guarantee should be set aside on an insolvency.[17]  The contractual requirements and corporate validity of guarantees are, however, outside the scope of this article.

18     Where a creditor, e.g. a bank, owes a fiduciary or other duty of care to its customers, special care is needed to avoid a conflict of interest under English law.  Barclays Bank plc v O’Brien[18] indicates that the guarantor should be separately advised, and the guarantee independently witnessed so as to permit full enforcement. Banks frequently require customers to obtain confirmation from their own lawyer that the guarantee was fully explained. The practice may be prudent in Jersey, although there is no specific authority on the point at present.

19     A guarantor may be released from liability upon certain occurrences in relation to the underlying principal contract.  If the primary obligor is not obliged to perform, there can be no liability of the guarantor.  Conversely, performance by the principal party which discharges him from his obligations under the principal contract will necessarily also discharge the guarantor.[19] 

20     The guarantor may also be discharged from liability where the terms of the principal contract are varied without his consent.  For example, if a creditor gives a principal debtor time to pay without the guarantor's consent, the guarantor will be discharged from liability regardless of whether or not he is actually prejudiced[20].  A guarantor may also be discharged if the liability of the principal debtor is increased, for example, by further advances being made without the consent of the guarantor. This is the case even where the variations are expressly permitted under the terms of the guarantee if the variations in fact constitute new and different agreements.[21]

21     The guarantor will be discharged if the creditor releases the debtor (whether the release is express or implied) or if the creditor agrees to a novation of the underlying contract.  This is, however, subject to the provisions of the guarantee itself.  Modern guarantees often contain provisions which avoid problems of incapacity, the scope of the guarantor's liability, and discharge from liability etc.

The rights of those involved

22     The parties involved in a guarantee arrangement will have all the rights arising under the general law of contract governing whether, when and how the obligation should be performed.  The tri-partite relationship gives rise to six sets of rights and various combinations of them.  A guarantor may also have rights or defences against certain third parties.  These are considered below.

The rights (or defences) of the guarantor against the creditor

23     Where the creditor misleads the guarantor (whether inadvertently or otherwise) as to the full nature of the transaction the guarantor will not be liable under the guarantee, e.g. if the guarantee refers to a hire purchase agreement but in fact it is a loan.[22] 

24     The creditor who sues his debtor for the debt must make the guarantor a party to the action: Le Bas v Balleine Exs.[23]   This rule will not apply where the guarantor has waived the right.  This is usually stipulated in the guarantee.  An example of a clause waiving the droit de discussion (as to which, see below) is set out in West v Lazard Brothers and Company (Jersey) Ltd.[24]  It may also be waived in a guarantee subject to non-Jersey law where the guarantor is resident in Jersey or which stipulates that enforcement may take place in Jersey.

25     As stated above, the creditor who agrees with his debtor a new condition for payment, or extends the time for payment, for valuable consideration or cause, loses his right of recourse against the guarantor if the latter has not given his consent.  Therefore, the guarantor will be freed of his obligation by virtue of such an agreement between the creditor and debtor to which he was not a party.  The same applies when at the date of payment the creditor agrees with his debtor that the obligation shall be discharged by partial payment.  If however the creditor makes a simple promise, (that is a promise not amounting to a contractual term), to the debtor to defer or vary payment, the guarantor is not released from his obligation; in this case the guarantor has the right to pay off the creditor and to demand the money “lent” (i.e. that paid by the guarantor to the creditor) from the debtor.

26     These principles were further explained in MAB Investments Ltd v Vibert[25] which concerned an action to recover monies from a guarantor in respect of a debt owed under a bond.  It was held that -

“Any material variation in the terms of the contract between the creditor and the principal debtor which could prejudice the guarantor will, unless the guarantor consents thereto, discharge him from his liability.  The mere giving of time to the debtor does not discharge the surety - there must be a binding agreement to give time.  Although the Court would not go so far as to say that the creditor owes a duty to the guarantor, it accepts that there are circumstances where conduct on the part of the creditor may have the effect of discharging the guarantor and that the law of Jersey and England were the same.

An omission by the creditor to do something which he is bound to do for the protection of the guarantor will discharge the latter; however, mere acquiescence in acts, which, though contrary to the conditions of the guarantee, do not amount to connivance or gross negligence (equivalent to shutting his eyes to fraud or something approximate thereto) will not discharge the guarantor.”

27     The droit de discussion is a customary law right held by a guarantor to require a person enforcing a guarantee first to have recourse to and exhaust the assets of the principal debtor before making a claim against him.  This right may be, and usually is, expressly waived by an appropriate clause in the guarantee so as to avert difficulty for a party attempting to enforce a guarantee (c.f. Le Cornu v CI Heat Pump Bureau).[26]  The rule requires that the goods of the principal debtor must first be exhausted (discuté) before the creditor can have recourse to the property of the guarantor.  The benefit/advantage of discussion is based on équité. This has some similarity to equity in English law – Lane v Lane[27] stated that the jurisdiction stems from the concept of fairness and that equity in Jersey veers more towards the French equité than its English counterpart.  Unless a guarantor waives the droit de discussion a guarantor has a defence to a claim from the creditor if it can be shown the debtor has assets available to satisfy the primary demand.  The defence may only involve delay whilst the debtor’s assets are realised which enable the guarantor’s liability to be quantified, but it reflects the true position that the debtor is primarily responsible and the guarantor only has a top up or subsidiary obligation.  This illustrates why the guaranteed party should require the droit de discussion to be waived.  But the position of a guarantor is very different when the principal debtor is manifestly insolvent.  In these circumstances the guarantor may be called upon by the creditor to pay what is owed and to be substituted in the place of the debtor.[28] That position is entirely consistent with the top-up or subsidiary obligation principle.

28     The droit de discussion is not available, inter alia -

(i)      where the guarantor has waived the right by the terms of the guarantee;

(ii)      for cautions judiciaires;[29]

(iii)     where the droit de discussion is not specifically pleaded by the guarantor;

(iv)     where the principal debtor is clearly insolvent, in which case the creditor does not have to commence proceedings against the guarantor (i.e. his assets have been declared en désastre);[30]

(iv)     probably, where the guarantor binds himself as the “principal debtor”); or

(vi)     possibly, where exhausting the assets of the principal debtor is too onerous ( for example the debtor is out of the country).

29     A guarantor of a number of debtors who are jointly and severally liable can insist that the assets of all the debtors be exhausted (discuté) before he is called upon to pay.  A guarantor has a right of subrogation against the creditor in respect of all rights, actions and hypothecs which he (the creditor) has against the principal debtor.   Extinction of the principal debt extinguishes the guarantee, but mere unenforceability of the principal debt for some personal reason (for example, minority or insolvency of the principal debtor) does not.  If the principal debt is unenforceable (other than through incapacity) the guarantee will be unenforceable to the same extent. An exception to this rule is where the principal obligation is undermined by some act or default of the guarantor.  In that case, the principal debtor may have his obligation extinguished, but the guarantor remains liable.

30     A bank requiring a guarantee from a customer has a duty to explain to the person about to sign a guarantee both the legal effects and the extent of the obligation.  This principle laid down in Lloyds Bank Limited vBundy[31]was approved in West v Lazard Brothers and Company (Jersey) Ltd.[32]  The House of Lords decision in Royal Bank of Scotland v Etridge (No 2)[33] is  particularly helpful in setting out the scope of the law of undue influence and creditors banks’ obligations to non-commercial guarantees and sureties.  In this respect, the Royal Court is likely to follow English common law authorities.

The rights (or defences) of the guarantor against the principal    debtor

31     When the guarantor pays the creditor, he is subrogated to all the creditor’s rights and actions against the debtor.  Where there are several debtors, the guarantor's right of subrogation is against all debtors and each one of them for the total amount due to the guarantor.  After the guarantor has discharged the debt to the creditor, the guarantor has rights of indemnity by way of subrogation against the principal debtor for reimbursement for all that he has paid.  However the principal debtor will have a defence to such a claim if-

(i)      the principal debtor had a defence to the creditor's claim;

(ii)      the payment had been made and the debtor had been freed from his debt to the creditor; or

(iii)     the debtor had not made the payment as a result of the fault of the guarantor.

The rights of the creditor against the principal debtor

32     Claims in contract under Jersey law are generally prescribed after 10 years.  Where a guarantor becomes obliged to pay interest on a debt, the passing of over 10 years will not allow the principal debtor to claim that the debt is prescribed.  In effect, the interest payments are made for the benefit of the debtor and they keep the obligation in force (see John de Gruchy v Executors of Philippe de Gruchy)[34]

The rights of the creditor against the guarantor

33     A creditor against whom the droit de discussion is pleaded is not bound to discute immediately, and if he delays and the principal debtor becomes insolvent in the meantime, the creditor does not lose his right of recourse against the guarantor. A guarantor exercising the droit de discussion is responsible for the costs incurred by it. The creditor can however raise one of the exceptions to the guarantor's droit de discussion, as stated above. A creditor was not bound to action his debtor in a désastre declared on the debtor’s property in order to preserve his right of recourse against the guarantor: Johnson & Malzard  v Tocque.[35]

The rights (or defences) of the principal debtor against the creditor

34     All the rights arising under the general law of contract governing whether, when, where and how an obligation should be performed apply.  No special additional rights apply to this relationship by virtue of the existence of a guarantee.

The rights (or defences) of the principal debtor against the guarantor

35     The debtor is not bound to provide the guarantor with more than the debtor has agreed with the creditor.  Each of these rights or defences may be affected where there is more than one creditor, or more than one principal debtor or more than one guarantor, as the rights of each inter se will also need to be considered.  Where there are several guarantors of the same debtor, each guarantor is deemed to have contracted to pay the whole of the principal sum and, consequently, may be called upon for the total sum, unless he has expressly limited or restricted his obligation. 

36     Co-guarantors may have a droit de division.  This is a right at customary law which provides a guarantor with a defence so that a creditor must divide his demand amongst the co-guarantors (when they are solvent) in appropriate proportions; the co-guarantor can only be sued to pay his fair share.  However it is generally thought that this rule may not apply so that each of several co-guarantors is liable for the whole debt.  The droit de division is usually waived by a suitable clause in a guarantee.  The defence of droit de division (to the extent that it applies) is not available, inter alia -

(i)      if the co-guarantor has waived or renounced it by the terms of the guarantee;

(ii)      where co-guarantors bind themselves “jointly and severally as principal debtors”; or

(iii)     where a co-guarantor has not acted in good faith.

To the extent that it is available, the defence could apply to the heirs of the co-guarantor and to guarantors of the co-guarantor.

37     Co-guarantors have a right to indemnity by way of subrogation to recover what each has paid under their guarantee for their respective share and right of contribution as between co-guarantors.  Furthermore, all such rights may be affected where either a creditor, the principal debtor or the guarantor or any combination of them is declared en désastre or subject to an insolvent winding up.

The rights (or defences) of guarantors against third parties

38     A lawyer has a duty, even when implementing a transaction rather than negotiating its terms, to advise on any hidden pitfalls such as to duration and the extent of the liability.  Generally and in the absence of specific instructions, the scope of a lawyer's duty does not extend to investigating (on behalf of his client) the financial viability of an indemnifier and, it is suggested, this would also apply to a guarantor.  (See Pickersgill and Le Cornu v Riley).[36]

To what may a guarantee relate?

39     Individuals lacking capacity, such as minors and interdicts, may be guaranteed for any matter on which they may become validly bound, without any act on their part (e.g. in quasi-contract to reimburse a guardian for what he has paid on behalf of a minor).  A person cannot however be a guarantor of himself; nor can a person give a guarantee in favour of a person who is not a creditor of the principal debtor.

40     Any obligation may be guaranteed (provided that the obligation is binding and not illegal or immoral). Failure by the guarantor to perform a guaranteed obligation transforms the obligation into a liability for pecuniary damages.  If the obligation is not to arise until some future date, the guarantor is not bound until the obligation crystallises and, in the meantime, the guarantor may withdraw from the agreement.

41     Standard-form bank guarantees generally provide for additional rights favouring the bank, including waiver of the usual rights of guarantors.  In effect, many such guarantees negate the guarantor's usual legal rights.  For example, for the operation of suspense accounts, liens and set offs it is usual to provide - 

(i)      that the security will be continuing and endure through death, disability, or bankruptcy of the principal debtor; 

(ii)      that the arrangement with the debtor can be changed or forbearance given without affecting the guarantor's obligation. (See Triodos Bank NV  v Dobbs)[37]

(iii)     that the rights of the bank against the debtor will be preserved against the debtor notwithstanding the principal debtor's insolvency, the guarantor's rights of subrogation and his right to claim in the bankruptcy in competition with the bank.

(iv)     that the rights of the bank against the guarantor will be preserved, notwithstanding any agreement between him and the principal debtor;

(v)      that the guarantor will waive his right to be made a party to any action against the principal debtor and likewise waive his rights to the droit de discussion and the droit de division.

Extinction of guarantees

42     The usual means of extinguishing obligations under contracts generally will apply in respect of guarantees including -

(i)      full performance;

(ii)      novation;

(iii)     remission or waiver by the creditor;

(iv)     set-off or counterclaim;

(v)      confusion, e.g. where the guarantor becomes an heir of the debtor or there is a merger of companies;

(vi)     extinction of the principal obligation or debt;

(vii) occurrence of a condition résolutoire (e.g. a guarantee until a ship returns);

(viii) expiry of term;

(ix)     when the creditor by his own act puts himself in a position where he cannot pass on his rights of action against any of the principal debtors, to which the guarantor is entitled to be subrogated;

(x)     where the principal obligation is varied without the guarantor's consent.

43     Guarantees are not extinguished by legal proceedings brought by the creditor against the debtor:  Guidon Investments Limited v Malet de Carteret.[38]  Money paid by a guarantor to a major creditor of an insolvent company cannot be set off against the guarantor’s personal liabilities to the insolvent company.  To allow such a set-off would be to prefer one creditor to another.  Therefore the guarantor, by stepping into the shoes of a creditor, has only limited rights of set off.

Guarantees and insolvency

44     In a désastre or insolvent winding up of either the principal debtor or the guarantor, the validity of the guarantee given will be considered.  Where a principal debtor is insolvent, the guarantor ought to consider the validity of guarantees given.  Where a guarantor is insolvent, the guarantee will be scrutinised in the désastre or liquidation by the Viscount or the liquidator respectively.  This could also occur in a solvent winding up but there will usually be less reason to do so. 

Désastre or winding up of the principal debtor

45     Where the principal debtor becomes subject to a désastre or an insolvent winding up, the creditor will usually declare a default in respect of the guaranteed contract and call on the guarantee.  He may do so either because the principal debtor is manifestly insolvent or because, it is usual for the droit de discussion to be waived in the guarantee.  The creditor will generally be entitled to proceed either against the principal debtor or the guarantor or both.  Any requirements for enforcement contained in the guarantee (for example, service of a demande) must be observed. The position seems to be that claims made against the guarantor must be reduced by recoveries from the principal debtor up to the date on which the creditor submits a proof of claim in the insolvency of the principal debtor but not thereafter, subject to the creditor not recovering more than 100% of the debt. 

46     Where a guarantor makes a payment pursuant to a guarantee he will have a right, as a matter of law, to be indemnified by the principal debtor.  Where the principal debtor is insolvent, the question arises whether and in what circumstances the guarantor is able to submit a proof of claim in the insolvency of the debtor for his indemnity.  The impact of the rule against double proof then arises.

47     There cannot be two proofs of claim against a single party in respect of the same debt in any insolvency.  Therefore, a guarantor cannot prove in the principal debtor's insolvency until such time as the principal creditor is no longer entitled to prove (e.g. because the guarantor has discharged the liability in full).  The rule against double proof also prevents the guarantor from proving in the winding-up of a debtor as a contingent creditor until he has discharged the entire guaranteed indebtedness.  Before this time, the principal creditor remains entitled to prove in respect of the whole debt and therefore the guarantor is debarred by the rule against double proof from making any claim at all.[39]

48     Guarantees often contain “non-compete” clauses providing that the guarantor may not claim in the insolvency of the principal debtor until such time as the creditor has been repaid in full.  They will also commonly entitle creditors (particularly in bank lending) to hold sums received from the principal debtor and from co-guarantors in suspense accounts to maximise recoveries from all sources before applying such recoveries against the outstanding debt.  This enables the creditor to continue to claim for the full amount of the debt from the insolvent principal debtor (subject to not recovering in excess of 100% of the claim).  In these circumstances, a guarantor will not be able to claim any right of indemnity against the debtor until the creditor has been repaid in full. This operates as a contractual subordination, and such provisions are given statutory force by the Bankruptcy (Netting Contractual Subordination and Non-Petitions) (Jersey) Law 2005.  

49     A “non-compete” clause or “no competition” provision is effectively a contractual subordination. It was thought that, under the English law, contractual subordination might offend against the mandatory principle of pari passu distribution of assets on the insolvency of the principal debtor, but a recent English case upheld its validity.[40]

50     In the absence of a “non-compete” clause, a guarantor who has paid the creditor in full may submit a proof of claim in the insolvency of the debtor.  He will be subrogated to any rights that the creditor may have had against the principal debtor in respect of the debt, including any rights to security or priority treatment and any dividends received by the creditor will be held on trust for the guarantor.  Where the creditor has not been paid in full, the ability of the guarantor to prove in the debtor's insolvency will depend on whether the whole or part of the debt has been guaranteed.  A guarantor who has guaranteed all liabilities of the principal debtor (even if subject to a monetary cap) will be prevented from claiming against the principal debtor until the creditor has been paid in full as a result of the rule against double proof[41].  However, if only a limited part of the underlying indebtedness has been guaranteed, the guarantor's right to pursue the principal debtor and be subrogated to the creditor's rights will apply on payment of that amount.[42]  This claim is treated as a separate debt and, therefore, does not infringe the rule against double proof (see below) and the creditor must reduce his proof by the part received.  It is in this situation that a ‘non-compete’ clause may be of importance to the creditor.

51     Where a guarantee is given in respect of the whole debt but is subject to a cap on the guarantor's liability, payment by the guarantor of his liability does not prevent the creditor from proving in the principal debtor's insolvency for the whole amount of the debt.

Insolvency of the guarantor

52     Where a guarantor becomes insolvent, the principal creditor may wish to submit a proof of claim in respect of the guarantee liability regardless of whether the principal debtor has defaulted on his obligation.  Where the principal obligation is ongoing, the creditor's claim will be contingent on the principal debtor defaulting.  The liquidator/Viscount must, therefore, estimate the value of the claim having regard to the likelihood of the principal debtor's default.  Assuming that the droit de discussion has been waived, the creditor must take into account all sums received from the principal debtor up to the time he submits his proof in the guarantor's insolvency, but need not adjust his claim if he receives further sums from the principal debtor subsequently[43].  However, where the guarantee is only in respect of part of a debt, the creditor cannot be forced to apply payments received from the debtor first to that guaranteed part (subject to contrary provisions in the guarantee).

53     If the guarantee is for part of the principal debt, the proof of claim against the guarantor cannot exceed that sum.  If, however, the guarantee is in respect of all monies due with a cap on the amount of recovery, the proof of claim may be in respect of all liabilities of the principal debtor to the creditor.  The dividends received by the creditor must not exceed the monetary limit contained in the guarantee.

54     In valuing contingent claims, the liquidator's/Viscount's estimate may be revised in the light of a change in circumstances, e.g. if the principal debtor defaults during the insolvency.  Thus an element of hindsight can be applied[44].

55     If a guarantor becomes insolvent, a guarantee given by him may be voidable in a désastre or winding-up as a preference or transaction at an undervalue.  Guarantees given to a creditor in the period leading up to insolvency of the guarantor will therefore be vulnerable to attack as will guarantees given where there is no obvious benefit to the guarantor. 

Insolvency of both principal debtor and guarantor

56     If the principal debtor and the guarantor both become insolvent (which may apply in cross-guarantees given by a group of companies), the creditor is generally entitled to prove in both insolvencies for the full amount of the debt due and is not obliged to reduce his proof in one insolvency for dividends declared or received in the other, subject to not recovering more than 100% of the debt.  This assumes that the droit de discussion has been waived.  However, as stated above, it seems that credit must be given for any payments or dividends received prior to lodging the proof of claim.  The right to claim the full debt from a guarantor will depend on whether a monetary cap has been placed on recoveries under the guarantee.

Conclusion

57     It is clearly essential to ensure that a guarantee is adequately drafted so as to provide fully for a number of differing events and circumstances and to reflect the true intention of the parties.  The differences between Jersey and English law need to be identified and appropriate wording used.  The peculiar nature of this accessory type obligation can clearly give rise to multiple relationships and new implied rights such as the right of subrogation.  The concept of equité and fairness may be more readily engaged where particular wording leaves doubt or seeks to create an injustice.  A guarantee unlimited in time and amount is similar to a blank cheque.  The French word “caution” is therefore perhaps a colourful and descriptive term with meaning.  

Anthony Dessain is an advocate of the Royal Court of Jersey and a partner in Bedell Cristin. 
Michael Wilkins is a barrister, and was appointed Viscount of the Royal Court of Jersey in 1981 and Judicial Greffier in 1997.
Deborah Gregory is a solicitor of the Supreme Court of England and Wales and a partner in Lovells, London.

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