Focus: No detailed explanation equals no guarantee
16 June 2011
In brief: It has recently been held that it would be unconscionable to allow a lender to enforce a guarantee against a borrower's wife, even though she was well-educated, not misinformed and understood the guarantee's general nature. Partner Michael Quinlan and Lawyer Stewart Webster report.
How does it affect you?
- The Queensland Court of Appeal decision1 underscores the potential difficulty that lenders face in enforcing guarantees against spouses.
- If a spouse is not receiving any direct or immediate benefit from giving a guarantee, and the transaction is not fully explained by the lender or an independent adviser, there is a real danger that the guarantee will not be enforceable.
- The danger is not avoided simply by ensuring that the spouse appreciates, in general terms, what a guarantee is. Rather, to avoid any danger, it is necessary to explain (or have explained by an independent adviser):
- the particular effect of the guarantee the spouse is signing (whether it is limited, what it guarantees, etc); and
- the risks specific to any contemplated transaction involving the guaranteed funds.
- As the decision does not give clear guidance as to exactly how much detail is enough, the safest course is to give more, rather than less, and, where possible, ensure that an independent adviser gives the explanation.
- While, in the past, the courts have only interfered with a guarantee to protect the wife of a borrower, there is probably no reason why a husband, or any de-facto partner, who trusts and has confidence in their partner to manage the family financial affairs could not attract such protection.
The respondent, Dr Joan Byrne, was married to the borrower, Mr Murray Byrne. Both were medical practitioners.
In June 2006, Dr Murray Byrne decided to make some tax-effective agricultural investments. On 3 June 2006, his financial planner visited the Byrne family home with application paperwork. The respondent, when asked, signed a loan application form with the heading 'Applicant 2/Guarantor'. Dr Byrne died in 2007, aged 38. His estate defaulted in the payment of interest due on the loan. That triggered the obligation of the respondent, as guarantor, to repay the outstanding principal and interest owed to the creditor.
The respondent later gave evidence that she was not informed about the nature of the investment or any of the terms of the application. She did not read the document, and felt ambushed and pressured to sign. She was told that she should seek independent advice, but was also told that she had to sign the paperwork that day, as otherwise her husband would not be able to proceed with the investment.
After she signed the application, Dr Byrne's financial adviser offered the respondent a brief explanation of the investment. The evidence suggested that this did not include information relating to the guarantee's legal effect or the financial obligations involved in the investment, but seemed to focus on the investment's possible benefits. The respondent gave evidence that she did not understand the presentation.
The respondent also gave evidence that she believed that she was legally bound as a guarantor from the day she signed the application form, even though she did not sign the guarantee until later in the month. As a result, she did not seek any independent advice between signing the application and signing the guarantee.
Sometime between 22 and 30 June 2006, when the respondent signed a formal guarantee, a loan agreement and other documents, she also signed a detailed declaration that, among other things, recorded that:
- the information relating to her financial position in the application was true and correct;
- she had been given the opportunity to receive independent tax and legal advice regarding her obligations under the loan agreement;
- she understood the effect of the loan agreement and her obligations under it; and
- she acknowledged that the lender would be relying on the declaration in providing financial accommodation.
The respondent gave evidence that no one ever explained to her the structure of the loans, the identity of the lender, the term of the loan or the risks associated with the investment.
She did accept that she broadly understood that if her husband could not meet his financial obligations, she would be responsible for paying back the money.
The respondent was aware (as was the lender) that her husband had taken out a life insurance policy that was broadly intended to cover his debts in the event of his death, and there was evidence the investment was potentially beneficial for the respondent, as:
- it reduced her husband's tax liability and thereby freed up more income for the household;
- if it were profitable in the future, the household would be better off; and
- if it were profitable in the future, some profit was likely to be directly earned by the Byrnes' joint superannuation fund.
The Court of Appeal unanimously upheld the primary judgment, though by way of three separate judgments. Their Honours agreed that:
- Any benefit derived by a guarantor must be direct or immediate, not indirect and prospective. The potential benefits that Ms Byrne would have received were too indirect and prospective to affect her status as a 'volunteer'.
- It is not necessary that a guarantor positively misapprehend some matter material to the guarantee: it is enough that she does not know its details, at least in circumstances in which there is 'pressure and surprise'.
- The transaction itself need not be 'unreasonable and oppressive', but merely one that the creditor has not properly explained or not ensured that the spouse appropriately understands.
- The existence of a life insurance policy, or similar arrangement designed to cover the debts guaranteed by the spouse, does not prevent the guarantee from being unenforceable. This is because the protection for the spouse is triggered not by conduct that is unfair based on ordinary standards of fair dealing, but simply by a creditor's failure to ensure that a wife properly understands her husband's guaranteed transaction.
The decision clearly puts a heavy onus on creditors in obtaining guarantees from spouses who do not receive a direct or immediate benefit from a transaction, and are therefore 'volunteers'. To ensure that a guarantee is enforceable, the creditor needs to take significant positive steps to explain, or have explained, the effect of the guarantee and the risks involved. Anything less than a detailed explanation is a recipe for trouble.
- Clint HinchenPartner, Practice Group Leader, Corporate Insolvency & Restructuring,
Ph: +61 3 9613 8924
- Geoff RankinPartner,
Ph: +61 7 3334 3235
- Kim ReidPartner,
Ph: +61 2 9230 4037