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Guarantees & Solicitors Certificates

As long ago as 2001 in Royal Bank of Scotland v Etridge the House of Lords significantly extended the circumstances in which a financier will be put on constructive notice of misrepresentation or undue influence committed against an individual executing a Guarantee or other security, but there remains a great deal of misunderstanding of the relevant principles.

There is a common assumption that the doctrine of “protected person status” applies only to wives or co-habitees, or that it is displaced where the individual concerned is a shareholder or a Director in the client company. This is not the case, as Lord Nicholls said at paras 49 and 87-8:-

“…where the wife becomes surety for the debts of a company whose shares are held by her and her husband. Her shareholding may be nominal, or she may have a minority shareholding or an equal shareholding with her husband. In my view the bank is put on enquiry in such cases, even when the wife is a director or secretary of the company. Such cases cannot be equated with joint loans. The shareholding interest, and the identity of the directors, are not a reliable guide to the identity of the persons who actually have the conduct of the company’s business…if a bank is not to be required to evaluate the extent to which its customer has influence over a proposed guarantor, the only practical way forward is to regard banks as “put on enquiry” in every case where the relationship between the surety and the debtor is non-commercial. The creditor must always take reasonable steps to bring home to the individual guarantor the risks he is running by standing as surety. As a measure of protection, this is valuable. But, in all conscience, it is a modest burden for banks and other lenders. It is no more than is reasonably to be expected of a creditor who is taking a guarantee from an individual. If the bank or other creditor does not take these steps, it is deemed to have notice of any claim the guarantor may have that the transaction was procured by undue influence or misrepresentation on the part of the debtor.

Different considerations apply where the relationship between the debtor and guarantor is commercial, as where a guarantor is being paid a fee, or a company is guaranteeing the debts of another company in the same group. Those engaged in business can be regarded as capable of looking after themselves and understanding the risks involved in the giving of guarantees.”

Steps to be Taken

The House of Lords directed that the creditor should require the Guarantor to instruct a Solicitor, and should get the client’s consent to send all the necessary information to the Solicitor to enable him to advise properly. This will depend on the circumstances, but will ordinarily include a description of the purpose and amount of the facility and a copy of any written Application by the client.

Once the Solicitor has advised the Guarantor, the creditor should ask the Solicitor to certify that he has acted for the Guarantor, has explained the transaction, the documents and their implications and the risks involved.

If the creditor fails to observe these guidelines and the Guarantor subsequently proves that either misrepresentation or undue influence by the client or another Guarantor has induced the transaction then the creditor will be affixed with constructive notice of the wrongdoing and the Guarantee or other security will be unenforceable.

Is it Sufficient to Give an Opportunity to Take Independent Legal advice?

In our experience a number of Receivables Financiers are still under the impression that the comprehensive requirements set out in Etridge are optional and that they can be replaced by the simple device of including a statement at the end of a Guarantee or other security document to the effect that the individual has been afforded the opportunity of taking independent legal advice. Unfortunately this is not the case: in the words of a leading textbook on the subject:-

“A written statement from the wife to the effect that she understood the transaction perfectly and had no wish to take independent legal advice could now be regarded as something of a poisoned chalice.”

Operations people seem to accept the protestations of new business that in a highly competitive market sales would be lost by going through the procedure of requiring a Solicitor’s Certificate, but this point was expressly dealt with by the House of Lords when Lord Nicholls pointed out that everyone is subject to the same playing field:-

“[it is]…a principle which imposes no more than a modest obligation on banks and other creditors. The existence of this obligation in all non-commercial cases does not go beyond the reasonable requirements of the present time. In future, banks and other creditors should regulate their affairs accordingly.”

However, we recognise that in the real world a balance has to be struck between the practicalities of signing up new business and the relatively minimal risk of a Guarantee or other security subsequently being challenged on the basis of misrepresentation or undue influence by the client (as opposed to alleged misrepresentation by new business, which is an entirely different matter). Nevertheless we do continue to come across such situations, sometimes in contexts involving individuals way outside the classic relationship of co-habitees.