Sale Proceeds and Claims Against Guarantors

The recent case of Barclays Bank plc v Kingston (([2006] EWHC 533(QB)) clearly establishes the principle that a creditor who realises security must take steps to achieve a proper price, and failure to do so will normally entitle a Guarantor to be relieved to the extent of any undervalue achieved on resale.

This is a complex legal area on which there have been conflicting decisions over the years. The Judgment in this case analyses earlier authorities and prefers a line of cases which establish the availability of an equitable right to a Guarantor to complain in the event of the negligent realisation of security. This case involved property but the principle applies to all forms of security, including chattel mortgages.

However, the Court confirmed that a creditor cannot be compelled to exercise the power of sale in the first place: he is free to choose whether and if so when to do so, but if he chooses to do so and exercises the power negligently then the Guarantor is entitled to set up a defence to the extent of the undervalue.

The bank sought to argue that any equitable duty owed to the Guarantor had been excluded by express terms in its standard form of Guarantee, which gave it various powers including the power to “release, enforce or not enforce our rights under any…security”. The Court construed this phrase strictly against the bank, and concluded that whilst in principle it might be possible for clear wording to exclude the bank’s liability for negligent realisation of its security, that had not been achieved in the present document.

The Court also rejected an argument by the bank that a clause of the Guarantee rendering the Guarantor liable as an Indemnifier in the event of his liability as a Guarantor being reduced could not assist the bank, since the principle of equitable relief in the event of sale at an undervalue applied equally to an Indemnifier.

Barclays Bank plc v Kingston is a useful reminder to Financiers that if they decide to realise security they must exercise reasonable care in achieving a proper market price. However, there is no duty to realise a security: so for example a Financier with a chattel mortgage over goods as security for a loan is not obliged to take possession of the goods and sell them, but may if it considers it commercially prudent to do so simply ignore the goods and proceed to enforce its remedy against a Guarantor or Indemnifier.

Resale Values of Repossessed Goods

How does this affect a Financier’s obligations in relation to repossessed goods? Here there is no question of security, because the goods have always been in the ownership of the Financier. Guarantors and Indemnifiers often allege that goods have been sold at an undervalue and that the contractual termination sum should be reduced accordingly. Is the Financier under a duty to take reasonable steps to obtain a proper market value?

In Scottish Midland Guarantee Trust Limited v Woolley (( [1964] 144 LJ 272)) the High Court held that a Financier owed no duty to mitigate loss to a Guarantor and there was therefore no obligation on the Financier to achieve the proper market price on resale of the goods. This decision has been criticised in the leading textbook on the Law of Guarantees, which argues that the reasoning was simply wrong, and it has similarly been doubted in Professor Guest’s text on The Law of Hire – Purchase.

However, the decision in Scottish Midland Guarantee Trust and its reasoning was upheld by the Court of Appeal in Royscot Commercial Leasing Limited v Ismail ((29 April 1993)) in which the Court confirmed that it is not open to a Guarantor to complain at the resale value of repossessed goods under a Lease Agreement because the concept of mitigation of damage does not apply.

Unfortunately the Royscot case has never been properly reported, so whilst it may be possible to persuade Courts that it should be followed on a case by case basis where the transcript of the authority is available, there is no reference to the authority in the standard textbooks and there is a danger that a future Court of Appeal will accept the academic criticism of the reasoning that a Guarantor effectively has no redress in the event of a sale of the Financier’s own goods at an undervalue.

Our advice is for Financiers to continue to take a pragmatic approach in obtaining several independent quotes from arm’s length buyers for the resale value of repossessed equipment in order to defeat any potential defences based on undervalue.