No guarantees

Can a bank's refusal to provide '¨a loan facility without a personal guarantee amount to illegitimate commercial pressure?

A borrower will often be under commercial pressure to enter into a personal guarantee, for example in order to obtain a loan to avoid a more immediate problem such as a failing business. However, can this typical scenario justifiably give rise to a defence in economic duress to claims brought by banks under the guarantee?

It is a defence which has in the past caused particular problems for banks on summary judgment applications, where the lack of clarity in the law has dissuaded judges from giving judgment on economic duress defences summarily.

There are few authorities to point to when faced with this defence, although the Chancery Division recently considered it on a summary judgment application in the unreported case of Bank of Scotland PLC v Cohen (2013). Cohen is a helpful reminder that the defences of economic duress and undue influence are neither too legally nor factually knotty to be suitable for determination under Part 24. It goes on to established some important points of guidance which may be of assistance to both lenders and guarantors.

The court applied the decision of the Privy Council in Pao On v Lau Yiu Long [1980] AC 614 at 635C, citing Lord Scarman's observations on coercion of will:

 Did the person alleged to have been coerced protest?

 At the time he was allegedly coerced into making the contract, did he have an alternative course open to him?

 Was he independently advised?

 After entering the contract, did he take steps to avoid it?'¨

In answer to Lord Scarman's test, the court held that personal guarantees could not be voided on the ground of economic duress. In particular, the court held that the bank was entitled to rely upon the guarantors' declarations that they had received legal advice and that they had entered into the guarantees freely. Importantly, it held that the commercial pressure under which the guarantors found themselves was caused '¨by their own poor commercial decisions, '¨blame for which could not be laid at the feet of the bank.

Applying Lord Scarman's test as it was applied in Cohen, it seems that the following factors are of crucial importance in considering economic duress, particularly where the court is required to decide the issues summarily:

 Did the guarantor object at the time of signing or since, whether orally or in writing?

 Was the commercial pressure caused by the guarantor's own commercial decisions?

 Did the guarantor declare that he had received legal advice and/or was entering into the agreement of his own free will, and was it reasonable for the bank to rely on that declaration?

Unhelpfully, the court declined to consider the wider question of whether a refusal to enter into an agreement unless onerous terms are agreed to can ever amount to economic duress. The court's attention was drawn to Chitty on Contracts 13th edition at paragraph 7-047, which doubts that it can, citing in support Commonwealth authorities which broadly conclude that a party to a contract is entitled to refuse to contract except on his own terms, even if the other party has little choice but to accept.

However, other Commonwealth authorities do not sit well with that principle. Burin Peninsula Community Business Development Corporation v Grandy 327 DLR (4th) 752 decided by the Newfoundland and Labrador Court of Appeal in 2010 considered the application '¨of economic duress to personal guarantees. The borrower approached the corporation for a loan in order to avoid legal proceedings which were being threatened by his '¨existing lender. The corporation agreed to provide the loan but five weeks later at the closing refused to release the funds until such time as the borrower entered into a personal guarantee. The court held that the personal guarantee was unenforceable for economic duress.

The court rejected the corporation's submission that offering to lend money on certain conditions was not illegitimate pressure, and that the borrower was free to refuse to sign the personal guarantee or request a waiver from the corporation. It held that the borrower's financial circumstances meant that refusal was not a practical option, and that the corporation had "sought to take advantage of the borrower's precarious financial predicament for their own benefit". It was a relevant factor that the corporation had not encouraged the borrower to seek independent legal advice.

The decision in Grandy is certainly flawed, but given the uncertainty of the law in this area, a bank would be advised to take proper steps to satisfy itself that the guarantor has been independently advised as a matter of course in order to avoid findings of unconscionable conduct.
Where economic duress is alleged, '¨banks can now point to Cohen for '¨guidance and in support of dealing with '¨the defence summarily.