Scottish Court of Session Decisions

You are here: BAILII >> Databases >> Scottish Court of Session Decisions >> Bank of Ireland v. Morton [2002] ScotCS 301 (22 November 2002)
URL: http://www.bailii.org/scot/cases/ScotCS/2002/301.html
Cite as: [2002] ScotCS 301

[New search] [Help]

Bank of Ireland v. Morton [2002] ScotCS 301 (22 November 2002)

FIRST DIVISION, INNER HOUSE, COURT OF SESSION

Lord President

Lord Marnoch

Lord McCluskey

XA136/01

OPINION OF THE COURT

delivered by THE LORD PRESIDENT

in

APPEAL

From the Sheriffdom of South Strathclyde, Dumfries and Galloway at Airdrie

in the cause

THE GOVERNOR AND COMPANY OF THE BANK OF IRELAND

Pursuers and Respondents;

against

BRIAN MORTON

Defender and Appellant:

_______

Act: Lindsay; Balfour & Manson (for Sinclair McCormick & Giusti Martin)

Alt: Davidson, Q.C., Brown; Beveridge & Kellas (for Munro, Solicitors, Glasgow)

22 November 2002

In this Sheriff Court action the pursuers seek to enforce the personal guarantee granted by the defender in their favour on 5 December 1996. They obtained decree against the defender on 1 June 2001. The defender has appealed to this court.

The guarantee was granted by the defender in the following circumstances. He was the managing director and principal shareholder of Lewis Loyd Holdings Limited ("LLHL") which undertook the development of property, primarily for use in the licensed trade. In August 1996 LLHL granted floating charges over its assets to the Royal Bank of Scotland ("RBS") and Bass Brewers Limited ("BBL"). Each of these floating charges contained a negative pledge, prohibiting LLHL from creating any subsequent security over its assets. In late 1996 LLHL wished to purchase Hazelburn Business Park in Campbeltown. In order to provide funds for the purchase LLHL obtained an offer by the pursuers to lend to LLHL the sum of £250,000 repayable over ten years. The offer was contained in a letter dated 14 November 1996 which was addressed to the defender as managing director. It stated that the banking facility to be provided by the pursuers was conditional upon, inter alia, the following:

"(i) first standard security over the freehold site known as the Hazelburn

Business Park, Campbeltown comprising offices, workshop and cleared site to the rear

(ii) personal guarantee from Brian Morton for the sum of £250,000

(iii) negative pledge from Lewis Loyd Holdings Limited confirming that

they will not grant a floating charge in favour of any other party".

On 18 November 1996 LLHL agreed to accept this offer and on 4 December 1996 it granted a standard security over Hazelburn to the pursuers. In the guarantee, which was granted by the defender on the following day, the defender and LLHL were referred to as "the Guarantors" and "the Customer" respectively. It stated in clause 1:

"In consideration of the bank making or continuing advances or otherwise giving credit or affording banking facilities, for so long as the bank may think fit, the Guarantors agree to pay to the bank on demand all sums of money...which are now or shall at any time be owing or remain unpaid to the bank anywhere from or by the Customer...".

This was subject to a proviso that the total amount ultimately enforceable under the guarantee should not exceed £250,000, exclusive of interest, commission, fees and other legal charges and expenses. In January 1997 LLHL purchased and took entry to Hazelburn.

In November 1996 it was agreed between the pursuers and LLHL that a ranking agreement would be entered into between the pursuers, LLHL, RBS and BBL which would enable the standard security granted by LLHL to rank in priority to the floating charges which had been granted by LLHL in favour of RBS and BBL. Such a ranking agreement was never entered into. The solicitors to LLHL obtained letters from RBS and BBL in which they consented to the granting of the standard security by LLHL, in the belief that the effect of such letters would be to disapply the negative pledges.

At about the end of 1997 LLHL got into financial difficulties. By notice dated 26 November 1997 the pursuers intimated to LLHL that the overdraft granted in connection with the banking facility had been called up. On 29 January 1998 the pursuers served notice on the defender under the guarantee demanding payment of £244,855.01. On 30 January and 9 February 1998 RBS and BBL petitioned for appointment of a receiver over the assets of LLHL. Joint receivers were appointed, and in due course on 12 April 1999 they sold Hazelburn for the sum of £150,000.

On 13 November 1998 it was held by Lord Cameron of Lochbroom, in a petition for directions at the instance of the receivers to which the pursuers and BBL had lodged answers, that the letters of consent which had been obtained by the solicitors for LLHL had no effect in regard to the ranking of the floating charges relative to the standard security. On 23 August 2000, in an action at the instance of the pursuers against BBL, Lord Macfadyen granted rectification of the BBL letter of consent to the effect of including in its terms the consent of BBL to the standard security having prior ranking. In the following year RBS accepted informally that it had no interest in the funds held by the receivers from the sale of Hazelburn. However, we were informed in the course of this appeal that BBL still maintain that, in a question with RBS, it has a contractual entitlement to the funds by virtue of an agreement as to their ranking inter se, to which BBL, RBS and LLHL were party in September 1996. In the circumstances it is clear that at the time of the proof the value of the standard security was very uncertain, and that this continues to be the case.

It is not in dispute that the pursuers were entitled to sue the defender on the guarantee. He did not have the right to insist that they should first enforce the standard security. In his defence to the present action the defender maintained that the pursuers had misrepresented to him that they would obtain a first ranking security over Hazelburn; that his consent to the guarantee had been vitiated by essential error induced by the pursuers; and that he and the pursuers had been under a common error as to the ranking of the standard security. After proof the sheriff rejected each of these defences. He found that the pursuers had made no representations to the defender in respect of the legal consequences or effect of his signing the guarantee, and that he had not been induced into signing it under essential error as to its meaning. He had erroneously thought that he had the benefit of discussion, and be liable only for any shortfall between the total sum due under the guarantee and the realised value of Hazelburn.

The remaining line of defence which was advanced before the sheriff was, in terms of the defender's fourth plea in law, that

"the pursuers having failed to perfect their security over Hazelburn as a result of their fault the defender is entitled to be released from his obligation under the guarantee to the extent of the value of the security which the pursuers have lost".

The sheriff stated as his third finding in fact and in law:

"The pursuers having failed to perfect the standard security granted by LLHL over Hazelburn to the prejudice of the defender he is freed from the obligations contained in the Personal Guarantee save in so far as the Personal Guarantee provides to the contrary".

Having considered the terms of the guarantee he expressed the view that he was satisfied that, properly construed, it made it abundantly clear that the intention of the parties in entering into the agreement was that the obligation to pay remained enforceable, notwithstanding the failure of the security.

In presenting the appeal counsel for the defender limited their submissions to a some only of the grounds of appeal which had been tabled. These included parts of ground No. 9 which sought the addition of certain findings in fact, namely that the defender would not have signed the guarantee had he thought that the pursuers would not get a first ranking security, and that the reason that there was no ranking agreement was fault on the part of the pursuers' agents. Counsel for the pursuers did not oppose the addition of these findings, which appear to be justified by the evidence at the proof.

The remaining grounds of appeal on which counsel for the defender relied were:

"5. The sheriff erred in law in holding that there was no duty on the pursuers to enter into a valid ranking agreement with the floating charge holders.

6. The sheriff erred in law in holding that on the proper construction of the personal guarantee the intention of the parties in entering into the agreement was that the obligation to pay would remain enforceable notwithstanding the failure of the security".

Before coming to the arguments which were presented in support of the appeal we should refer to the terms and conditions of the guarantee on which the sheriff founded his view as to its effect. These were as follows:

"D. This guarantee shall be in addition to and shall not be in any way prejudiced or affected by any collateral or other security now or hereafter held by the Bank for all or any part of the liabilities hereby guaranteed.

K. The Bank shall be at liberty without any further consent from the Guarantors and without in any way affecting its rights against the Guarantors, at any time to renew, determine, enlarge or vary any credit to the customer, to renew, vary, exchange, release or abstain from perfecting or enforcing any other securities held or to be held by the Bank for or on account of the monies intended to be hereby secured or any part thereof, to renew bills and promissory notes in any manner and to compound with, give time for payment to, accept compositions from and made any other arrangements with the Customer or any other party in respect of the liabilities hereby secured, and the Bank may release or discharge any of the Guarantors from the obligations of this guarantee or make any composition or arrangement with any one or more of them without affecting its rights against the other or others of them.

R. This guarantee shall not be discharged nor shall the Guarantors' liability be affected by reason of any failure or irregularity, defect or informality in any security given by or on behalf of the Customer in respect of the monies or liabilities hereby secured nor by any legal limitation, disability, incapacity or want of any borrowing powers of or by the Customer or want of authority of any director, manager, official or other person appearing to be acting for the Customer in any matter in respect of the monies or liabilities hereby secured or any other circumstance which renders the liability of the Customer void or unenforceable and such monies or liabilities will be recoverable by the Bank by the Guarantors as sole, original and independent obligors upon first written demand by way of a full indemnity together with all losses, claims, costs, charges and expenses to which the Bank may be subject or which it may incur in connection with the Customers' liabilities or this guarantee".

Junior counsel for the defender submitted that the pursuers as creditors had a duty to the defender as cautioner to act reasonably in regard to securities to which they were entitled. There had been a clear understanding that the standard security would have priority. Arising out of that understanding the pursuers had a duty to "preserve" that security and not to act or omit to act in any way which prejudiced the defender's interest in that security. The pursuers' duty arose by operation of law and could not be excluded by the terms of the contract between the pursuers and the defender. Counsel went on to elaborate this submission by maintaining that, where a creditor and a cautioner entered into a "contract of guarantee" on the understanding that the creditor had obtained or would obtain a first ranking security and this was not obtained (as in the case of RBS), the creditor was under a duty to notify the cautioner when it knew or ought to have known that this had not been obtained. That would enable the cautioner to take steps to protect his position. In the case of the defender he could have arranged to have the debt repaid by means of his control over LLHL and the venture could then have been re-financed by other means.

Senior counsel for the defender, while he submitted that the creditor was under a duty to protect the cautioner against being prejudiced, did not argue that the defender had a right to insist that a first ranking security was put in place, either on the basis of his having a jus quaesitum tertio or otherwise. Although it was clear, he said, that the defender had granted the guarantee in reliance on the pursuers' obtaining a first ranking standard security, senior counsel did not maintain that it was essential to the enforceability of the guarantee that this was achieved. His submission was that the pursuers should have informed him that a first ranking standard security had not been obtained, due to the fault of the pursuers' solicitors, so that he could take steps to arrange re-financing.

Counsel for the defender submitted that, to the extent that the defender was prejudiced by the pursuers' breach of duty, the pursuers were deprived of the benefit of the guarantee. Counsel submitted that in any event, in accordance with ground of appeal 6, on a proper construction of its terms, the guarantee did not involve that any obligation on the part of the defender to pay remained enforceable.

It is not in doubt that, on paying the debt owed by a principal debtor, a cautioner in respect of that debt has de jure not only a right of relief against the principal debtor but also the right to exercise the rights which the creditor holds against the principal debtor in respect of that debt.

"From the right of the cautioner to total relief against the principal debtor, and to the benefit of all securities for the debt in the hands of the creditor, there arises a corresponding duty on the part of the creditor to have regard to the interests of the cautioner. To this extent the creditor is in the position of a trustee for the cautioner, and, as such, he must preserve intact all the remedies against the principal debtor, whether in his own name or in the name of the cautioner; must not, by any voluntary act, do away with, release, lose, or depreciate any securities for the principal debt; and must abstain from any dealing with the principal debtor, or with third parties, which would prejudicially affect the position of the cautioner, as by extending the time of payment of the debt, varying the mode of accounting, or the like". (Gloag and Irvine Law of Rights in Security pages 809-810).

Thus far it is clear that the duty of the creditor, with reference to the interests of the cautioner is of a negative character and is not founded on terms of contract between them.

It is also clear that there may be circumstances in which the creditor is under a positive duty to protect the interests of the cautioner. Gloag and Irvine go on to state at page 918:

"A cautioner may be liberated not only by a voluntary act of the creditor, but also where, through mere neglect or omission on the part of the creditor, securities, to the benefit of which the cautioner is entitled, are lost or rendered ineffectual through not being properly perfected".

The authors cite in support of this proposition the decision of the House of Lords in Fleming v. Thomson (1826) 2 W. & S. 277. In that case it was held that cautioners were relieved from their obligation by reason of the fact that the creditor had neglected to complete title to heritable property which was to be held in security, with the result that the property was carried off by a third party. At page 292 Lord Gifford, who delivered the only speech, stated:

"But really the main question in the cause is this, Whether or not the completion of the title to the heritable property by the agent of the Bank, was not a material part of the agreement entered into with these sureties. If it was, Was it not incumbent on the Bank to have completed their title; or if there was any difficulty in their completing that title, by there being an arrear of feu-duties, Was it not incumbent on them to give notice to the sureties, when they made this arrangement with the trustee, that the sureties might exercise their discretion, whether they would advance those feu-duties, or would insist, as the appellant does now insist, that he will have nothing to do with it, because he conceives it was the duty of the Bank to complete their title to the

property?

My Lords, upon the best consideration I have been able to give this case, I think that the sureties entered into this engagement on the faith of this heritable property having been conveyed to the Bank; that it was incumbent on the Bank to obtain a conveyance of this property; and that, by not doing so, they have placed the sureties in a situation in which they never intended to have been placed, and in which they never would have been placed but for the negligence of the Bank".

It may be noted that the judgment of the House of Lords proceeded on the basis that there was an agreement from the creditor and the sureties that the creditor would complete title to the heritable property. On that basis it is not difficult to understand that, by reason for the failure of the creditor to complete that security, the sureties were entitled to regard themselves as released. The other point which should be noted is that the purpose of giving notice to the sureties in the way which was envisaged by Lord Gifford was to enable them, if so advised, to bring about the completion of the title by means of advancing the feu-duties, without which the completion could not be achieved.

The decision in Storie v. Carnie (1830) 8 S. 853 provides a further instance of a case in which the cautioner was released from his obligation on account of the failure on the part of the creditor to complete the heritable security. In that case, however, the cautionary obligation was contained in the same document as the heritable bond granted by the principal debtor. While the reasoning is not entirely clear, it seems that both in the Outer House and the Inner House the decision was thought to turn on the implied obligation of the creditor to "hold" the security for the benefit of the cautioner as well as for himself.

Counsel for the defenders placed some reliance on the observations of Lord Ross in Lord Advocate v. Maritime Fruit Carriers Co. Ltd. 1983 S.L.T. 357. In that case it was a condition of a financial agreement that a guarantee should be granted in favour of a bank and that the bank should have power to sell a vessel for the construction of which money had been advanced. In answer to a claim based on the guarantee it was maintained that the guarantor had been prejudiced by the failure to take due care in the sale of the vessel. It is difficult to place much reliance on this case since it was only concerned with whether or not this defence to the enforcement of the guarantee should be the subject of enquiry. In allowing a proof before answer Lord Ross went no further than to state (at page 360) that he was not prepared at that stage to hold that a cautioner was not entitled to plead by way of defence that the creditor had acted without due care in realising the security subjects with the result that the cautioner had been prejudiced.

The decisions in Fleming and Storie suggest that whether it is incumbent on a creditor to complete a particular security depends on the express or implied terms of the contract between the creditor and the cautioner. However, even if that duty arises as a matter of law it must, in our view, be subject to the terms of that contract.

In the present case the guarantee which was granted by the defender used a standard form which was evidently provided by the pursuers. Although it was granted as a consequence of the banking facilities which were extended by the pursuers to LLHL, it was expressed, subject to the ceiling to which we have referred, as a guarantee of all sums owed by LLHL to the pursuers. More importantly, it contained no reference to any particular security which was taken by the pursuers in connection with the granting of those facilities, let alone any ranking which such security was to have. Moreover, it contained particular provisions (in condition K) which stated explicitly that the guarantee was to be unaffected by a number of acts on the part of the pursuers, in regard to "any other security held by the pursuers for or on account of the monies intended to be hereby secured or any part thereof".

In these circumstances it is not surprising that senior counsel for the defender did not seek to argue that the pursuers had a duty to achieve a first ranking of the standard security or that such a ranking was essential to the enforceability of the guarantee.

As we have already noted, the submission on which senior counsel concentrated was that the pursuers were under a duty to advise the defender that such a first ranking had not been obtained, so that he could make alternative arrangements for the financing of the debt. This way of presenting the defender's case faces a number of difficulties:

First, the existence of such a duty is not supported by authority in the law of cautionry, on the basis of which the appeal was argued. It is plain that the provision of information by the pursuers to the defender would not have enabled the security to be completed (as in the case of Fleming). Nor would it have had any effect on the enforceability of the guarantee. As we have already noted, counsel for the defender did not submit that it was essential to the enforceability of the guarantee that a first ranking security should have been obtained. The supposed duty cannot, it seems to us, be based on any requirement of the law or of the contract between the pursuers and the defender. The law may decline to enforce a cautionary obligation where the party who is seeking to enforce it has not acted in accordance with good faith (see e.g. Smith v. Bank of Scotland 1997 S.C. (H.L.) 111), but no suggestion of bad faith has been made in the present case. It accordingly appears that the supposed duty to provide information must be based on an attempt to apply the law of negligence in the particular circumstances of the present case, in which the defender controlled LLHL, the principal debtor. We were referred to no authority in support of such an application of the law of negligence, and the decision of the Judicial Committee of the Privy Council in China and South Seas Bank Ltd. v. Tan Soon Gin [1990] 1 AC 536 appears to be against it.

Secondly, the existence of a duty to provide information, as envisaged by counsel for the defender, must be considered in the light of the terms of the defender's guarantee which represents the contract between him and the pursuers. The existence of such a duty is inconsistent with those terms and conditions, and in particular condition K which provides that the pursuers were to be at liberty without any further consent from the defender and without in any way affecting its rights against the defender, to take a number of actions in regard to "any other security held by the pursuers for or on account of the monies intended to be hereby secured or any part thereof". These actions involved releasing or abstaining from perfecting any such security.

Thirdly, it is plain that such a duty and the consequences, if any, of its not being performed, were not the subject of pleadings, evidence or discussion before the sheriff. They do not even form part of the defender's grounds of appeal. More fundamentally the extent of any loss to the defender is wholly uncertain. It cannot be determined on the basis of the evidence before the sheriff. Senior counsel for the defender made it clear that he did not know the true position as between the pursuers and the floating charge holders, or for that matter the extent of any loss which the pursuers themselves had sustained. The court was not invited to take the exceptional course of entertaining a proposal for the amendment of the defender's pleadings.

In these circumstances we are satisfied that the submissions made on behalf of the defender in support of the conclusion that the defender was not bound by his guarantee are not well founded. We will, however, add as an additional finding in fact the following:

"The defender would not have signed the guarantee had he thought that the pursuers would not get a first ranking security. The reason there was no ranking agreement was fault on the part of the pursuers' agents".

In the light of what we have said earlier in this opinion we consider that the sheriff's third finding in fact and in law is ill-founded and should be deleted.

The appeal is refused.