Guarantees ‘n’ Roses – a win for guarantors

The Code of Banking Practice (Code) establishes standards of good practice when banks deal with small businesses and individuals. In recent years, a growing number of customers and guarantors have sought to rely on the Code in litigation with banks.

Recently in National Australia Bank Ltd v Rose [2016] VSCA 169, the Victorian Supreme Court of Appeal upheld (2-1) a decision that effectively allowed a guarantor to avoid his obligations on the basis that the bank did not provide him with ‘prominent notice’ of certain matters required under the Code before accepting the guarantee.

Key messages

• The ruling demonstrates a further shift from the common law principle that parties will be bound by the documents they execute, regardless of whether they have read or received legal advice in respect of them. It provides further ammunition for guarantors to challenge guarantees under the Code’s provisions (see our update on Doggett v Commonwealth Bank of Australia [2015] VSCA 351 for another example).
• Whether a bank has provided ‘prominent notice’ of matters set out in clause 28.4 of the Code (such as a recommendation to obtain legal advice) is an objective consideration that depends on the circumstances. In this case, the written and verbal warnings were held to be insufficient.
• Banks must be vigilant when obtaining guarantees to ensure they have complied with the Code.
• A banker meeting with a guarantor to witness documents being executed carries greater risk than the banker receiving executed documents by post, because it is easier to argue that a banker did not provide prominent notice to the guarantor before the documents were executed. Where guarantees are executed in front of a banker, we recommend that:
  • the relevant documents are sent to the guarantor at least 24 hours before the meeting, so the guarantor has an opportunity to read them; and
  • at a minimum, the banker reads a statement to the guarantor that comprehensively sets out the matters required under clause 28.4 of the Code.
• NAB has not sought special leave to appeal the decision to the High Court. If the issue again comes before the courts, we consider banks may be encouraged by Justice Ferguson’s dissenting view that greater weight ought to have been given to the guarantor being an experienced businessman, presumably familiar with complex documentation and warnings, when determining the context of ‘prominence’.

Background

Timothy Rice (Rice) and John Rose (Rose), friends for a number of years, entered into a ‘handshake’ joint venture deal to invest in luxury Gold Coast real estate on an equal basis. The investments were made through Pavement Reef Pty Ltd (Pavement Reef), of which Rice and Rose were each a director and held equal shares. Rice was an experienced investor in real estate, whereas Rose was a successful business proprietor without real estate experience.

To assist in purchasing properties, Pavement Reef entered into several facility agreements with the bank totaling $18.89m. Rice, primarily dealing with the bank’s manager John D’Angelo (D’Angelo) on behalf of himself and Rose, arranged for them both to execute guarantees in respect of the facilities for which each was jointly and severally liable. A $400,000 term deposit with the bank was also available to be drawn down if Pavement Reef fell behind on repayments. The bank issued proceedings to enforce five guarantees (Guarantees) against Rose claiming approximately $6.18m.¹ Rose claimed the Guarantees could not be enforced because the bank had breached the Code when they were executed.²

It was established at trial that Rose signed the Guarantees as follows:

• D’Angelo attended Rose’s home with the Guarantees (which Rose had not previously seen) and met with him for 15 to 30 minutes.
• Although he could not specifically recall his advice to Rose, D’Angelo’s standard practice when taking guarantees was to look at and summarise the front page³ containing a boxed warning (Warning) addressing the matters in clause 28.4 by stating the guarantor would become liable for the debt if the customer defaulted. He would then ask whether the prospective guarantor was ‘happy to sign’ the guarantee or whether they ‘would like’ to seek legal advice.
• Rose signed the documents without waiting a day to consider the information received. D’Angelo knew that Rose had not read the Guarantees (including the Warning), received legal advice or taken a day to consider the information provided.

Rose submitted that the bank had breached the Code because:

• The bank did not provide prominent notice of the matters listed in clause 28.4. In contrast, Rose’s understanding of the Guarantees was based on incorrect assurances from Rice that each of them was only liable for their own share of the joint venture.
• The bank did not allow Rose until the next day to consider the information received.

Trial decision

The trial judge ruled in Rose’s favour, finding that:

• Rose would not have executed the Guarantees had he been told that he should seek independent legal advice (as opposed to whether he would like to). Such notice would have rung alarm bells, likely resulting in Rose seeking advice, realising the true extent of his liability, and not executing the Guarantees.
• In contrast, the failure to allow a day for Rose to consider the Guarantees did not in itself cause any loss, because it is unlikely that Rose would have read them absent the warning to seek independent legal advice.

Since the Guarantees incorporated the Code’s provisions and also contained terms effectively waiving any rights Rose had to reduce his own liability or to restrict the bank’s rights or remedies, the Court ruled that the Code’s provisions were to be construed as warranties. This allowed Rose to set off any amount owing to the bank against his loss for the breach of warranty. This aspect of the judgment was not appealed.

The bank appealed on the basis that:

• It had provided Rose ‘prominent notice’ of the matters in clause 28.4(a).
• Any breaches of the Code had not caused Rose to enter into the Guarantees, and accordingly had not caused him any loss.

Court of Appeal

The Court of Appeal (2-1) ruled in Rose’s favour. Chief Justice Warren  and Justice McLeish  gave a joint majority opinion, with Justice Ferguson  dissenting.

‘Prominent’ notice

The Court considered the word ‘prominent’ under the Code bore its ordinary meaning, requiring an assessment regarding whether notice of the matters in clause 28.4 stood out in such a way that was conspicuous or likely to be noticed. Although prominence must be assessed objectively, it is inherently a question of degree and largely dependent on context. For example, it did not necessarily require notice to be in written form, verbal form, or both.

In this case, ‘prominence’ had to be assessed in the context of the substantially curtailed time that Rose spent with the Guarantees. For example, the Warning occupied a prominent position on each Guarantee’s front page, but that did not mean it was prominent in the context it was presented to Rose (presuming D’Angelo had followed his standard practice). The short length of the meeting and the large volume of documentation indicated that the Warning (as well as the signature page referring to it)⁴ was in front of Rose for a very limited time. Further, because D’Angelo had delivered a verbal summary during the time the Warning was visible, there was a risk that Rose thought that summary was a sufficient substitute to reading the Warning.

The majority noted that the outcome would be very different if the bank had separately provided notice of the matters in clause 28.4, or had delivered the information to Rose the day before signing in accordance with clause 28.5. Either of these steps would have likely provided Rose a minimum threshold opportunity to gain an understanding about the risks involved in signing a guarantee. In the majority’s opinion, such steps were not ‘overly burdensome in the ordinary course of commerce.’

In dissent, while Justice Ferguson  agreed that that ‘prominence’ was a question of degree and context, she ruled in the bank’s favour by placing greater weight on the following factors:

• Rose was an experienced businessman who knew he was signing guarantees to finance an investment property joint venture. It was expected that he would be familiar with long and complex documentation containing warnings, and would be more likely to notice the Warning and read it.
• The Warning was presented in a visually prominent way (using bold font and a box) and separately addressed each matter in clause 28.4 in an easily readable format.
• The additional information on the signature page directed Rose to read the Warning.

Causation

The majority noted that causation did not need to be individually assessed for each sub-clause in clause 28.4, because the bank’s obligation was to provide prominent notice for all of them. If it had done so, it would have given Rose prominent notice to seek legal advice. While it could not be assumed that prominent notice would (as a matter of course) have brought the matters to Rose’s attention, the likelihood would be higher than otherwise. The bank did not dispute the trial judge’s finding in this respect, and accordingly, the failure to provide prominent notice caused Rose loss in the circumstances.

Having decided that the bank provided prominent notice, Justice Ferguson did not provide reasons regarding causation.

¹Default judgment was entered against Rice and he did not appear as a witness.
²A superseded version of the Code applied in this matter, however the relevant provisions are set out at clause 31 of the current Code and are unchanged.
³An extract of the front page is provided below.
⁴An extract of the signature page is provided below.