The equitable doctrine of undue influence is there to prevent one person from taking advantage of their position of power and authority over another person. This inequity in power between parties can vitiate the weaker party’s consent to an agreement, as they were unable to freely exercise their independent will. In other words, they would not have done what they did had they not been under that “undue influence”. 

There normally needs to be a factual matrix supporting such a conclusion. However, in certain circumstances, the law will make a presumption of undue influence. It is a rebuttable presumption, meaning the defendant has to lead evidence to rebut the allegation. The presumption arises where the nature of the relationship, when coupled with the transaction in question, justifies an inference that the deal was entered into only through undue influence.

Effect of the Presumption on Loan Guarantees

The presumption, first of all, gives notice to any lender to ensure that any guarantee they obtain was not received because of any undue influence. Therefore, the lender must take active steps to obtain that assurance through encouraging the party to seek independent advice and otherwise do all it can to ensure the weaker party understands what they are doing and that they are doing so voluntarily.

If the lender has not taken these steps prior to the transaction, and the guarantor now seeks to avoid the surety, then the evidentiary burden will first be on the lender to rebut the presumption.

At that point the judge must decide if they feel the evidence, in its entirety, has or has not proven undue influence. That is done by first determining if the presumption arises. If it does, has the defendant been successful in rebutting it? If it does not, then the burden remains with the plaintiff.

The Doctrine is Tested by the Court of Appeal

The doctrine was recently tested by a case before the Ontario Court of Appeal, in which a woman and her husband each provided guarantees for the indebtedness of a company to a lender in the U.S. To secure her guarantee, the wife granted the lender a mortgage over a property she owned in Ontario. The property was a farm that had been in her family for generations. When the business defaulted, the lender sought to enforce the mortgage over the farm before an Ontario court.

The wife claimed she had issued the guarantee due to the undue influence of her husband. She claimed she unquestionably signed documents he asked her to sign. The lower court found this to be true and subsequently concluded that the lender had constructive notice of this fact. As a result, it denied the lender’s request to enforce the mortgage. The lender appealed.

On appeal, the ONCA found that the facts demonstrated the woman stood to benefit personally from the guarantee. She herself was a part-owner of the company for which she provided the guarantee. Further, the property used to secure her guarantee, while it had been in her family for hundreds of years, had been purchased by her husband and gifted to her. Therefore, the ownership of the property was made possible by the fruits of her husband’s labour. Overall, the nature of the loan transaction did not justify a finding of undue influence.

Given the existence of this defence, it is likely to be the route of choice for most reluctant guarantors. Lenders had best be prepared. It is much like the analysis in medical negligence cases involving the causation aspect of informed consent. Would the party have signed if they had not been under the undue influence of another? The best way to avoid this in future litigation would be to ensure all parties obtain a certificate of independent legal advice prior to signing a guarantee. However, even without it, lenders can survive such withdrawals of commitment by preserving the record of how that understanding and voluntariness was created.

Factors that Help to Rebut the Presumption

1. The nature of the relationship is only one component of the analysis leading to the presumption. The deal or transaction entered into must also be examined;
2. Where the weaker party has an interest in the loan being secured and the business behind it this helps to rebut the presumption;
3. Where there are relatives or friends of the weaker party employed by the business this helps to rebut the presumption;
4. Where the assets behind the guarantee were gifts from the business or stronger party this helps to rebut the presumption;
5. It is not necessary to have a Certificate of Independent Legal advice but it by itself would likely rebut the presumption

If you are involved in commercial litigation relating to debt enforcement, the exceptionally skilled corporate litigation lawyers at Milosevic & Associates in Toronto can help. Over the years, our team of lawyers has successfully fought for our clients’ rights and our impressive track record speaks for itself. Please contact us by calling 416-916-1387 or connect online for a consultation.