A guarantee is often an essential part of debt financing. However, the personal liability of the person making the guarantee, or “guarantor,” may be called into question when the risk assumed by the guarantor changes because of circumstances surrounding the guarantee or transaction.
The starting point for considering this aspect of the law is considering the legal nature of a guarantee. A guarantee has been defined as “a contractual obligation undertaken by a person known as a surety or guarantor in which that person promises that a second person, known as the principal, will perform a contract or fulfil some other obligation and, if the principal fails to do so, the surety will do so for the principal” (see the decision of the Ontario Court of Justice (General Division) in Toronto Dominion Bank v. Poli Holdings Ltd., citing the Nova Scotia Court of Appeal).
As noted above, a guarantee is a contract entered into between a creditor and a guarantor or surety. As such, the enforcement by a creditor of the guarantee is subject to the kind of defences ordinarily available to a party to a contract. Such defences include:
Similarly, where a creditor breaches a term of the guarantee and that term is classified as a “condition” of the contract, the guarantor may be discharged from their obligations under the guarantee. Again, this analysis entails considerations similar to those for breaches of other types of contracts.
There are also defences available to a guarantor that are unique to situations involving guarantees, as discussed below.
It is not uncommon for creditors and principals to consider changes to a principal contract after it is executed. Caution is warranted when doing so, however. Where the contract between the creditor and the principal is materially altered without the consent of the guarantor, the guarantor will be fully discharged from their obligations under the guarantee unless “it is self-evident that the change is unsubstantial or not harmful” to the guarantor (see Doe et al. v. Canadian Surety Co.).
There are good reasons for this. It has been held that a guarantee is an obligation assumed by a guarantor “on the basis of the risk inherent in the contract which is being guaranteed” (see Pax Management Ltd. v. Canadian Imperial Bank of Commerce). Since the guarantor cannot “protect against variation of the principal contract by the parties to that contract,” equity will intervene (see Pax Management). Ultimately, a discharge is generally seen by courts as appropriate where the variation is “of a type that would prejudice the interests of the surety” or guarantor (see Bank of Montreal v. Javed).
It has also been held that an agreement by a creditor to grant a principal a binding extension of time in relation to the principal contract may fully discharge a guarantor. This may be the case if the extension of time does not reserve the rights of the guarantor (see Oxier v. Bank of Montreal).
Just as a material variation in the principal contract can release the guarantor from their obligations under the guarantee, a release by the creditor of the principal under the principal contract can fully discharge the guarantor (see, for example, Levy Bros. Co. Ltd. v. Sole et al.). Thus, if the principal contract is rescinded or otherwise set aside, the guarantor will generally also be released from their obligations.
The leading case on the discharge of a guarantor caused by a creditor’s breach of the principal contract is Pax Management, a decision of the Supreme Court of Canada. As with the topic of material variations, the crux of the matter here is the risk inherent in the principal contract. In other words, the question to be asked is whether the breach in question “materially changed the risk assumed by the guarantor, to the guarantor’s detriment” (see Pax Management).
Where the breach in question results in a guarantor undertaking a risk materially different from that which they agreed to take when they executed the guarantee, it will generally result in a full discharge of the guarantor from their obligations. However, where the creditor’s breach “does not prejudice the guarantor,” no such discharge will be permitted. In that situation – one in which “the surety’s risk of being called upon remains the same, but the amount for which he or she will be liable is increased by an act of the creditor,” a discharge will only be permitted “to the extent of that increase” (see Pax Management).
Case law has also held that a guarantor generally will only be partially discharged from their obligations under a guarantee where the creditor “impairs the value” of security taken by that creditor. Specifically, a “wrongful dealing” with such security will only relieve the guarantor of the value of the security lost to him (see Rose v. Aftenberger). This assumes that the taking and keeping of the security by the creditor did not violate “a condition of the giving of the guarantee” (per Rose).
Lastly, it is worth noting the comments of the Supreme Court of Canada in Pax Management that a guarantor should not be discharged from their obligations under a guarantee simply because of “objectionable or wrongful conduct” by the creditor towards the guarantor where that conduct has not had an impact on the “magnitude or likelihood of the materialization” of the risk assumed by the guarantor when they executed the guarantee. This is because other causes of action are available to address such conduct.
In short, creditors should be wary of taking action that is inconsistent with the terms of an applicable principal contract or guarantee, especially if that action is likely to alter the nature of the risk posed to the guarantor.
If you are a creditor seeking to enforce a guarantee or a guarantor questioning whether creditor conduct has discharged your obligations, early legal advice is critical. The enforceability of a guarantee can turn on subtle issues such as material variations to the principal contract, extensions of time, impairment of security, or the release of the principal debtor.
The skilled commercial litigation team at Milosevic & Associates advises lenders, businesses, and individual guarantors on guarantee enforcement, surety defences, and complex debt recovery disputes. We provide strategic, evidence-based guidance to protect your rights and minimize financial exposure. To book a confidential consultation, please contact us online or call (416) 916-1387.
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