LAWYERS TO THE FINANCE
INDUSTRY
www.klng.com
Winter 2005/06
Banknotes
Variations to credit facilities and
guarantor liability
The recently decided case of Triodos
Bank N.V. v Dobbs [2005] EWCA Civ
630 provides a warning to lenders to
look carefully at the obligations of
guarantors of existing facilities when
varying or extending those facilities. An
existing guarantee may be discharged
by variations to a facility agreement
unless the particular variations are
clearly provided for by the guarantee,
or express consent to the variations is
obtained from the guarantor.
Background
The case involved a limited guarantee
given by Mr Dobbs ("D") to secure the
obligations of a company under two
loan agreements made in 1996. The
guarantee contained provisions
permitting the Bank to agree to
amendments and variations of
obligations of the company without
reference to D. In 1998 and 1999,
further loan agreements were entered
into by the company with the Bank.
Each further agreement stated that it
replaced the prior agreements and
listed D's guarantee as security. The
sums borrowed increased from
£900,000 in 1996 to £1.9m in 1998 and
£2.6m in 1999. The company defaulted
under the 1999 agreement and the
Bank sought to enforce the terms of D's
guarantee.
Judgment
The Court of Appeal held that D's
guarantee was unenforceable. The
'replacement' loan agreements differed
substantially in their terms from the
1996 agreements, not least in the
amounts of the facilities granted to the
company. The differences were
variations that went beyond the scope
provided for by the guarantee as they
placed D under much more onerous
obligations. Although D's liability
under the guarantee was limited to
£50,000, there was a substantial
difference in the risk associated with
guaranteeing a facility of £900,000
compared to a facility of £2.6m.
Comment
It is important to preserve guarantor’s
liability when varying or extending
your loan facilities. It’s best practice to
obtain the express consent of a
guarantor to consent to changes in the
underlying facility particularly where
the changes are substantial.
Welcome to the Winter Edition.
The past six months have seen
developments in the law affecting
secured lenders and developments in
the banking group at K&LNG.
This edition reviews changes to the
law relating to guarantees, freezing
orders, exclusive jurisdiction clauses
and sales at an undervalue.
We have also welcomed three new
members to the team.
Contents
Variations to credit facilities and
guarantor liability
1
Freezing orders
2
UCP 500 update
2
New arrivals
2
Guarantees: A primary or
secondary obligation?
3
Sales at an undervalue
3
Exclusive jurisdiction clauses
4
Who to contact
4
Banknotes
Freezing orders
Receiving and dealing with freezing
orders is an inconvenient fact of life for
most banks. Following the Court of
Appeal's decision in Customs & Excise
Commissioners v Barclays Bank PLC
[2004] EWCA Civ 1555 a duty will be
imposed upon a bank, which has
received notice of a freezing order, to
take care that funds in a frozen account
are not dissipated in breach of the order.
The Commissioners obtained freezing
orders against two companies with
accounts at the Bank. The Bank sent
standard letters to the Commissioners
confirming that it would comply with
the terms of the order. It subsequently
informed the Commissioners that
transfers had been made from the
accounts after receipt of the freezing
order due to “operator error” and due to
use of its “Faxpay” system. Faxpay
enabled customers to send instructions
direct to the Bank’s payment centre,
New arrivals
Jonathan Lawrence
John Archer
Gareth Lawson
2
WINTER 2005/06
bypassing the customer’s branch. The
Commissioners commenced
proceedings against the Bank for
negligence. The Bank denied that it
owed a duty of care.
The court revisited the threefold test
for the existence of a duty of care:
Was the damage foreseeable?
The Bank accepted that the
foreseeability element existed.
Was the relationship between the
parties sufficiently proximate?
The court found that once the Bank
was on notice of the freezing order,
the relationship between the
Commissioners and the Bank was
sufficiently proximate.
Was it was fair, just and reasonable
to impose a duty?
This aspect caused the court more
The banking group has recently
welcomed the arrivals of Jonathan
Lawrence as a partner, John Archer as an
associate and Gareth Lawson as an
assistant. Jonathan joins us from Allen
& Overy and in addition to his broader
banking practice, he has particular
experience in complex real estate
finance transactions involving UK and
international clients and properties.
John joins us from Taylor Wessing and
will also be focussing on real estate
finance as well as working on a broad
range of corporate finance transactions.
Gareth joined the group on qualification
September 2005. During his two years’
training, he has concentrated on
commercial banking, banking litigation,
property finance and insolvency.
concern. It acknowledged that
freezing orders do create burdens
and problems for banks but found
that this is why banks are allowed to
charge a reasonable sum for their cooperation. The charge was, in part,
a recognition that the Bank should
take care not to dissipate assets
frozen by the court's order.
Having applied the threefold test, the
court found that a duty ought to be
imposed on the Bank and that an
express or deliberate assumption of
responsibility by the Bank was not
necessary. Lord Justice Peter Gibson
commented that a bank ought to limit
its exposure by taking proper steps to
ensure compliance with court orders
notified to it. This gives an indication
of the approach that the courts are
likely to take to a defaulting bank.
UCP 500 update
At the ICC Banking Commission
meeting in Dublin in June, a
considerable amount of progress was
made in relation to the redraft of UCP
500 and consensus was achieved in a
number of areas. The transport
articles require a considerable amount
of work. The timing of UCP 600 is
still uncertain, though it is likely to be
some time in 2007 before it replaces
UCP 500.
www.klng.com
Guarantees: A primary or secondary obligation?
The decision in Marubeni Hong Kong
& South China Ltd v The Mongolian
Government [2005] EWCA Civ 395
(CA) serves as guidance as to whether a
guarantee, expressed to be "on demand",
creates a demand bond (i.e. a primary
obligation to pay on demand) or a
performance guarantee (i.e. an
obligation to pay on the default of a
performance obligation).
The Mongolian government had
entered into a contract with a subsidiary
of Marubeni Hong Kong & South China
Ltd to purchase machinery for a
cashmere processing plant. As part of
this agreement, the Mongolian Central
Bank provided a letter (the "MCB
Letter") guaranteeing the obligations of
the Mongolian Government under the
contract. On the same date, a legal
opinion confirmed that the Mongolian
Central Bank (described in the
document as the "Guarantor") had full
power and authority to enter into the
MCB Letter.
The issue before the court was whether
the MCB Letter was an unconditional
promise by the Mongolian Central Bank
to pay on demand all amounts payable
under the sales contract (that being a
demand bond) or if it was a secondary or
conditional promise to act as a surety on
default by Marubeni.
The court held that the MCB Letter
created a guarantee and not a demand
bond and as such was a secondary
obligation. The reasons the court gave
for this were:
on demand bonds are specific
banking instruments and the MCB
Letter was not described as such;
the MCB Letter was described as a
guarantee on the face of it and by
the supporting legal opinion; and
the language used in the MCB
Letter was that of a secondary
obligation.
Despite including the words
"unconditionally pledges" and "simple
demand", it also included an obligation
for sums to be paid only when the
Mongolian Government failed to pay
sums due under the contract.
Comment
To create a primary obligation rather
than a secondary one, it must be
absolutely clear in the documentation
that a primary obligation is to be given.
This is especially important when
documents described as guarantees are
replaced by instruments that create
primary obligations. Unless evidence to
the contrary is provided, the court will
be likely to presume that a secondary
obligation has been created.
Sales at an undervalue
In Bradford & Bingley Plc v Ross
[2005] All ER (D) 210 (MAR), the
Bank issued proceedings against one
of its borrowers (“R”) seeking to
recover the shortfall following the sale
of a mortgaged property. R
contended that the Bank had sold the
property at an undervalue. The judge
however found that R had been
unable to discharge the burden of
proof to show that the Bank was at
fault and accordingly gave judgment
for the Bank.
R appealed arguing that evidence had
come to light which suggested that
the Bank had sold the property to a
connected company and had failed to
disclose that information to the judge
at trial. R also submitted that the
judge had approached the issue of the
burden of proof on the wrong basis
and R’s appeal was allowed for the
following reasons:
There was no hard and fast rule
that a mortgagee might not sell a
property to a company in which it
had an interest. However, the
mortgagee had to show that the
transaction was in good faith and
that reasonable precautions had
been taken to show that it had
obtained the best price reasonably
obtainable at the time.
As a result of the non-disclosure of
relevant material to the judge, the
matter had been approached on a
false basis and the decision could
not stand. The decision was set
aside and the matter was remitted
for re-trial.
WINTER 2005/06
3
Banknotes
Exclusive jurisdiction clauses
It is important to establish which courts
are to have jurisdiction in the event of
dispute on loan documents involving
international parties. Parties will often
agree to submit to the exclusive
jurisdiction of the courts of the bank or,
if different, that of the document's
governing law. An exclusive
jurisdiction clause may not however be
effective where the borrower or
guarantor is resident in another EC
country. As a result of Article 27 of EC
Regulation (No. 441/2001) (the
"Regulation"), where court proceedings
involving the same cause of action are
brought in the courts of different
Member States, it is the courts of the
country in which the proceedings are
first brought which must decide
whether they have jurisdiction.
Article 27 can therefore frustrate the
intention of a contractual bargain as to
jurisdiction. Banks lending on a crossborder basis should be entitled to be
certain where loan agreement disputes
will be resolved. If this loophole
becomes widely exploited by
borrowers, there must be strong
arguments for changing the law.
In Erich Gasser GmbH -v- MISAT Srl
[2005] 1QB 1, it was held that Article
27 could not be overridden by an
exclusive jurisdiction clause in a facility
agreement. The Borrower issued
proceedings in its home jurisdiction of
Germany (challenging the Bank's rights
to claim interest in this case) which,
even though in breach of an exclusive
jurisdiction clause, meant that the
Bank's proceedings in England were
stayed.
What can a bank which finds itself in
this situation do? In challenging the
borrower’s decision to proceed in
another jurisdiction it may incur
considerable costs. Even if successful,
the borrower may have no, or a limited,
liability to pay those costs, although
these costs should be covered by a
costs indemnity provision in the loan
agreement.
There is also the possibility that a court
will decline to give effect to an
exclusive jurisdiction clause but this
should be remote as Article 23 of the
Regulation states that where parties
have agreed that the courts of a
particular Member State shall have
jurisdiction, then those courts shall
have jurisdiction. It is not possible to
draft an exclusive jurisdiction clause in
a way that avoids the effect of Article
27. The only real solution is to take
quick action if the borrower defaults in
issuing proceedings before the
borrower has time to issue proceedings
in its home country. In reality, the
parties will usually prefer to resolve
disputes without issuing proceedings.
Alternatively, the bank can either fight
the jurisdiction issue (and accept the
corresponding delay) or it can resign
itself to losing the benefit of the
exclusive jurisdiction clause and pursue
the proceedings in the courts of the
borrower’s home jurisdiction.
Who to Contact
Kirkpatrick & Lockhart
For further information contact
Nicholson Graham LLP
Richard Hardwick
110 Cannon Street
email: rhardwick@klng.com
London EC4N 6AR
tel: +44 (0)20 7360 8125
www.klng.com
tel: +44 (0)20 7648 9000
fax: +44 (0)20 7648 9001
Kirkpatrick & Lockhart Nicholson Graham (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market
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WINTER 2005/06
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