In the case of guarantees, a guarantor who has discharged the liability of a principal debtor to a creditor may be subrogated to the creditor's rights and remedies under the creditor's security for the debt.
In Bowesco Pty Ltd v Westpoint Management Ltd  WASCA 184 the Court of Appeal of Western Australia considered the application of the doctrine of subrogation in connection with a payment by a guarantor but in a factual context different from the established categories of case.
Bowesco Pty Ltd (Bowesco) claimed entitlement to $550,000 and interest from the proceeds of sale of assets of Lanepoint Enterprises Pty Ltd (Lanepoint) received by Westpoint under its second ranking security over Lanepoint's assets.
Suncorp-Metway Ltd (Suncorp) was the first ranking secured party. Bowesco claimed it was entitled to be subrogated to Suncorp's rights under its first ranking security.
Suncorp had loaned Lanepoint money to purchase and develop land. The loan was secured by a mortgage over the land, a fixed and floating charge over Lanepoint's assets and a guarantee from Bowesco.
Wespoint also financed the development and was given a second ranking charge by Lanepoint.
As a consequence of an interim stop order under section 1020E of the Corporations Act 2001 (Cth), Westpoint was unable to make further advances to Lanepoint.
Bowesco relied upon a letter from it to Lanepoint and Westpoint recording an agreement whereby Boweco, as guarantor, would fund the completion of the development to reduce the monies required from Suncorp. In accordance with the letter, Bowesco paid $550,000 to Lanepoint.
Subsequently Suncorp appointed Receivers and Managers to Lanepoint who collected assets in excess of the amount required to repay Suncorp. Bowesco claimed Suncorp held the surplus with a fiduciary obligation to account to Bowesco and that in breach of that duty paid the surplus to Westpoint. Bowesco also alleged that Westpoint received the surplus with knowledge of Bowesco's entitlement and therefore held the surplus on constructive trust for Bowesco.
The trial judge dismissed Bowesco's claim.
On appeal Bowesco submitted the trial judge erred in finding that:
- Lanepoint did not covenant with Suncorp to complete the development (Grounds 1 and 2);
- Suncorp had no right under its securities to complete the development itself (Ground 3);
- Suncorp could not have completed the development itself (Ground 4);
- Bowesco had not guaranteed the completion of the development (Ground 5); and
- There was no basis upon which Bowesco could be subrogated to the rights and remedies of Suncorp because the funds advanced by Bowesco to Lanepoint did not reduce Lanepoint's indebtedness to Suncorp (Ground 6).
The trial judge's finding that the funds advanced by Bowesco to Lanepoint did not reduce Lanepoint's indebtedness to Suncorp was unchallenged.
The Court of Appeal upheld grounds 1 and 2. The objective intention of the parties was that Lanepoint was obliged to complete the development.
Wespoint conceded grounds 3 and 4.
Ground 5 was dismissed on the basis that the guarantee guaranteed performance of Lanepoint's obligations but was not a promise that Bowesco would itself perform Lanepoint's obligations. Bowesco's obligation under the guarantee was to pay any damages arising from Lanepoint's default.
Subrogation (Ground 6)
Ground 6 was dismissed.
The Court said: "Subrogation is an equitable doctrine…The equity arises from the conduct of the parties on well-settled principles and in defined circumstances which make it unconscionable for the defendant to deny the plaintiff's right: Re Delma No 1 Pty Ltd (in liq) (2013) 279 FLR 80 (24)" (at 74).
Bowesco's claim was based on Bofinger v Kingsway Group Ltd (2009) 239 CLR 269. In Bofinger a company borrowed money from three lenders on the security of mortgages over the same land. Guarantees were given to each of the mortgagees supported by mortgages over land belonging to the guarantors. The guarantors sold their properties and applied the proceeds to reduce the company's indebtedness to the first mortgagee. The first mortgagee exercised its power of sale and paid the second mortgagee the surplus sale proceeds without accounting to the guarantors. Gummow, Hayne, Heydon, Kiefel & Bell JJ quoted the following description of the right of subrogation with approval: "The right operates to confer on the surety who has paid the debt in full the rights against the debtor formerly enjoyed by the creditor or by imposing on the creditor the obligation to account to the surety for any recovery in excess of the full amount of his debt."
In this case Bowesco's advance was used to directly fund the costs of completing the development and was considered by the Court of Appeal clearly distinguishable form Bofinger and the guarantee category of subrogation generally.
Crucially, the payments by Bowesco did not reduce Lanepoint's actual indebtedness to Suncorp in substance or effect at any time.
There was no finding that, but for Bowesco's payments, Suncorp may have funded Lanepoint to that extent. It was therefore unnecessary to determine whether subrogation applied by analogy if the payment by the guarantor avoided a payment which the creditor was otherwise contractually obliged to make.
In finding that subrogation was not available the Court of Appeal highlighted some key principles of subrogation to keep in mind:
- There is no all embracing statement of when subrogation is permitted;
- Where a guarantor discharges the liability of a principal debtor to a creditor, the principal debtor is obliged to indemnify the guarantor. This liability founds the application of subrogation which entitles the guarantor to the benefit of any securities held by the creditor;
- It is crucial that the guarantor's payment reduces the indebtedness of the principal debtor to the creditor. It is possible, although not certain, that subrogation applies where the guarantor's payment avoids the need for payments which the creditor would otherwise have had to make;
- The breach by a creditor of its fiduciary obligation to a guarantor to account engages the principles associated with the second limb of Barnes v Addy (1874) LR 9 Ch App 244;
- Subrogation will be permitted outside established categories only when necessary to avoid unconscionable double recovery by a creditor or the inequitable discharge of liability of a debtor; and
- It is unclear whether subrogation is only available when payment is made by the guarantor after its liability under the guarantee is triggered by a default of the principal debtor. However, the obiter in Bofinger and Bowesco suggest subrogation is not so confined.
This article was written by Simon Crawford, Partner and Jessica Cullin, Associate.
Disclaimer: This article is not intended to be a substitute for obtaining legal or other expert advice and no responsibility is accepted for any action taken as a result of any material in this article. Information and advice relating to your specific commercial dealings can be obtained by contacting HWL Ebsworth Lawyers.