Personal Guarantees (Part 2) – When can they be set aside?

Part 2 – Common Law – Misrepresentation and Unconscionable Conduct and Undue Influence:

At common law, there are a number of different defences that can be raised when a lender tries to enforce a guarantee that the guarantor considers unjust. While there is some degree of overlap between them, each of these has different technical criteria that govern when they can be used and what remedies are available (for example, setting aside the contract or limiting the amount owed). These categories include unconscionability (or unconscionable conduct), mistake, misrepresentation, undue influence and duress.

Unconscionable Conduct:

Courts have traditionally set aside, in whole or in part, contracts held to be unconscionable. Unconscionable conduct applies in situations where the guarantor is under a special disadvantage or disability in relation to the other parties to the transaction so that there is “an absence of any reasonable degree of equality between them”. Certain relationships are considered more likely to give rise to unconscientious dealing. One of the classic statements is that of Justice Fullagar of the High Court:

The circumstances adversely affecting a party … are of great variety and can hardly be satisfactorily classified. Among them are poverty or need of any kind, sickness, age, sex, infirmity of body or mind, drunkenness, illiteracy or lack of education, lack of assistance or explanation where assistance or explanation is necessary. The common characteristic seems to be that they have the effect of placing one party at a serious disadvantage vis-à-vis the other.[1]

However, personal characteristics are not the only indicators of special disadvantage. Other factors relating to the contract and its formation may be relevant. These include:

• • the form and content of the contract;
  • the characteristics and relative positions of all parties to the transaction; and
  • the circumstances surrounding the formation of and entry into the contract.

The disability must be evident to the other party and must be taken advantage of in circumstances where it is prima facie unfair to do so. This usually requires proof that the lender knew of the disability or could infer it from the facts available.

Despite the existence of a disability that might indicate unconscionability, a contract can be saved if the party seeking to enforce the guarantee shows that the contract was in fact “fair, just and reasonable.” For a contract to be set aside, some detriment to the guarantor, or an absence of benefit, must usually be shown.

Misrepresentation:

Where a contract has been entered into on the basis of a false understanding because of a misrepresentation of a material fact, the person misled can choose to avoid the contract. This is the case with innocent, fraudulent or negligent misstatements. However, an innocent misrepresentation, that is, where the person making the representation believed the statement was accurate, usually allows for rescission only where the contract has not already been carried out. It also allows for a defence to a claim for damages or specific performance of the contract. By contrast, fraudulent and negligent misrepresentations allow the aggrieved person to seek to rescind the contract and to recover damages that have arisen as a result of the misrepresentation.

A misrepresentation at the pre-contractual stage may also amount to the formation of a contract of guarantee that is “unjust in the circumstances” under the Contracts Review Act 1980 (NSW).

Undue Influence:

The equitable doctrine of undue influence is mainly concerned with the quality of the consent of a guarantor who enters a contract of guarantee. Relief is available where the guarantor, because of actual influence on his or her mind, does not bring an independent or voluntary will to the decision to enter the contract of guarantee. Normally there is a pre-existing relationship between the borrower and guarantor involving trust, confidence or some form of power imbalance. In these circumstances the guarantor’s will is treated as not being voluntary because it has been overborne.

For relief to be granted it must be shown that the borrower or lender exploited the guarantor’s disadvantage. It is this unconscientious behaviour that equity protects against.

Establishing undue influence:

The courts establish undue influence in two ways, by:

1.  finding actual undue influence; or
2. finding presumed undue influence:

With actual undue influence, the nature and extent of the undue influence must be proved by evidence.

With presumed undue influence, a presumption of undue influence, rebuttable by evidence, arises from a particular relationship between the parties.

The class of presumed undue influence is divided into two further categories:

• 1. Where the pre-existing relationship is one of a class traditionally held to give rise to a presumption of undue influence, for example, where the parties are: parent and child, guardian and ward, trustee and beneficiary, solicitor and client, physician and patient, and in a relationship of religious influence.  All of these may be, and often are, rebutted by evidence.
  2. Where the facts of the relationship, even if not within one of the traditional categories, give rise to a relationship susceptible to undue influence.There is a fine line between this category and the class of actual undue influence.

Remedies:

The result of a successful plea of undue influence is that the contract of guarantee may be set aside in equity. The principal remedy granted by the court is rescission of the contract with consequential orders aimed at restitution in favour of all parties.

If you have been asked to sign a guarantee for someone, we strongly recommend you contact us to seek independent legal advice so you are fully appraised of the consequences prior to signing.

For further information, please contact us on 1800 621 071 or email info@attwoodmarshall.com.au or complete an online enquiry form.