Pending Appeal : New South Wales District Court CITATION: Morgan v Rankin [2008] NSWDC 166 HEARING DATE(S): 11-12 August 2008 JUDGMENT DATE: 14 August 2008 JURISDICTION: Civil JUDGMENT OF: Sidis DCJ 1. Verdict and judgment for the plaintiffs in the sum of $289,890.41. DECISION: 2. The defendants are to pay the plaintiffs' costs of the proceedings. This order is suspended until 22 August 2008 to allow either party to list the proceedings for further argument on the issue of costs. 3. The exhibits are returned. CATCHWORDS: GUARANTEE - whether enforceable against directors of principal debtor in the light of subsequent transactions CASES CITED: Ankar Pty Ltd v National Westminster Finance (Australia) Ltd (1987) 162 CLR 549 Hancock v Williams (1942) 42 SR (NSW) 252 TEXTS CITED: O'Donovan, The Modern Contract of Guarantee, 3rd ed Scott Anthony Morgan (First Plaintiff) Annette Frances Morgan (Second plaintiff) PARTIES: Phillip Norman Rankin (First defendant) Gregg Morgan (Second defendant) David Warne (Third defendant) Darren Van Aardt (Fourth Defendant) FILE NUMBER(S): Newcastle 438/07 COUNSEL: M R Lawson (Plaintiffs) M J Dawson (First and third Defendants) SOLICITORS: Thomas Mitchell (Plaintiffs) NOT Lawyers (First and Third Defendants) JUDGMENT 1 Scott and Annette Morgan claimed to recover $200,000 and interest from the defendants Phillip Norman Rankin and David Warne. The parties named as second and fourth defendants are bankrupt and took no part in the proceedings. 2 The plaintiffs' claim was made on the basis of personal guarantees given by the defendants of repayment of the loan made by the plaintiffs to Morgan Building and Property Maintenance Pty Ltd in December 2004. The defendants were former directors of Morgan Building. The terms of the guarantee were set out in a document signed by the parties and dated 20 December 2004. 3 The defendants did not challenge the terms of the document containing the guarantee or its legal affect in binding them as guarantors. They denied liability to the plaintiffs under the guarantee on the following bases: 1 The plaintiffs and Morgan Building varied the terms of the loan in December 2005 to their disadvantage and without their consent so that they were discharged from the guarantees. 2 Morgan Building was discharged from its liability under the 2004 loan agreement by either: (a) loan agreements entered into in December 2005 between the plaintiffs and Morgan Building; or (b) loan agreements entered into in 2006 between the plaintiffs and Lammington Drive Pty Ltd. 4 Some factual background is necessary before turning to the legal principles and their application in this case. 5 It was not disputed that the plaintiffs and Morgan Building entered into a loan agreement dated 20 December 2004, guaranteed by the defendants, pursuant to which they lent Morgan Building $200,000 for a term of one year with interest at 17% payable quarterly in arrears. The principal sum was paid to Morgan Building on 21 December 2004. Interest was paid in accordance with the terms of the agreement. 6 Towards the end of 2005 conversations took place between Mr Morgan one of the plaintiffs, and Mr Rankin one of the defendants, as a result of which the plaintiffs advanced a further sum of $100,000 to Morgan Building. 7 Two documents dated 20 December 2005 were signed by the four directors of Morgan Building. Those documents provided for: 1 A loan to Morgan Building from the plaintiffs of $200,000 for a term of 12 months with interest at 8% payable quarterly in arrears. 2 A loan to Morgan Building from the plaintiffs of $100,000 for a term of 12 months with interest at 8% payable quarterly in arrears. Neither document provided for the directors to guarantee the repayment of the loan personally. 8 The plaintiffs denied that they signed these documents and no such document signed by the plaintiffs was in evidence. 9 On 22 December 2005 the plaintiffs paid $100,000 to Morgan Building. 10 Morgan Building was placed under voluntary administration on 27 February 2006 and was subsequently wound up. The administrator's report indicated that Morgan Building was insolvent at the time of his appointment and that, in his opinion, Morgan Building traded while insolvent for at least six months prior to his appointment. 11 No part of the $200,000 or the $100,000 loan was repaid by Morgan Building. 12 At some time in March, April or May 2006 the plaintiffs entered into a transaction with Lammington Drive that was documented as follows: 1 Agreement for loan by the plaintiffs to Lammington Drive of $200,000 for a term of 12 months with interest at 8% payable quarterly in arrears. 2 Agreement for loan by the plaintiffs to Lammington Drive of $100,000 for a term of 12 months with interest at 8% payable quarterly in arrears. 3 Mortgages granted by Lammington Drive to the plaintiffs over property registered in its name at Mount Hutton. 13 Lammington Drive defaulted and the property was sold under the first mortgagee's power of sale. The proceeds of sale were insufficient to repay any moneys to the plaintiffs. 14 There was discussion in evidence concerning the purpose and intent of the transaction with Lammington Drive. 15 Mr Rankin said the initial loan was made to Morgan Building because Lammington Drive at that stage was not registered and contracts for the purchase of the property were not exchanged. This was incorrect because his affidavit stated that Lammington Drive was registered on 15 December 2004. 16 Mr Rankin said that $125,000 of the initial $200,000 loan was applied by Lammington Drive to pay the deposit on the Mount Hutton property and to meet development expenses. There was no evidence concerning the application of the balance of the initial loan. 17 According to Mr Rankin, it was proposed that the Mount Hutton property be developed by subdividing it into 18 lots. Lammington Drive was disappointed when its development ambitions were reduced to the point where the local Council, as consent authority for the development, permitted a subdivision of only 13 lots. 18 Mr Rankin said that in December 2005 the plaintiffs approached him and offered further investment of $100,000. At the same time they discussed an extension of the term of the initial loan. At that stage he offered them by way of security a mortgage and caveat on the Mount Hutton property. He did not explain why, if Lammington Drive was then registered and the title holder to the Mount Hutton property and it was proposed to transfer liability from Morgan Building to Lammington Drive, the loan agreements were prepared in the name of Morgan Building. 19 Mr Morgan said that Mr Rankin in December 2005 told him that Morgan Building could not repay the $200,000 loan but that, if the plaintiffs invested a further $100,000, the development at Mount Hutton could be completed, sold and the loans repaid. He said the plaintiffs received the two loan agreements in December 2005 but did not sign them because they provided no additional security for the repayment of the loans. He said Mr Rankin offered that Lammington Drive would secure the loans to Morgan Building by granting a mortgage over the Mount Hutton property. 20 Mr Rankin said that in documenting the loans in 2005 and 2006 it was not his intention that the personal guarantees of the directors of Morgan would continue. Mr Morgan said it was not the plaintiffs' intention that the personal guarantees of the directors of Morgan Building provided for in the 2004 loan documentation would be released. Issue 1 – the effect of the 2005 documents 21 The defendants relied upon the principles set out in O'Donovan, The Modern Contract of Guarantee, Law Book Co, 3rd Ed, at page 339 under the heading: Discharge by the Creditor Agreeing with the Principle to Vary the Principal Contract. The text states that the general rule is: … that the guarantor is responsible only for the obligations which are guaranteed. Thus, as Jordan CJ stated in Hancock v Williams, if the principal and creditor without the guarantor's consent, "agreed between themselves to alter the nature of the [principal] obligation the guarantor is discharged because the obligation in its altered form is not that which he guaranteed". (Hancock v Williams (1942) 42 SR (NSW) 252 at 255; reference to other authority omitted). 22 The defendants also relied on Ankar Pty Ltd v National Westminster Finance (Australia) Ltd (1987) 162 CLR 549 at 559 to the effect that: According to the English cases, the principle applies so as to discharge the surety when conduct on the part of the creditor has the effect of altering the surety's rights, unless the alteration is unsubstantial and not prejudicial to the surety. The rule does not permit the courts to enquire into the effect of the alteration. The consequence is that, to hold the surety to its bargain, the creditor must show that the nature of the alteration can be beneficial to the surety only or that by its nature it cannot in any circumstances increase the surety's risk. I was taken to a number of decided cases in which these principles were applied. 23 The position taken by the defendants was that the 2005 loan documents, signed by the directors of Morgan Building, altered the obligations of Morgan Building by extending the term of the loan by one year and by increasing the principal sum to $300,000. 24 There were problems with this argument: 1 The principle applies only where the guarantors do not consent to the alteration. In this case the documents relied upon by the defendants were signed by each of the guarantors so that, in my view, it could not be argued that the alteration was made without their knowledge or consent. 2 For reasons which will be explained later in this decision, I have determined that Morgan Building was not in a position to repay to the plaintiffs the $200,000 loan in December 2005. The extension of the loan for a further 12 month period therefore was not to the disadvantage of the guarantors. 3 There were two separate documents for two separate loans. The document relating to the $100,000 loan did not provide for the personal guarantees of the directors of Morgan Building. It could not be said therefore that the obligations of the guarantors in respect of the principal sum of the 2004 loan were increased. 4 There was no evidence that the plaintiffs signed any documentation in December 2005 and therefore the documents of that date signed by the directors of Morgan Building could be of no effect in varying the obligations of Morgan Building under the 2004 loan agreement. Issue 2 – the effect of the 2006 documents 25 The defendants relied upon O'Donovan at page 347 and the decision in Hancock to argue that the transactions involving Lammington Drive that were undertaken in 2006 involved a variation of the 2004 agreement so that they were discharged from their obligations. Their arguments were that they were either released for valuable consideration, namely the grant of security by Lammington Drive, or that the transaction with Lammington Drive impliedly amounted to a rescission of the 2004 agreement. 26 The principles referred to by O'Donovan concerning rescission could not apply in this case because those principles applied to arrangements between the parties to the original agreement. In this case the subsequent transactions took place between the plaintiffs and Lammington Drive. 27 The argument could succeed only if it were established that the transactions with Lammington Drive had the effect of replacing the 2004 transaction with Morgan Building. 28 In arguing that they did, the defendants relied upon figures in the administrator's report that indicated that Morgan Building's records showed a debt of $200,000 to the plaintiffs at 30 June 2005 and no debt to the plaintiffs at the date of appointment of the administrator, 27 February 2006. Mr Rankin produced a document said to be a balance sheet of Lammington Drive Unit Trust at February 2006 indicating liabilities to the plaintiffs in the nature of two loans of $200,000 and $100,000. 29 The problems with this argument were: 1 The administrator made the point that he had been required to reconstruct the financial accounts of Morgan Building from June 2004 because its computer server containing financial information was: stolen/removed by unknown person(s) prior to my appointment. Cheque books and bank statements were also unavailable. The administrator therefore used a backup disk, copies of bank statements provided by Morgan Building's banker and limited books and records to prepare a summary of balance sheets for the financial years 2004 and 2005 and to 27 February 2006. The administrator's disclaimer noted that he relied upon information from these limited records and from information provided by the company's officers and senior management and that he did not audit the financial affairs of Morgan Building. 2 No documents or information were in evidence to validate or support the figures set out in the Lammington Drive Unit Trust balance sheet. It was not signed or adopted as a true statement of the financial position of the Trust by any office bearer of Lammington Drive or of the Unit Trust. 3 According to the evidence of Mr Rankin, the Lammington Drive Unit Trust balance sheet cannot be correct. He said that the transaction involving Lammington Drive did not take place until March 2006. The documents and correspondence indicated that this was correct. By March 2006 Morgan Building was under the control of the administrator. There was no evidence from the administrator to suggest that he had undertaken any steps to transfer to Lammington Drive the liability of Morgan Building to the plaintiffs. 4 No books of either company were in evidence that indicated that any book entry had been made pursuant to which the liability of Morgan Building to the plaintiffs was transferred to Lammington Drive. 30 There was therefore no evidence of any express release of Morgan Building from its obligations to the plaintiffs or any consequential release of the guarantors. 31 I reject the argument that I should imply that the guarantors were released from the guarantees. 32 I prefer the evidence of Mr Morgan to that of Mr Rankin concerning the purpose with which the transactions with Lammington Drive took place. The administrator concluded that Morgan Building was insolvent for six months prior to his appointment. This conclusion was consistent with Mr Morgan's evidence that Mr Rankin told him that Morgan Building was unable to repay the 2004 loan and that the basis upon which he was persuaded not to press for repayment of that loan and to advance a further sum of $100,000 was that the plaintiffs would be provided with further security. 33 I find that by December 2005 it was apparent to the directors of Morgan Building that it was unable to repay the 2004 loan and that they were at risk that the debt would be enforced against them personally. Accordingly, additional security, through Lammington Drive, was provided in anticipation that personal liability would be avoided on the successful completion of the development at Mount Hutton. 34 I find that in entering into these arrangements with the plaintiffs, the guarantors effectively acknowledged their ongoing continuing personal liability pursuant to the guarantees given in the 2004 agreement. Interest 35 At the conclusion of the evidence and submissions, counsel for the defendants sought to raise argument concerning their liability for interest payable under the 2004 agreement. I declined to allow further argument because this issue was not raised on the pleadings, no evidence was taken on the issue in the course of the hearing and no prior notice of the submission was given to the plaintiffs. 36 I find the defendants liable to the plaintiffs on the guarantee of 20 December 2004 for the principal sum of $200,000 and interest to the date of hearing of $89,890.41. ORDERS 37 Verdict and judgment for the plaintiffs in the sum of $289,890.41. 38 The defendants are to pay the plaintiffs' costs of the proceedings. This order is suspended until 22 August 2008 to allow either party to list the proceedings for further argument on the issue of costs. 39 The exhibits are returned. ********** DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.