Guarantee - Breach by creditor - Circumstances in which surety discharged - Guarantee of hirer's obligations under hiring of machinery - Agreement by creditor to give notice of hirer's breach or of proposal by hirer to assign rights - Failure to do so.

MASON A.C.J., WILSON, BRENNAN AND DAWSON JJ.: These two appeals raise an important question of principle: In what circumstances does a creditor's breach of a contract of guarantee discharge the surety from liability under that contract? Although the facts and the history of the two appeals, including the relevant transactions, have been sufficiently stated in the reasons prepared by Deane J., we set out very briefly the principal features so far as they are relevant to the first appeal as a preliminary to a statement of our reasons for arriving at the conclusion that the appeals should be allowed. It is common ground that the outcome of the first appeal is necessarily decisive of the second appeal.

2. The appellant Ankar Pty. Limited ("Ankar") entered into a Security Deposit Agreement with the respondent, National Westminster Finance (Australia) Limited, previously named Lombard Australia Limited, ("Lombard") whereby the appellant deposited a sum of $125,000 as a loan and gave security over it by way of charge for the performance by General Energy (Manufacturing) Pty. Limited ("Manufacturing") of its obligations under a Lease Agreement made on or about 6 May 1982 of certain plant and equipment from Lombard as lessor to Manufacturing as lessee. Ankar subsequently deposited a further sum of $75,000 pursuant to the Security Deposit Agreement as security for the performance by another lessee of its obligations under a lease, but no question arises in relation to that further sum. The Security Deposit Agreement contained two provisions, cll.8 and 9, which were breached by the respondent. The provisions are in these terms:

3. Manufacturing, after making default in payment of rent under the lease between December 1982 and March 1983, assigned its interest by an assignment dated 18 March 1983 in the leased plant and equipment to General Energy Company Pty. Limited, the parent company of Manufacturing. Lombard was a party to the agreement dated 18 March 1983 and as such consented to the assignment. The respondent committed a breach of cl.8 of the Security Deposit Agreement by failing to notify Ankar of Manufacturing's proposal to assign its interest in the plant and equipment which was the subject of the lease.

4. Lombard also committed a breach of cl.9 of the Security Deposit Agreement by failing to notify Ankar before the assignment that Manufacturing was in default under the Lease Agreement in failing to pay rent. Moreover, there was no consultation between Lombard and Ankar with a view to determining what cause of action would be taken by Lombard in consequence of the default.

5. The critical issue is whether Lombard's breaches of the Security Deposit Agreement discharged Ankar from its obligations under that agreement and thereby entitled it to recover the sum of $125,000 which it had paid. The Security Deposit Agreement set out the terms on which Ankar lent the sum of $125,000 to Lombard at 17.5 per cent per annum. But the Security Deposit Agreement also operated as a contract of guarantee in so far as Ankar charged the money lent with the payment by Manufacturing of all moneys payable by it to Lombard under the Lease Agreement. So much was common ground between the parties.

6. The appellant's case was that it was discharged from liability on the ground that the breaches of cll.8 and 9 were breaches of essential conditions or, alternatively, on the ground that they were material breaches of the contract of guarantee. It was not in controversy that a surety is discharged from its obligation under a contract of suretyship by the creditor's breach of an essential condition, so long at any rate as the surety treats the contract as at an end. On the other hand Lombard strongly contested the notion that a surety is discharged by anything less than a breach of an essential term or a breach going to the root of the contract. According to Lombard, discharge of the surety for breach of the suretyship contract by the creditor is governed by the ordinary principles of the law of contract, there being no special rule applicable to contracts of suretyship.

7. Unfortunately the decided cases do not speak with a single voice on the issues presented by these arguments. On the contrary, support can be found in the authorities for a variety of discordant propositions relating to the discharge of the surety. For the moment we shall pass them by with a view to stating as briefly as may be the relevant principles of the general law of contract as they apply to the discharge of the surety's obligations under the suretyship contract for breach of it by the creditor.

8. Breach of an essential term or a breach going to the root of the contract will of course discharge the surety from future liability if the surety elects to rescind for breach. The expression "essential term" perhaps needs some elaboration in the context of suretyship because it is said sometimes that a surety is discharged by non-fulfilment of a condition precedent and at other times that a surety is discharged by the creditor's breach of a condition. A condition precedent may be unfulfilled without any breach of contract, but when performance by the creditor of a contractual promise is a condition precedent to the liability of the surety under a contract of suretyship which otherwise involves no more than a guarantee of payment of the debt owing to that creditor, the creditor's promise is necessarily an essential term of the contract. The terms of the contract itself demonstrate that the surety would not have entered into the contract of suretyship unless he had been assured of a strict performance of the promise: see Tramways Advertising Pty. Ltd. v. Luna Park (N.S.W.) Ltd. (1938) 38 SR (NSW) 632, at pp 641-642; Associated Newspapers Ltd. v. Bancks [1951] HCA 24; (1951) 83 CLR 322, at p 337; D.T.R. Nominees Pty. Ltd. v. Mona Homes Pty. Ltd. [1978] HCA 12; (1978) 138 CLR 423, at pp 430-431.

9. Conversely, when a contractual promise is a condition, performance of the promise, if the promisee so elects, is treated as a condition precedent to the promisee's executory obligations. Acceptance that a promissory condition operated in this way was the very foundation of the illuminating judgment of Bowen L.J. in Bentsen v. Taylor, Sons & Co. (1893) 2 QB 274, where his Lordship, in deciding whether a provision was a condition or a warranty, spoke (at p.281) of the need to determine:

"... whether the intention of the parties, as

gathered from the instrument itself, will best be

carried out by treating the promise as a warranty

sounding only in damages, or as a condition

precedent by the failure to perform which the other

party is relieved of his liability."

See also Hongkong Fir Shipping Co. Ltd. v. Kawasaki Kisen Kaisha Ltd. (1962) 2 QB 26, at pp 60, 69-70; Bunge Corporation v. Tradax S.A. [1981] UKHL 11; (1981) 1 WLR 711, at pp 717, 718, 721, 725; [1981] UKHL 11; (1981) 2 All ER 513, at pp 543, 544, 546, 549-550.

10. In the context of suretyship contracts there has been a natural tendency to refer to the creditor's promise as a condition precedent rather than as a condition. This is because many guarantees are unilateral instruments, containing no promises on the part of the creditor except in so far as the recital of the consideration may refer to such a promise. See, for example, United Dominions Trust (Commercial) Ltd. v. Eagle Aircraft Services Ltd. (1968) 1 WLR 74; (1968) 1 All ER 104 which, though not involving a guarantee, concerned a unilateral undertaking. This tendency in no way affects the discussion in the preceding paragraph.

11. In deciding whether a promise has the status and effect of a condition, courts are not too ready to construe a term as a condition and, at least where other considerations are finely balanced, will hold that a term is of such a kind that breach of it does not give rise to an automatic right to rescind. This approach is explained by a preference for a construction that will encourage performance rather than avoidance of contractual obligations: Cehave N.V. v. Bremer m.b.H. (1976) QB 44, at pp 70-71; Bunge Corporation, at pp 715-716; pp 541-542 of All ER

12. Three factors favouring an interpretation of cll.8 and 9 that gives them the status of conditions may be mentioned. First, in the event of breach, neither clause is readily enforceable by way of an action for damages. Damages for breach would be difficult to prove. Secondly, the two clauses impose an obligation to give the surety notice and the purpose of imposing an obligation to give that notice is to enable the surety to take such action as it can to safeguard its position and its interests. Notice of default would alert the appellant to the immediacy of its risk, enable it to persuade the debtor to remedy the default and put possible alternative proposals to Lombard for its consideration. Notice of a proposed assignment would possibly enable the appellant to make suggestions for the disposition of the debtor's interest in the machinery to the best advantage. Thirdly, as Deane J. explains in his judgment, it was clearly disadvantageous to the surety to be faced with a situation in which it would be liable as surety for a lessee of equipment who no longer enjoyed possession of that equipment, notwithstanding that it remained liable to pay the rent.

13. On the other hand the provisions are not expressed to be conditions. No time is fixed within which notice is to be given (cf. Midland Counties Motor Finance Co. Ltd. v. Slade (1951) 1 KB 346, at p 351; United Dominions Trust (Commercial) Ltd.). And the language in which the clauses are expressed does not provide a clear indication that they were intended to be fundamental obligations or to operate as conditions.

14. If the contract in the present case were to be viewed as an ordinary contract without regard to its special character as a suretyship contract, we incline to think that the factors already mentioned would establish cll.8 and 9 to be conditions. It is necessary to take into account as well the special character of a suretyship contract and of the relationship that it creates between the parties. As appears later, when this is done, the relevant obligations in cll.8 and 9 are seen clearly to have the status of conditions. As a preliminary to a consideration of this matter it is necessary to examine the special principle, said to apply to a suretyship contract, that the surety is discharged from its obligations by the creditor's breach of that contract, so long at any rate as the breach materially prejudices the interests of the surety.

15. One of the problems with this special principle is that it has been expressed in a variety of ways. Thus, it has been said that the surety is discharged by "any departure ... from the terms as agreed upon in the guarantee" (Barber v. Mackrell (1892) 67 LT 108, at p 109) and see Rose v. Aftenberger (1969) 9 DLR(3d) 42, at p 49. And in Bacon v. Chesney [1814] EngR 11; (1816) 1 Stark 192, at p 193; [1814] EngR 11; 171 ER 443, at p 443, Lord Ellenborough said that a claim against a surety is strictissimi juris and that "it is incumbent on the plaintiff to shew that the terms of the guarantee have been strictly complied with".

16. Then it has been said that any departure by the creditor from the suretyship contract "which is not obviously and without inquiry quite unsubstantial, will discharge the surety from liability, whether it injures him or not, for it constitutes an alteration in the surety's obligations" (Halsbury's Laws of England, 4th ed., vol. 20 par.259). The final clause in the passage quoted from Halsbury indicates that this proposition is founded not so much on cases dealing with a breach of a term in the suretyship contract, as on cases in which conduct on the part of the creditor materially altered the surety's obligations. Such an alteration takes place when the creditor agrees to a variation of the principal contract or to an extension of time within which the debtor may comply with that contract. The creditor's agreement with the debtor thereby alters the nature of the surety's obligations without the surety's consent.

17. Two of the authorities cited in support of the proposition stated in Halsbury make the point. In Holme v. Brunskill (1877) 3 QBD 495, the surety's defence to an action on the guarantee was that he was discharged by a material variation of the contract between creditor and debtor. At first instance Denman J. said (at p.498):

"There must, I think, be many cases in which the

judge would have to take the opinion of the jury

upon the question, whether the alteration was of

such a character as to affect the surety in any way

by substantially or materially altering the risk."

On appeal, Cotton L.J. expressed a similar view in different terms, saying (at pp.505-506):

"The true rule in my opinion is, that if there is

any agreement between the principals with reference

to the contract guaranteed, the surety ought to be

consulted, and that if he has not consented to the

alteration, although in cases where it is without

inquiry evident that the alteration is

unsubstantial, or that it cannot be otherwise than

beneficial to the surety, the surety may not be

discharged; yet, that if it is not self-evident

that the alteration is unsubstantial, or one which

cannot be prejudicial to the surety, the Court,

will not, in an action against the surety, go into

an inquiry as to the effect of the alteration, or

allow the question, whether the surety is

discharged or not, to be determined by the finding

of a jury as to the materiality of the alteration

or on the question whether it is to the prejudice

of the surety, but will hold that in such a case

the surety himself must be the sole judge whether

or not he will consent to remain liable

notwithstanding the alteration, and that if he has

not so consented he will be discharged. This is in

accordance with what is stated to be the law by

Amphlett, L.J., in the Croydon Gas Company v.

Dickinson ((1876) 2 C.P.D. 46, at p.51)."

Brett L.J. related the principle to the terms of the suretyship contract, observing (at p.508):

"The proposition of law as to suretyship to which I

assent is this, if there is a material alteration

of the relation in a contract, the observance of

which is necessary, and if a man makes himself

surety by an instrument reciting the principal

relation or contract, in such specific terms as to

make the observance of specific terms the condition

of his liability, then any alteration which happens

is material; but where the surety makes himself

responsible in general terms for the observance of

certain relations between parties in a certain

contract between two parties, he is not released by

an immaterial alteration in that relation or

contract."

Croydon Gas Co. v. Dickinson was also a case in which the creditor had by arrangement with the debtor altered this relationship by extending the time within which the debtor was bound to make payments, the arrangement being made without the surety's assent.

18. These statements of the principle, like that of Blackburn J. in Polak v. Everett (1876) 1 QBD 669, at p 674, indicate that the principle is the by-product, not so much of the general law of contract, as of the special relationship between creditor and surety arising out of the suretyship contract upon which equity fastened to protect the surety when the creditor's conduct affected the surety's liability: Holme v. Brunskill, at p 505. 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 inquire 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, e.g., a reduction in the debtor's debt or in the interest payable by the surety. The mere possibility of detriment is enough to bring about the discharge of the surety.

19. The foundation of the rule is that the creditor, by varying the principal contract or extending time, has altered the surety's rights without consulting it though the surety has an interest in the principal contract, and that the creditor cannot be permitted to do: see Rees v. Berrington [1795] EngR 4082; (1795) 2 Ves Jun 540; 30 ER 765. Thus the liability of the surety was seen to be strictissimi juris and the suretyship contract was construed strictly in his favour. In the United States the rule of strict construction, though applied in favour of sureties who receive no reward, is not applied to a compensated surety, i.e., a surety for reward. On the contrary the suretyship contract is construed against the compensated surety. This is largely because surety bonds are thought to resemble insurance contracts, the premiums are calculated against estimated risks and the contracts incorporate forms prepared by the surety. The United States approach may be partly due to a belief that the rule of strict construction, as it has been applied in England, is over-zealous in its protection of the surety: see Cardozo, The Nature of the Judicial Process (1921) p.152, et seq.; Stearns, The Law of Suretyship 5th ed., (1951) 5.1; New York Law Revision Commission Annual Report (1937) at pp.891-895; "Guarantee - Effect upon Guarantor's Liability of Subsequent Agreement between Creditor and Principal Debtor" Notes and Comments, Australian Law Journal, vol. 8, (1934), 58. According to the law as it has developed in the United States, the surety company must show some injury before it will be absolved from the contract (Chapman v. Hoage [1936] USSC 3; (1936) 296 US 526, at p 530), and then it will be discharged pro tanto to the extent of the damage or prejudice it suffers: American Jurisprudence (2d) vol. 74, "Suretyship", 259. In accordance with this approach, a surety company is discharged by the creditor giving the debtor an extension of time only if it is shown that the extension is a material variance in the sense that it results in material harm or prejudice to the surety: Guaranty Co. v. Pressed Brick Co. [1903] USSC 212; (1903) 191 US 416.

20. Lombard does not submit that we should adopt the United States approach. For this reason, if no other, it would be inappropriate to take this course. However, it is of some importance to note that the different approach taken in the United States with respect to the special principle rests on the view that it arises not so much from the terms of the suretyship contract, as from the relationship between the parties which the contract creates.

21. However, the fundamental question still remains: Is the rule of strict construction, derived from the equitable rule which protects the surety from any alteration in its liability, subsumed in the general principles of the law of contract so that the surety may treat itself as discharged from liability if, but only if, the breach is such as to entitle the surety at law to rescind the contract? In truth there is no difference between the equitable rule and the legal rule, as Lord Selborne L.C. pointed out in In re Sherry. London and County Banking Company v. Terry (1884) 25 ChD 692, at p 703. There, in a passage accepted by the Privy Council in National Bank of Nigeria Ltd. v. Awolesi (1964) 1 WLR 1311, at p 1316, his Lordship said:

"A surety is undoubtedly and not unjustly the

object of some favour both at law and in equity,

and I do not know that the rules of law and equity

differ on the subject."

At law, as in equity, the traditional view is that the liability of the surety is strictissimi juris and that ambiguous contractual provisions should be construed in favour of the surety. The doctrine of strictissimi juris provides a counterpoise to the law's preference for a construction that reads a provision otherwise than as a condition. A doubt as to the status of a provision in a guarantee should therefore be resolved in favour of the surety and so the provision should be interpreted as a condition, or perhaps as an innominate term, instead of a mere warranty. If the surety is to be discharged for breach of a promissory term in the suretyship contract, the justification for the discharge must be that the creditor has failed to comply with a provision that, as a matter of interpretation, requires strict performance as a condition precedent to the surety's obligation or at least requires substantial performance of the promise such that the surety would not have entered into the contract if it had not been assured that there would not be a breach such as the breach which in fact occurred. If on its true interpretation the term is not intended so to operate, it is not easy to understand why the surety should be discharged by its breach. Of course, in construing the contract the court is entitled to look to the general setting in which the contract has come into existence: see, for example, the discussion in Reardon Smith Line Ltd. v. Hansen-Tangen (1976) 1 WLR 989, at pp 996-997; (1976) 3 All ER 570, at pp 574-575.

22. Since the judgment of Diplock L.J. in Hongkong Fir it has been recognized in England that a term in a contract may stand somewhere between a condition and a warranty. Such an intermediate or innominate term, it has been held, is capable of operating, according to the gravity of the breach, as either a condition or a warranty. In Hongkong Fir the obligation of seaworthiness was readily classified as innominate because a breach of the obligation might be trivial, making damages an adequate remedy, or grave, in which event it should have effect as a breach of condition. The innominate term brings a greater flexibility to the law of contract, as Lord Wilberforce has remarked on more than one occasion (Reardon Smith Line Ltd. v. Hansen-Tangen, at p 998; pp 576-577 of All ER; Bunge Corporation, at pp 715-716; pp 541-542 of All ER). Although nothing less than a serious breach of an innominate term entitles the innocent party to treat the contract as at an end, the breaches of cll.8 and 9 merit this description.

23. Whether provisions of the kind found in cll.8 and 9 are provisions which, if they cannot be described as conditions, can be described accurately as innominate terms is a question of some difficulty. In Bunge Corporation, Lord Wilberforce suggested (at p.715; p.541 of All E.R.) that a time clause is not susceptible of treatment as an innominate clause because it can give rise to one kind of breach only - to be late. If this suggestion be well founded, and we would not wish to be taken as implying that it is, there might be a problem in treating the provisions of cll.8 and 9, especially cl.9, as innominate terms.

24. Be this as it may, returning to the earlier discussion of the two provisions in the context of conditions, the special characteristics of the suretyship relationship and the fact that it creates a liability strictissimi juris on the part of the surety are enough, when added to the factors mentioned earlier in this judgment, to justify treating the relevant obligations in the two provisions as conditions, breach of which, at Ankar's option, discharged it from performance of its obligations under the Security Deposit Agreement to the extent to which they related to the sum of $125,000.

DEANE J: These two appeals have been heard together. It is common ground that the relevant facts and issues involved in them and the course of proceedings which they have followed in the courts below correspond and that the outcome of the appeal in one must necessarily determine that in the other. That being so, the material placed before the Court has been largely confined to what is relevant to the appeal by Ankar Pty. Limited ("Ankar") and it is to that appeal only that it is necessary to make detailed reference in these reasons for judgment.

2. The respondent, National Westminster Finance (Australia) Limited, was formerly known as Lombard Australia Limited. Its change of name occurred after the making of the agreements giving rise to these proceedings and it is convenient to refer to it as "Lombard". On or about 6 May 1982, Lombard entered into a number of written agreements relating to the "lease" of a long list of items of manufacturing plant and equipment to a company called General Energy (Manufacturing) Pty. Limited ("Manufacturing"). The central agreement was the actual "Lease Agreement" between Lombard and Manufacturing. Its effect was that Manufacturing agreed "to take on lease" from Lombard the relevant plant and equipment for a period of forty eight months at a total rental of $573,025.92 ($11,938.04 per month). This "Lease Agreement" was referred to in the courts below as "the lease" and I shall do likewise. It is necessary to make express mention of but one of its numerous clauses. Clause 25 provided:

"That the Lessee shall not without the consent in

writing of Lombard first had and obtained transfer

or assign or purport to transfer or assign the

goods or any interest therein provided that Lombard

shall not unreasonably refuse its consent to a

proposed assignment of the Lessee's rights to a

respectable and responsible assignee who is

capable of carrying out the Lessee's obligations

hereunder and who enters into an agreement with

Lombard in such form as Lombard may reasonably

require for the performance of the Lessee's

obligations hereunder."

The other agreements included written guarantees of the due and punctual payment by Manufacturing of the rent and every other sum payable under the lease and the due performance and observance of all the terms and provisions of the lease. There were apparently four of those guarantees: two by companies and two by individuals. One of the guaranteeing companies was General Energy Company Pty. Limited which was Manufacturing's parent company and to which I shall refer as "the parent company". There was also an agreement between Ankar and Lombard described as a "Security Deposit Agreement" and I shall refer to it by that description.

3. The Security Deposit Agreement recited that Manufacturing had offered to lease from Lombard the plant and equipment and that, as a condition precedent to Lombard's acceptance of that offer, Lombard had "required" Ankar to pay to Lombard "a sum of money as security for the performance of (Manufacturing's) obligations" under the lease. It provided for payment by Ankar to Lombard of the sum of $125,000 as security for the performance by Manufacturing of its obligations under the lease and that Lombard should open a special account ("the Security Account") in the name of Ankar in the books of Lombard to which the $125,000 was to be credited. Under cl.3 of the Security Deposit Agreement, Lombard was required to pay to Ankar interest on the amount from time to time standing to the credit of the Security Account at a rate of 17.5 per cent. Clauses 4 to 9 are of central importance to the appeal. In them, Manufacturing is referred to as "the Lessee" and Ankar is referred to as "the Depositor". Those clauses provided:

"4. The Depositor hereby charges to Lombard the

Security Account and all moneys from time to time

credited to the Depositor therein as security for

the payment by the Lessee of all moneys payable by

the Lessee to Lombard under the Lease Agreement.

5. Lombard shall be entitled in its absolute

discretion at any time and from time to time to

debit the Security Account with all or part of any

moneys then due and payable by the Lessee to

Lombard whether under the Lease Agreement.

6. Nothing herein contained shall in any way

affect the Lessee's obligations to pay to Lombard

the rent and other moneys referred to in the Lease

Agreement in the manner and at the times therein

prescribed.

7. The charge hereby created shall be and be

deemed to be fully discharged and satisfied when

all moneys payable or which may become payable by

the Lessee to Lombard under the Lease Agreement

have been paid and upon discharge of the said

charge the amount then standing to the credit of

the Security Account shall be paid by Lombard to

the Depositor.

8. Lombard agrees with the Depositor that it will

use its best endeavours to ensure that the

machinery referred to in the Schedule to the Lease

Agreement shall remain in the possession of the

Lessee and will notify the Depositor should the

Lessee propose to sell or assign its interest in

any of the said machinery.

9. Upon the Lessee being in default under the

Lease Agreement Lombard shall agree to notify the

Depositor whereupon Lombard and the Depositor shall

consult with a view to determine what course of

action will be taken by Lombard following such

default and without limiting the generality of that

action Lombard may at its option assign the Lease

Agreement and any security held therefor to the

Depositor."

The sum of $125,000 was duly paid by Ankar to Lombard pursuant to the terms of the Security Deposit Agreement. A similar "Security Deposit Agreement" was executed by the appellant in the other appeal, Arnick Holdings Limited ("Arnick"), which deposited a separate sum of $125,000 with Lombard.

4. By a subsequent agreement between Ankar and Lombard, the sum of $125,000 lodged by Ankar with Lombard pursuant to the Security Deposit Agreement was further charged with repayment of moneys advanced or to be advanced by Lombard to another company, Nuinga Pty. Limited. The contents of that further agreement, to which I shall refer as the "Deed of Charge", are otherwise not directly relevant to the issues raised on the appeal. On 24 November 1982 Ankar lodged a further $75,000 with Lombard to be held by Lombard upon the terms of the Security Deposit Agreement as varied by the Deed of Charge. The amount deposited by Ankar with Lombard was therefore increased to a total sum of $200,000. A similar "Deed of Charge" was executed by Arnick which also lodged a further $75,000 with Lombard.

5. In December 1982, Manufacturing first made default in payment of rent under the lease. Default continued until early March 1983 when, in discussions between officers of the respective companies, Manufacturing requested Lombard to consent to an assignment of its interest under the lease to the parent company. There followed an agreement dated 18 March 1983 ("the assignment") to which Lombard was a party and by which Manufacturing assigned its interest under the lease to the parent company. The assignment expressly provided that nothing contained in it should "relieve or be deemed to relieve" Manufacturing from its "personal liability" to Lombard under the lease and that that liability should "continue and be and remain of full force and effect until all the obligations under the lease on the part of the lessee thereunder have been fully discharged and satisfied."

6. It is common ground that Ankar was not, prior to the assignment, notified by Lombard of Manufacturing's default under the lease. Nor was it consulted about the assignment to the parent company. There is nothing in the evidence to suggest, and it is not suggested, that Ankar was aware of either the default or the assignment until after the assignment had been effected. On 31 March 1983, after Ankar became aware of what had occurred, a letter was written on its behalf to Lombard recording its concern at the fact that it had not been notified of the default by Manufacturing and the assignment of the lease. On 5 April 1983, a formal request was made by Ankar for the repayment of the security deposit together with accrued interest. The letter did not identify the basis upon which the request, which was said to be pursuant to "senior legal advice", was made. Presumably, the basis was a claim that the deposit had become freed of the charge to secure the performance by Manufacturing of its obligations under the lease. Lombard refused to comply with the request. By letter of 12 April 1983, it advised that it considered that the security deposit was "held as security for the performance of the lease agreement" by the parent company. In fact, what Lombard maintains is that the security deposit was held by it as security for the performance by Manufacturing of its continuing obligations under the lease in circumstances where the parent company has failed to discharge its obligations as lessee of the plant and equipment pursuant to the assignment to it of Manufacturing's right, title and interest under the lease.

7. In due course, Ankar instituted proceedings in the Supreme Court of New South Wales seeking judgment for the amount of $200,000 together with interest. On the hearing of the action, it became apparent that, even if the deposit no longer remained charged to secure performance by Manufacturing of its continuing obligations, Ankar was not then entitled to a return of the $200,000 since the deposit at that stage remained charged to secure the repayment by Nuinga of moneys advanced to that company by Lombard. In those circumstances, the claim was altered to seek declaratory relief. At first instance, Clarke J. found (as was obviously the case) that Lombard was guilty of breaches of its contractual obligations under cll.8 and 9 of the Security Deposit Agreement in failing to notify Ankar either of Manufacturing's default (cl.8) or intended assignment (cl.9). His Honour rejected an argument that, regardless of whether the relationship between Lombard and Ankar was that of creditor and surety, those clauses constituted essential terms of the contract between Ankar and Lombard according to general principles of contract law. He held, however, that the Security Deposit Agreement constituted Ankar as surety, to the extent of the amount deposited, for the performance by Manufacturing of its obligations under the lease with the consequence that Ankar was entitled to rely upon the special rules which regulate the rights and obligations of sureties. His Honour concluded that, under those special rules, the consequence of the assignment of the lease by Manufacturing with the consent of Lombard "in circumstances involving breaches by (Lombard) of conditions 8 and 9 of the Security Deposit Agreement" was that Ankar was discharged from its obligations as surety for the performance by Manufacturing of its obligations under the lease. Accordingly, his Honour granted declaratory relief in Ankar's favour. Subsequently, when it was disclosed that the liability of Nuinga to Lombard had been fully discharged at the time his Honour had granted that declaratory relief, his Honour entered judgment in Ankar's favour for the then outstanding balance under the Security Deposit Agreement.

8. Lombard appealed from the decision of the learned trial judge to the New South Wales Court of Appeal. The Court of Appeal (Glass, Samuels and Priestley JJ.A.) agreed with Clarke J's conclusion that cll.8 and 9 of the Security Deposit Agreement were not essential terms of the contract between Lombard and Ankar according to general principles. That court also agreed with his Honour that Ankar was constituted a surety under the terms of the Security Deposit Agreement with the consequence that the rules regulating the rights and obligations of a surety were applicable. However, the members of the Court of Appeal disagreed with Clarke J's finding that the assignment of the lease by Manufacturing with the consent of Lombard had, in the circumstances in which that assignment and consent had been effected and given, discharged Ankar from its obligations as surety for Manufacturing. Their Honours identified two distinct grounds upon which Ankar had relied to support that finding that it was discharged from its obligations as a surety. The first of those grounds was that the assignment, to which Lombard had been a party, constituted a variation of the principal contract (i.e. the lease) between Lombard and Manufacturing. They held that that ground had not been made good for the reason that the assignment with the consent of Lombard had not involved any variation of the principal contract (i.e. the lease) at all since cl.25 of that contract had expressly authorized such an assignment. The second ground was that Lombard had been guilty of breach of its obligations under conditions 8 and 9 of the surety agreement (i.e. the Security Deposit Agreement) between itself as principal creditor and Ankar as surety. It would seem that the basis upon which this second ground was advanced before the Court of Appeal was that, even accepting that cll.8 and 9 were not essential or fundamental terms of the contract between Lombard and Ankar according to general principles, Lombard's conduct in consenting to the assignment in the circumstances of the breaches varied the contract of suretyship or altered Ankar's obligations under it. Their Honours rejected this ground, holding that Lombard's breach of cll.8 and 9 "did not constitute a variation of the terms of the guarantee" (per Samuels J.A., with whom Glass J.A. agreed). In the result, the Court of Appeal upheld the appeal and dismissed Ankar's action. The present appeal is from the judgment and orders of the Court of Appeal.

9. The argument in this Court has been more narrowly confined than in the courts below. Lombard no longer disputes that the effect of the Security Deposit Agreement was to constitute Ankar a surety with the consequence that the special rules relating to the rights and obligations of sureties are applicable. For its part, Ankar no longer argues that the effect of Lombard's consenting to the assignment of the lease by Manufacturing was to vary the principal agreement between Lombard as creditor and Manufacturing as debtor. The argument actually advanced on behalf of Ankar has involved a refinement of, and to some extent a departure from, the manner in which it would seem to have been propounded before the Court of Appeal. It is no longer argued that Lombard's breaches of cll.8 and 9 of the Security Deposit Agreement constituted a "variation" of that agreement in the ordinary meaning of that word. What is now argued is that Lombard's breaches of cll.8 and 9 of the Security Deposit Agreement were breaches of an agreement between principal creditor and surety of such a nature as to discharge Ankar from its obligations as surety pursuant to the special rules applicable to determine the rights and obligations of a surety. The submission that cll.8 and 9 constituted essential or fundamental terms of the Security Deposit Agreement has not been abandoned. It has, however, been advanced not so much as a matter of general principle but as a particular consequence of the operation of those special rules.

10. The argument for Ankar was, to no small extent, founded upon a proposition extracted from Halsbury's Laws of England, 4th ed., vol. 20, p.141, par.259:

"Any departure by the creditor from his contract

with the surety without the surety's consent,

whether it be from the express terms of the

guarantee itself or from the embodied terms of the

principal contract, which is not obviously and

without inquiry quite unsubstantial, will discharge

the surety from liability, whether it injures him

or not, for it constitutes an alteration in the

surety's obligations."

As Samuels J.A. pointed out in the Court of Appeal and senior counsel for Lombard demonstrated in argument in this Court, not all of the large number of cases which are cited in the footnotes of Halsbury (ibid., at p.142) in support of that proposition actually support it. Moreover, the terms in which the proposition is framed are not without difficulty. Thus, the qualification that the departure be "not obviously and without inquiry quite unsubstantial" is framed in words which are as likely to raise as to solve problems. More important for present purposes is the difficulty in the explanatory statement that a relevant "departure" by the creditor from his contract with the surety "constitutes an alteration in the surety's obligations". In the Court of Appeal, the view prevailed that, in the light of that explanatory statement, the general proposition in Halsbury is to be understood as referring to an alteration in the terms of the surety's obligations and not a failure or refusal of performance by the creditor. It seems to me, with respect, that that view attributes to the words "an alteration in the surety's obligations" a meaning which, properly understood, they were not intended to bear.

11. Obviously, a creditor could not "without the surety's consent" effect a "departure" from the contract with the surety in the sense of effecting a unilateral variation or alteration of its terms. The reference to a "departure" by the creditor from his contract with the surety constituting an "alteration in the surety's obligations" is a reflection of the fact that the obligations of a surety are strictly confined to what he has undertaken in the contract which constitutes him a surety; "(h)e is bound ... merely" to "the letter of his engagement" (see per Lord Westbury L.C., Blest v. Brown (1862) 4 De GF & J 367, at p 376 [1862] EngR 631; (45 ER 1225, at p 1229)). A failure by the creditor to observe the terms of that contract would, if the surety nonetheless remained liable, alter the surety's obligations in the sense that the surety would be held liable in circumstances which did not accord with the letter of his engagement as specified by the contract. In other words, the proposition in Halsbury should be understood as meaning that a relevant failure by the creditor to perform the terms of his contract with the surety will "discharge" the surety for the reason that the creditor's failure to perform the terms of his contract would otherwise result in a situation where the surety was held liable in circumstances other than those in which he had agreed to be bound. As senior counsel for Ankar pointed out, this reading of the proposition in the 4th edition of Halsbury derives support from de Colyar K.C.'s original article on Guarantees (in the 1st edition of Halsbury) from which the proposition was derived (see Halsbury's Laws of England, 1st ed., vol. 15, pp.550-552, pars. 1034-1035 and see also de Colyar, A Treatise on the Law of Guarantees, 3rd ed. (1897), p.405). That general proposition accords with the long-standing statement of high authority that a "claim as against a surety is strictissimi juris, and it is incumbent on the plaintiff to shew that the terms of the guarantee have been strictly complied with" (see per Lord Ellenborough, Bacon v. Chesney [1814] EngR 11; (1816) 1 Stark 192, at p 193 [1814] EngR 11; (171 ER 443, at p 443)). So understood, and subject to what is said hereunder, it represents a correct statement of a special rule which prima facie (in the sense that it may be excluded by express or implied agreement to the contrary) governs the particular relationship of guarantor and principal creditor.

12. In the context of defining that special rule it is inappropriate to speak, as does the 25th edition of Chitty on Contracts (1983), vol. II, at p.1222 (and cf., e.g., Bowmaker (Commercial) Ltd. v. Smith (1965) 1 WLR 855, at p 858; (1965) 2 All ER 304, at p 306), of it being necessary that the creditor's breach go "to the root of the contract" between himself and the surety or evince "an intention to repudiate the contract". Nor is it appropriate in that context to speak either of essential or fundamental terms of the guarantee or of the surety being pro tanto discharged to the extent of damage actually sustained (cf. American Jurisprudence 2d, vol.38, "Guaranty", par.107; Corpus Juris Secundum, vol.38, "Guaranty", par.63, at p.1225). If the breach by the creditor is of an essential or fundamental term or constitutes repudiation of the contract between the surety and himself, the surety will, of course, be entitled to rescind the contract in accordance with general principle. That is not, however, the special rule which is here under discussion. That special rule is that, in the ordinary case where a surety agrees to be liable for the default of another upon the terms of the contract of suretyship, a significant departure by the creditor from the terms of that contract will, in the absence of agreement to the contrary, operate to preclude the existence or continued existence of the circumstances in which the surety has agreed to be bound. That being so, there is no need for the surety to rescind the contract for repudiation or breach of an essential or fundamental term. In the absence of any question of waiver or estoppel, the situation is simply that the circumstances of his liability as surety do not exist (cf., e.g., United Dominions Trust (Commercial) Ltd. v. Eagle Aircraft Services Ltd. (1968) 1 WLR 74, at p 81; (1968) 1 All ER 104, at p 107; Eshelby v. Federated European Bank, Ltd. (1931) 146 LT 336, at p 342 (Divisional Court) and (1932) 1 KB 423, at p 432 (Court of Appeal); Bank of British Columbia v. Turbo Resources Ltd. (1983) 148 DLR (3d) 598, at pp 605-608; Corporation of Chatham v. McCrea (1862) 12 UCCP 352, at p 355; Sullivan v. Willson (1864) 3 SCR (N.S.W.) (L) 180, at p 184; but note e.g., Bank of Montreal v. Wilder (1983) 149 DLR (3d) 193, at pp 199-200). In some of the cases, one finds that the promissory obligations of the creditor under the surety agreement are described as conditions precedent of the surety's liability. While the difference would seem to be of little real importance, it is preferable to speak of those promissory obligations in terms of their constituting part of the general circumstances in which the surety has agreed to become liable for the default of the principal debtor rather than to categorize them as conditions precedent. One reason for that is the obvious difficulty in reconciling the unqualified fulfilment required of a true condition precedent with the apparently established qualification to the effect that an obviously immaterial and insignificant failure by the creditor fully to discharge his promissory obligations will not preclude the liability of the surety (see below). A more fundamental reason is that the basis and, for present purposes, the limits of the rights and liabilities of the parties to the particular relationship of guarantor and principal creditor are consensual and it is impermissible to approach the identification of the special rules defining the prima facie limits of the consensual rights and liabilities of the parties to a particular category of relationship in a way that effectively denies their special character by forcing them into the formalized terms appropriate to the expression of universal principle. Put differently, special rules which prima facie (in the sense of being subject to contrary agreement) define the rights and liabilities of the parties to a particular category of consensual relationship, such as that between guarantor and creditor or that between partners, are essentially concerned with presumptions of contractual intention. There is no warrant, either in principle or in utility, for distorting them into statements of immutable and overriding principle.

13. The Security Deposit Agreement between Lombard and Ankar in the present case had a twofold character. Its first character was that of a contract for the loan of money under which Ankar agreed to place money on deposit with Lombard and Lombard agreed to pay Ankar interest at the rate of 17.5 per cent per annum. Its second character was that of creditor and surety under which Ankar charged the money lent ("deposited") by it to Lombard with the payment by Manufacturing of all moneys payable by it to Lombard under the lease. Analysis of the overall agreement makes it plain that cll.8 and 9 are properly to be seen as relating to the second character of the agreement, namely, to its character as a contract of suretyship. The effect of those clauses was that Ankar agreed to be liable as surety (up to the amount of the moneys lent) in circumstances where (cl.8) Lombard would notify it if Manufacturing proposed to sell or assign its interest in any of the machinery and where (cl.9) Lombard would notify it in the event that Manufacturing was in default under the lease and consult with it with a view to determining a mutually agreeable course of action.

14. As has been seen, the above-quoted statement of the special rule in Halsbury that a departure by the creditor from the terms of his agreement will preclude the surety being held liable is qualified by being confined to the case where the departure is significant in the sense that it "is not obviously and without inquiry quite unsubstantial". While some such qualification would seem to be established and desirable, there are some problems with that wording of it. In particular, it would seem arguable in some situations that it is impossible to appreciate the true nature or effect of a particular departure by the creditor from his promissory obligations without some knowledge of or inquiry into the circumstances surrounding its occurrence and that the limitation would be more appropriately framed without the reference to "without inquiry". It is, however, unnecessary to pursue that question here since it seems to me that, regardless of what be the precise qualification, Lombard's departure from its obligations under cll.8 and 9 was plainly of the seriousness or substantiality necessary to preclude the existence of the circumstances under which Ankar had agreed to be liable as surety for the default of Manufacturing. I turn to explain why that is so.

15. The provisions of cll.8 and 9 of the Security Deposit Agreement make clear Ankar's concern to avoid a situation in which its liability as surety for Manufacturing as "lessee" in possession of the equipment had been transformed into a liability as surety for the performance by Manufacturing of its obligations under the lease in circumstances where Manufacturing had ceased to be entitled to possession of the leased machinery. The reason for that is not hard to discern. Obviously, in the latter situation, any rights of subrogation against Manufacturing would be of dubious value. Thus it was that cl.8 of the Security Deposit Agreement expressly required Lombard to use its best endeavours to ensure that the equipment remained in the possession of Manufacturing while cl.9 contemplated that, in the event of default by Manufacturing in performance of its obligations under the lease, Ankar might negotiate with Lombard for an assignment to it of Lombard's interest as lessor of the leased equipment. In that context, it simply could not be said that, viewed objectively, Lombard's departure from its obligations under cll.8 and 9 was not sufficiently serious to preclude the existence of the circumstances under which Ankar had agreed to be liable as surety. To the contrary, the failure to notify Ankar of Manufacturing's default (cl.8) and intended assignment (cl.9) precluded the circumstances existing in which Ankar could enjoy the agreed opportunity of attempting to avoid the very situation which it was obviously most concerned to avoid, namely, the situation in which it would be liable as surety for a lessee of equipment who remained liable to pay the rent for the equipment but no longer enjoyed the quid pro quo of possession of it. It follows that Lombard was not entitled to claim from Ankar, as surety, payment of the moneys owing to it by Manufacturing under the lease or to apply the amount deposited with it by Ankar in payment of those moneys. It may well be that this result in the instant case is open to the justified criticism that it is brought about by the application to a commercial transaction of a special rule which reflects a common law approach to sureties which is a survival "of the days when commercial dealings were simpler, when surety companies were unknown, when sureties were commonly generous friends whose confidence had been abused" (see Cardozo, The Nature of the Judicial Process, (1921), p 154 and cf. Midland Counties Motor Finance Co. Ltd. v. Slade (1951) 1 KB 346, at p 352). That special rule can however be excluded by contrary agreement of the parties to a commercial transaction if they so desire. The wider question whether the traditional special rules applicable to sureties should be made generally inapplicable to a guarantee given in a purely commercial context raises considerations of general policy which, in the context of settled law, are best left to the legislature to resolve.

16. The appeal by Ankar should be upheld and orders should be made having the effect that the judgment and orders of the learned trial judge are restored. Similar orders should be made in the case of the appeal by Arnick.

Order that the orders of the New South Wales Court of Appeal dated 21 December 1984 be set aside and in lieu thereof order that the appeals be dismissed with costs.

Further order that the declarations of Clarke J. dated 26 September 1983 and the order of Clarke J. dated 6 December 1983 be restored.