Bankruptcy - whether a debt was owed by a guarantor for the purposes of an administration under Part X before a demand was made - whether debt or contingent debt.

Bankruptcy Act 1966, ss. 82 and 237

In re J. Brown's Estate. Brown v Brown (1893) 2 Ch. 300

Bradford Old Bank, Limited v Sutcliffe (1918) 2 KB 833

Moschi v Lep Air Services Ltd (1973) AC 331

Sunbird Plaza Proprietary Limited v Maloney [1988] HCA 11; (1988) 166 CLR 245

David Securities Pty Limited v Commonwealth Bank of Australia (1992) 175 CLR

Stadium Finance Co, Ltd v Helm (1965) 109 Sol J 471

Esso Petroleum Co Ltd v Alstonbridge Properties Ltd (1975) 1 WLR 1,474

General Produce Co v United Bank Ltd (1979) 2 Lloyd's LR 255

Bond v. Hongkong Bank of Australia Ltd (1991) 25 NSWLR 286

Heald v. O'Connor (1971) 1 WLR 497

Citicorp Australia Ltd v. Hendry (1985) 4 NSWLR 1

Morris v. Maroudas [1986] FCA 406; (1986) 12 FCR 346

Gye v. McIntyre [1991] HCA 60; (1991) 171 CLR 609

Re Cufari; Ex parte Deputy Commissioner of Taxation v. Huppatz (1992) 110

Hawkins v. Bank of China (1992) 26 NSWLR 562

Solicitors for the Applicant: Kemp Strang and Chippindall

THE COURT ORDERS THAT the applicant bring in, on a date to be fixed, short minutes of orders reflecting the reasons of the Court.

NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

BURCHETT J This case raises a strict point of law as to whether, under certain documents described as deeds of guarantee and indemnity, a debt or liability attached without the necessity for the making of a demand. The significance of the point is that the applicant claims to be a creditor entitled to seek to set aside a deed of arrangement which was executed by the debtors on 24 July 1991 under Part X of the Bankruptcy Act 1966. But if the making of a demand was requisite before the obligation alleged by the applicant could have arisen, and if none was made, the whole complexion of the case would be changed (cf. Beard v. Prestige Baking Industries Pty Ltd [1981] FCA 97; (1981) 36 ALR 307 at 318). Indeed, the applicant says that, instead of pursuing its claim to set aside the deed, it would seek a declaration that it is not bound by the deed, not being a creditor for the purposes of it, and is entitled to make demand now under the documents which, it claims, amount to guarantees and indemnities. In this situation, the parties have agreed that I should determine, as a preliminary question, whether the applicant was a creditor at the date of the deed of arrangement.

2. There are two documents described as deeds of guarantee and indemnity on which the applicant relies. One relates to a loan made by the applicant (described as "Century 21") at the request of the debtors (described as "the Guarantors") to a company Century 21 South Pacific Pty Limited (described as "South Pacific") in the sum of $70,000. The other relates to unspecified amounts to be provided from time to time. Although the terms of the documents are not quite identical, counsel made no distinction for the purposes of their arguments, and I shall confine myself in these reasons to the terms of the former. The documents are very nearly identical.

3. After referring to the loan transaction between the companies, and the request of the guarantors, the former instrument proceeds:

"(W)e ... ("the Guarantors"):

1. Hereby jointly and severally, unconditionally

guarantee to Century 21 the payment, when demanded

(emphasis added) from us or any one or more of us, as

determined by Century 21, of any sum of money

whatsoever that may become payable by South Pacific to

Century 21 under or in accordance with the Promissory

Note provided by South Pacific to Century 21 dated

January 19, 1990, a copy of which is annexed hereto as

Exhibit A (`the Promissory Note').

2. As a separate and severable covenant, hereby jointly

and severally agree that, in the event of South

Pacific in any respect failing to discharge its

obligations under the Promissory Note, the Guarantors

shall jointly and severally indemnify and keep

indemnified Century 21 from and against all costs,

damages, expenses and losses of any nature whatsoever

arising out of or in consequence of any such failure."

The document goes on to contain provisions, of the kind usual in guarantees, against impairment or release by reason of variation or waiver of the obligations in the promissory note, the granting of forbearance to South Pacific, and various other specific matters, as well as, generally, "any other fact, circumstance or thing whatsoever which but for this provision might determine, discharge, impair or release any of the guarantees or indemnities provided hereunder". There is a specific clause (cl. 3(b)) placing upon the guarantors the obligation to "obtain for themselves, as their own responsibility and at their own costs, their own information on all matters affecting the Promissory Note or any variation thereof or the fulfillment (sic) or breach by South Pacific of any of South Pacific's obligations therein contained". There is also a cl. 3(d), as follows:

"The guarantees and indemnities contained in Clauses 1 and 2

of this Guarantee and Indemnity shall be principal

obligations and shall not be treated as ancillary or

collateral to any other obligation howsoever created or

arising to the intent that these guarantees and indemnities

shall be fully enforceable without Century 21 taking any

step whatsoever against South Pacific or otherwise (emphasis

added), unless the same shall have been satisfied according

to the terms hereof, and notwithstanding that all or any one

or more of the obligations of South Pacific shall be or be

declared to be in whole or in part unenforceable whether by

reason of any statute (including without limitation any

statute of limitation) or for any other reason."

The instrument is dated 19 January 1990, thus well antedating the deed of arrangement, as does the other relevant instrument, which is dated 2 February 1990.

4. The general rule as to whether a demand is necessary before liability attaches under a guarantee is stated in Rowlatt on the Law of Principal and Surety 4th ed. (1982) at 115, as follows:

"A surety has not, unless his contract so provides, any right

to require a demand to be made upon him before action. If a

surety gives a bond conditioned to be void on the payment of

a similar sum `on demand,' or covenants or promises to pay

the principal debt `on demand,' a demand must be made upon

him before he can be sued. His obligation is to pay the

collateral sum, and differs from a promise to pay on demand

a present debt owing by the promisor. In the latter case an

action can be brought at once without any other demand than

the writ."

The broad proposition, that a surety whose contract did not stipulate for notice became immediately liable when due payment was not made, is supported, with reference to a guarantee of payment under a bill of exchange, by the judgment of Lindley LJ in Barber v. Mackrell (1892) 68 LT (N.S.) 29 at 31. See also Bank of Montreal v. Hache (1982) 38 NBR (2d) 54 at 57-58; G. Andrews and R. Millett, Law of Guarantees (1992) 163.

5. But in the case of the instruments on which the applicant relies, it will have been noticed that cl. 1 includes the express words "when demanded from us ... ". As Rowlatt indicates, these words may require a demand. The question was considered by Chitty J (as he then was) in In re J. Brown's Estate. Brown v Brown (1893) 2 Ch. 300 at 304-305. That learned judge said, in relation to the rule that, where money is lent payable upon request, no demand is necessary before bringing the action:

"That is a general proposition ... and ... it is plain that a

distinction has been taken and maintained in law, the result

of which is, that where there is a present debt and a

promise to pay on demand, the demand is not considered to be

a condition precedent to the bringing of the action. But it

is otherwise on a promise to pay a collateral sum on

request, for then the request ought to be made before action

brought."

He added the conclusion: "It is a question, then, of the construction of the instrument", that is to say, as I understand his reasoning, in order to ascertain whether it provides for the payment of "a collateral sum on request". This case was relied upon, together with a number of other authorities, by Scrutton LJ in Bradford Old Bank, Limited v. Sutcliffe (1918) 2 KB 833 at 848-849, where he said:

"Was it here necessary for the plaintiff to prove a demand?

Generally, a request for the payment of a debt is quite

immaterial, unless the parties to the contract have

stipulated it should be made: per Parke B. in Walton v.

Mascall [1844] EngR 1018; (1844) 13 M. and W. 452, 458. Even if the word

'demand' is used in the case of a present debt, it is

meaningless, and express demand is not necessary, as in the

case of a promissory note payable on demand ... . But it is

otherwise where the debt is not present but to accrue, as in

the case of a note payable three months after demand ... ;

or where the debt is not a present debt, but a collateral

promise: Birks v. Trippet [1845] EngR 19; 1 Wms. Saund. 32 In re Brown's

Estate (1893) 2 Ch 300. The promise of a surety to pay on

demand if his principal does not appears to me to be a

collateral promise within the authorities; and I entertain

no doubt that in this guarantee the provisions about demand

are a real stipulation, and not mere words. The surety is

to pay 'on demand' ... ; while, as the guarantee is 'against

loss on the realisation of debentures,' the surety would

need to be informed by demand of the amount he was called

upon to pay. I am of opinion that the creditor must prove a

real demand, and therefore that the Statute of Limitations

did not run till the demand had been made."

"In my opinion the document, both from its nature and from its

language, indicates that the guarantors stipulated for a

demand being made upon them before the bank could enforce

the guarantee against them."

"It was argued on behalf of the defendant that the words 'on

demand' should be neglected because the money was due, and

therefore a demand was unnecessary and added nothing to the

liability. This proposition is true in the case of what has

been called a direct liability - for example, for money

lent. There the liability exists as soon as the loan is

made, and a promise to pay on demand adds nothing to it, as

in the case of a promissory note for the amount payable on

demand, and the words 'on demand' may be neglected. It has,

however, been held long ago in cases more particularly

mentioned by the other members of the Court that this

doctrine does not apply to what has been called a collateral

promise or collateral debt, and I think a promise by a

surety to pay the original debt is such a collateral

promise, or creates such a collateral debt. ... The only

question, therefore, is whether, on the construction of the

guarantee, the parties meant the words 'on demand' to mean

what they say. I cannot doubt that they did."

The same view was taken by a Canadian appellate Court in Canadian Petrofina Ltd v. Motormart Ltd (1969) 7 DLR (3d) 330 at 335-337, and is implicit in the decision of the New South Wales Court of Appeal in Bond v. Hongkong Bank of Australia Ltd (1991) 25 NSWLR 286.

6. The emphasis placed in Re Brown and Bradford Old Bank on the construction of the particular document is fully supported by high modern authority. In Moschi v. Lep Air Services Ltd (also called Lep Air Services v. Rolloswin Ltd) (1973) AC 331 at 344, Lord Reid said:

"... I think that it is necessary to see what in fact the

appellant did undertake to do. I would not proceed by

saying this is a contract of guarantee and there is a

general rule applicable to all guarantees. Parties are free

to make any agreement they like and we must I think

determine just what this agreement means."

"Whether any particular contractual promise is to be

classified as a guarantee so as to attract all or any of the

legal consequences to which I have referred depends upon the

words in which the parties have expressed the promise. Even

the use of the word 'guarantee' is not in itself conclusive.

It is often used loosely in commercial dealings to mean an

ordinary warranty. It is sometimes used to mis- describe

what is in law a contract of indemnity and not of guarantee.

Where the contractual promise can be correctly classified as

a guarantee it is open to the parties expressly to exclude

or vary any of their mutual rights or obligations which

would otherwise result from its being classifiable as a

guarantee. Every case must depend upon the true

construction of the actual words in which the promise is

expressed."

In Sunbird Plaza Proprietary Limited v. Maloney [1988] HCA 11; (1988) 166 CLR 245 at 255, Mason CJ said:

"So it is that a creditor's rights against a guarantor depend

on the terms of the guarantee and the nature of the

obligation, performance of which is guaranteed. If the

subject of the guarantee is payment of a debt or a sum of

money which has accrued due, the creditor may, on default by

the principal debtor, sue the guarantor instead of the

principal debtor for the debt or sum of money, his claim

being for a liquidated amount. If, on the other hand, the

subject of the guarantee is the performance of some other

obligation, then the person having the benefit of the

guarantee may, upon default, sue the guarantor for damages

for breach of contract."

7. Thus Mason CJ saw at least two quite different ways in which might be reflected the major obligation involved in a contract of guarantee, which he had defined (at 254) as,

"subject to any qualifications made by the particular

instrument, a collateral contract to answer for the debt,

default or miscarriage of another who is or is contemplated

to be or to become liable to the person to whom the

guarantee is given".

In so defining a guarantee, he had distinguished an indemnity as "a promise by the promisor that he will keep the promisee harmless against loss as a result of entering into a transaction with a third party". (Cf. the definition given in Stroud's Judicial Dictionary (5th ed, 1986) vol. 3 p. 1,278.) His Honour, after discussing Lord Diplock's view of the effect of a contract of guarantee, concluded (at 256):

"My own view of the matter accords with that expressed by Lord

Reid in Moschi (at 344-345) where his Lordship rejected the

notion that there was a common rule applicable to all

guarantees and acknowledged that the parties are at liberty

to make such agreement as they choose. There are, however,

two common classes of guarantee of the payment of

instalments by the principal debtor. The first is an

undertaking by the guarantor that if the debtor fails to pay

an instalment he will pay. This is a conditional agreement.

The guarantor's obligation to pay arises on the debtor's

failure to pay. The second is an undertaking by the

guarantor that the debtor will carry out his contract. Then

a failure by the debtor to perform his contract puts the

guarantor in breach of his."

8. The present case is not a case of a guarantee of instalments, and the form of the instrument does not fit neatly, except as regards cl. 1, within either of the two categories mentioned by Mason CJ Certainly, cl. 1 is a guarantee of "the payment", although, as the clause is expressed, only "when demanded". But cl. 2 has been drafted as an obligation to indemnify against costs, damages, expenses and losses "arising out of or in consequence of" a failure, and that failure is expressed by the words: "in the event of South Pacific in any respect failing to discharge its obligations under the Promissory Note". The word "indemnify" is used, but the obligation is only to attach in the event of a failure by South Pacific to discharge its obligations. This looks very like the language of a collateral contract to answer for the default of another, who is contemplated as liable in the first place to the promisee. It does not appear to express a primary obligation undertaken by the guarantors.

9. Of course, it is not necessary that the obligation undertaken by the guarantors should be in any sense secondary for it to be correctly described as "collateral". That was made clear in In re Athill. Athill v Athill (1880) 16 Ch D 211, a decision accepted as right in David Securities Pty Limited v Commonwealth Bank of Australia [1992] HCA 48; (1992) 175 CLR 353 at 364-365 in the joint judgment of Mason CJ, Deane, Toohey, Gaudron and McHugh JJ. Their Honours said:

"Collateral contracts are so called not because they are

subordinate or of lesser importance (although they may well

be, depending on the facts of the case), but because they

impinge upon and are related to another contract. ... Once

the notion of primacy is jettisoned, 'collateral' must be

understood in the sense of 'related to' or even 'in addition

to'."

It is interesting to note how, in In re Athill, Cotton LJ described (at 224) the argument for subordination of the collateral security. He referred to it as being that the property the subject of this security was "taken as an indemnity ... in case the (property the subject of the allegedly primary security) should be insufficient". That is to treat an indemnity as an example of a secondary collateral obligation. However, Cotton LJ rejected this view on the basis that it did not accord with "the construction of the deeds". He concluded (at 225) that the property the subject of the collateral security was to be "an additional or further security, not that one was to be secondary and the other the primary security".

10. There is no doubt that a true guarantee is a collateral contract, not only in the strict sense of an additional contract related to the principal contract, but also in the sense that it involves a secondary obligation. A true indemnity involves a primary obligation: see G. Andrews and R. Millett, op. cit. 9-10. In Stadium Finance Co, Ltd v Helm (1965) 109 Sol J 471 (cf. Heald v. O'Connor (1971) 1 WLR 497 at 503; Citicorp Australia Ltd v. Hendry (1985) 4 NSWLR 1 at 20, per Clarke J), the Court of Appeal had to consider the question whether a document, described as an "indemnity form" but expressed in the following terms, was, in fact, a guarantee:

"(1) I will upon demand pay to you such sum or sums of money

as may at any time or from time to time have become payable

by the customer but be unpaid by him. (2) I will indemnify

and keep indemnified you your successors and assigns from

all loss or damage suffered and all claims costs and

expenses made against or incurred by you in any way arising

out of or consequent upon your having entered into such

agreement, whether arising out of a breach by the customer

of any of the terms and conditions thereof or otherwise

including any such loss or damage, etc., as aforesaid as may

arise from the said agreement being (for whatever reason)

unenforceable against the customer. (3) No relaxation or

indulgence which you may from time to time or at any time

extend to the customer shall in any way prejudice or act as

a waiver of your strict rights against me hereunder."

Lord Denning MR, with whom Davies and Russell LJJ agreed, held that the document was a guarantee, despite its use of the word "indemnify". The report in the Solicitors Journal contains only a note of his Lordship's judgment in summary form, which includes the following:

"LORD DENNING, MR, said that the test was whether, as

between two people, one of the two was under a primary

liability to perform the obligation, while the other's

obligation was secondary only. If so, it was a contract of

guarantee and not of indemnity. One always looked to see if

there was a primary and a secondary obligation, or two

primary obligations. Clause (1) of this document was a

contract of guarantee. It was something which the customer

ought to pay and had not paid. Clause (3) was also

applicable to a guarantee. But the company relied on cl.

(2) as an indemnity. His lordship did not think that these

cases could be decided on a literal construction of these

documents. Reading cl. (2) in relation to cll. (1) and (3),

the whole burden of this document was that it was a

guarantee, to come into force if the principal debtor

defaulted and to the extent of his default."

"if finance companies wished to make sure that a primary

liability was put on others, ... they must find some other

and clearer form, bearing in mind that most people were not

prepared to subject themselves to the nuisance of primary

liability, and were not prepared to pay what the contract

did not oblige the hirer himself to pay."

It seems to me that the language of the document involved in that case went much closer to expressing an indemnity than does the language of cl. 2 of the document with which I am concerned, standing alone. For, as I have said, cl. 2 limits the obligation it expresses to the situation arising in the event of South Pacific's failure to discharge an obligation which, so far as cl. 2 is concerned, seems plainly to be a primary obligation.

11. However, cl. 2 does not stand alone. Clause 3(d) must also be taken into account. This provision expressly refers to both cl. 1 and cl. 2. It says they "shall be principal obligations and shall not be treated as ancillary or collateral to any other obligation ... ". Pausing there, an obvious difficulty which would be involved in taking this express statement as converting cl. 2 into a principal obligation is that, in the very same phrase, it purports to convert cl. 1 into such an obligation. Clause 1 is plainly expressed as a secondary obligation. I think that, in respect of both cl. 1 and cl. 2, the key to understanding cl. 3(d) is to be found in the words "to the intent that these guarantees and indemnities shall be fully enforceable without Century 21 taking any step whatsoever against South Pacific or otherwise ... ." Clause 3(d) does not make cll. 1 and 2 principal obligations for all purposes (cf. General Produce Co v. United Bank Ltd (infra)), but only so that certain consequences expressed in cl. 3(d) may follow. One of those is to avoid the effect upon a guarantee of the unenforceability of the principal obligation. But another object of the subclause is expressed by the words I have quoted denying the need to take any step. The question which is relevant for present purposes is whether those words deny the need to make any demand.

12. So far as cl. 1 is concerned, I do not think the very broad general language of cl. 3(d) can be given the effect of contradicting the express provision by which the liability imposed on the guarantors is to attach only when a demand is made upon them. At least in relation to cl. 1, the somewhat Delphic words "or otherwise" cannot extend to the making of a demand. But can they have a different operation in respect of cl. 2 from that to which they are confined in respect of cl. 1? This seems to me to be a difficult question. However, of their own force, the words are quite apt to embrace the making of a demand. They deny, perfectly comprehensively, the need for Century 21 to take "any step whatsoever against South Pacific or otherwise". It is only because of the clear terms in which cl. 1 is expressed, and not because of any deficiency in the language of cl. 3(d), that the stipulation of the necessity of a demand must survive unscathed in cl. 1. So far as cl. 2 is concerned, it contains no such stipulation. Had there been no cl. 3(d), it is true that the nature of the circumstance in which cl. 2 takes effect, the failure of South Pacific to discharge its obligations, might possibly be regarded as a reason for inferring that the demand required by cl. 1 must also be required in a case falling within cl. 2: cf. the reference by Bankes LJ to the nature of the contract in the passage I cited earlier from his judgment in Bradford Old Bank. However, cl. 2 is prefaced by words indicating that it is "a separate and severable covenant". It does not contain, in express terms, any requirement of a demand. There is therefore nothing in the clause, as there is in cl. 1, to forbid the application of the words of cl. 3(d) in their natural meaning to the obligation arising under cl. 2. And, as I have said, the general rule is that there is no right in a surety to require a demand to be made upon him, unless his contract so provides. That general rule is reinforced, in the present case, by cl. 3(b), which throws the responsibility on the guarantors to ascertain for themselves whether the principal debtor is in breach of its obligations. Cf. the remarks of Lord Diplock in Moschi at 348.

13. It has been suggested that the presence, in a contract of guarantee, of a "principal debtor" clause will obviate the need for a demand, where it would otherwise be required: Phillips and O'Donovan, The Modern Contract of Guarantee 2nd ed. (1992) at 28 and 420, citing Esso Petroleum Co Ltd v Alstonbridge Properties Ltd (1975) 1 WLR 1,474 at 1,483, per Walton J. However, Walton J did not really commit himself to this proposition. He said (at 1,483), referring to the fact that the guarantee he was construing stipulated for payment "on demand" but also entitled the creditor to treat the sureties as principal debtors:

"(W)here the character in which payment is required is that of

surety, a demand is, in general, necessary; but I assume for

present purposes (without finding it necessary so to decide)

that the provisions ... equating the liability of the

sureties to that of principal debtor, (are) effective to

obviate the necessity for a demand merely on this ground."

This statement was discussed by Lloyd J in General Produce Co v United Bank Ltd (1979) 2 Lloyd's LR 255 at 259. Lloyd J made it clear that the extremely guarded dictum, if that is what it really is, in the earlier decision could offer little guidance for a different case. He also made it clear that a "principal debtor" clause "does not necessarily mean (the guarantor) is to be regarded as the principal debtor for all purposes from the inception of the guarantee but only that the creditor is entitled to treat him as a principal debtor in certain events". To my mind, this comment refutes the statement made in Phillips and O'Donovan. No generalization is possible; the question must always be one of construction of the particular guarantee. Bearing in mind the comments of Lord Denning MR to which I have referred earlier, if the general tenor of the document indicates that it is a guarantee, it will often be appropriate to read a "principal debtor" clause as having effect only for the purposes expressed in it. Generally, if the contract is a collateral contract, the reasoning of the Court of Appeal in Bradford Old Bank would require a conclusion contrary to that so tentatively suggested in Esso Petroleum. But it is unnecessary to pursue this point further in the present case, since, as it seems to me, cl. 2 does not stipulate for a demand.

14. Since cl. 2 does not stipulate for a demand, and cl. 3(d) denies that the applicant need take any step before cl. 2 becomes "fully enforceable", I have reached the conclusion that a liability came into existence, without notice or demand, from the time Century 21 South Pacific Pty Limited failed to honour its obligations under each promissory note. It follows that the applicant was, at the date of the deed of arrangement, a creditor of the guarantors who executed it as debtors.

15. This result means that, once again, it is unnecessary for the Court to pronounce upon an interesting and difficult question, which other judges of this Court and judges of the High Court have, in a succession of cases, refrained from answering: see Morris v. Maroudas [1986] FCA 406; (1986) 12 FCR 346 at 357, per Toohey J (with whom, on this point, Northrop J agreed); Re Gye and Perkes; Ex parte McIntyre (1989) 89 ALR 460 at 481-482, per Hill J, and cf., on appeal, Gye v. McIntyre [1991] HCA 60; (1991) 171 CLR 609 at 618; Re Cufari; Ex parte Deputy Commissioner of Taxation v. Huppatz [1992] FCA 95; (1992) 110 ALR 497 at 503-504. That question is whether a contingent debt is within the debts that may be proved in an administration under Part X. Had I concluded that no obligation could arise under the instruments of guarantee until after demand, the debtors would have owed debts contingent upon the making of demands, and the point would have arisen squarely for decision. But in the circumstances it does not arise, and I will not rush in to decide it, where all those learned judges have feared to tread. I will say, however, that I do not think the answer is to be found in Hawkins v. Bank of China (1992) 26 NSWLR 562, which was pressed upon me. That authority is concerned with an entirely different problem - the application to a guarantee of s. 556 of the Companies (New South Wales) Code.

16. The order of the Court is that the applicant bring in, on a date to be fixed, short minutes of orders reflecting these reasons.