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Can a personal guarantee be set aside due to the mental impairment of the guarantor?
By Fiona Reynolds MICM*
Fiona Reynolds MICM
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A recent NSW Court of Appeal decision of Hardy v Coates Hire Operations Pty Ltd [2022] NSWCA 122 considered whether a director’s guarantee was unenforceable because the director was suffering from physical and mental impairment at the time that he signed it.
The contention is one which suppliers are likely to see raised more frequently as the impact of the devastating bushfires and the COVID-19 pandemic on the mental health of individuals translates into more significant and long term mental and physical health issues which have flow on effects for businesses.
Key Takeaways
l Consider incorporating mental health ’first-aid’ training into professional development of credit managers and ‘front line’ business officers to enable them to identify and manage mental health distress in existing and prospective customers. If your credit manager is qualified to identify signs of mental health illness and distress, appropriate measures can be taken before credit is approved to protect the supplier and customer. l Encourage staff engaged in negotiating and approving credit to make detailed file notes of the conversations that
they have with each customer when assessing applications for credit. l Always encourage prospective customers and guarantors to obtain independent legal advice before they sign your credit agreement or guarantee. l Ensure that the clearly legible copies of the credit agreement and guarantee are provided to the customers prior to and after the agreements are signed.
Brief Facts
Coates Hire Operations Pty Ltd (Coates Hire) commenced proceedings against a director of a company to enforce his personal guarantee. Recovery was not available against the company because it was in liquidation.
At the time of the hearing, the director was in an advanced stage of Lewy body dementia and so he could not actively participate in the hearing. He was represented at the hearing by his wife as his tutor.
It was submitted on behalf of the director that at the time that he signed the guarantee, in May 2016, he was suffering from poor physical and mental health due to depression and symptoms of Parkinson’s disease which included poor concentration, poor memory and difficulty in processing information.
The director’s defence sought relief under the Contracts Review Act 1980 (NSW) to declare the guarantee unjust and unenforceable arguing that: 1. there was a material inequality of bargaining power between
Coates Hire and the director because the director lacked the mental capacity to understand the terms of the guarantee or to negotiate its terms to protect his interests due to his ill health; 2. the director did not understand the terms of the guarantee because they were not explained to him by anyone; and 3. the terms of the guarantee were complex and the guarantee document was issued to him electronically which impacted on the readability of the terms of the guarantee.
The evidence before the Judge included evidence from lay witnesses concerning the events and circumstances at the time of signing the guarantee and expert medical evidence as to the director’s level of physical and mental impairment from May 2016 onwards.
Decision at first instance
At first instance, SJ Gibbs DCJ gave judgment in favour of Coates Hire.
The Judge focused on the evidence of the director’s level of ➤
impairment at the time that he signed the guarantee. There was evidence that the director was ’alert and rational’ in his dealings with Coates Hire and that the director had continued to manage the day to day business of his company despite his deteriorating health. The Judge was not satisfied, on the balance of probabilities, that the director suffered from any relevant mental or intellectual impairment at the time that he signed the guarantee.
The Judge was also not satisfied that there was sufficient evidence to establish that there was any material inequality of bargaining power or that the director had not wanted; sought; obtained; understood or did not understand any legal advice. The Judge observed that there was evidence that the company was represented by a lawyer at the time the Coates Hire credit agreement was signed and that when the signed credit agreement was first returned to Coates Hire, the director’s guarantee was struck through and not signed. This plainly indicated that the directors understood the implications of the guarantee and that legal advice was available to the director.
Decision on appeal
On appeal, it was argued on behalf of the director that the trial judge had erred by failing to assess the difficulties inherent in understanding the guarantee from the position of a person in the director’s circumstances.
Importantly, it was not submitted on behalf of the director that any particular term of the guarantee was unfair, unjust or unexpected.
The judgment of the Court of Appeal was delivered by Basten AJA, with whom White and Krik JJA agreed. The Court held: 1. The Judge did consider the
matter from the perspective of the director and she was correct to take into consideration the director’s commercial experience and his position as managing director of the company in that assessment. 2. Whilst there was a significant level of detail in the terms of the guarantee, the overall intention and effect of the document were reasonably transparent. The fact that the directors had first ruled through the personal guarantee demonstrated that they were aware of its terms. 3. The guarantee was not unjust or unfair merely because its terms were not negotiable. 4. There was no evidence that the director did not have a reasonably legible copy of the guarantee before he signed it. In the absence of any contention that the terms of the guarantee were unfair or unjust, questions of readability are of secondary importance. 5. The trial judge did not err in concluding that the evidence did not establish that the director had such a material mental impairment which affected him to such a degree that he could not carry out his functions as director of the company in May 2016.
Implications
It is clear from reading the judgment that the director failed either to lead any, or any satisfactory, evidence to establish the grounds of his defence. Whilst the case was a ‘win’ for Coates Hire, the decision does not beat a clear path to victory for other suppliers facing similar issues.
However, the remarks made by White JA in his judgment, suggest that there may be some sympathy for the difficulties experienced by suppliers facing similar issues:
“It is unnecessary to consider what the position would be if the appellant had established that when he signed the guarantee he suffered from the cognitive deficits for which he contended. It was not suggested that the respondent had notice that he suffered such deficits when he gave the guarantee. As the appellant was the managing director of the company, and the trustee of his family trust was a shareholder of the company, it is far from clear that it would be just for the respondent (Coates
Hire), rather than the appellant (the director), to bear the risk of the company’s insolvency, even if he suffered the cognitive deficits asserts”.
Many supplier readers will certainly endorse and support his Honour’s views. No doubt this issue will receive a lot more judicial consideration and treatment in the near future as suppliers start to resume collection and enforcement activity.
*Fiona Reynolds MICM Partner Turks T: 02 8257 5751 M: 0417 215 703 E: Fiona.Reynolds@turkslegal.com.au turkslegal.com.au
