CHALLENGING DEBT CLAIMS: PAY LATER AND LITIGATE NOW?

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KEY POINTS Pay now and litigate later clauses in facility documents commonly deny osetting rights to the borrower/guarantor. The recent decision of the NSW Court of Appeal in OBrien v Bank of Western Australia Ltd [2013] NSWCA 71 potentially breathes new life into a guarantors ability to resist summary judgment and circumvent such clauses. Borrowers/guarantors may now run similar arguments in English law facilities, and the recent decision in Deutsche Bank SA v Khan [2013] EWHC 482 (Comm) indicates that approach will work. However Australian lenders will remain worse o than English ones due to the superior remedies available to Australian borrowers/guarantors.

Author Shail Patel

Challenging debt claims: pay later and litigate now?

In this article, Shail Patel considers the effect of the anti set-off clause in loan documentation in light of recent Australian and English case law, in particular debtors attempts to outank the clause. Australian Securities and Investments Commissions (ASIC) Act 2001.

OBRIEN : CONTRACTUAL PROVISIONS PAY NOW, LITIGATE LATER

Loan and guarantee agreements often incorporate clauses designed to provide the lender with a degree of certainty as to the recoverability of advances and guaranteed sums. Known as pay now and litigate later or anti set-o clauses, these are to be distinguished from conventional exclusion or limitation of liability clauses in that they do not purport to neutralise or limit the ability of the borrower or guarantor (referred to here interchangeably as the guarantor) to sue the lender. Rather, they postpone the guarantors rights by providing that he must pay the debt without set-o, counterclaim or other deductions (or similar). It has been held that such a clause: fulls a legitimate commercial function by entitling the creditor to prompt payment of monies due and payable so that cross-claims (which may or may not have merit) cannot be used to withhold or delay payment. This is a perfectly sensible arrangement intended to protect the lenders liquidity/solvency by permitting it to know with condence that sums due will be paid on the appointed day(s). It is understandable that in a loan contract, the lender, who is the party advancing the money and taking the risk, should wish to be protected in this way (Deutsche Bank v Khan, per Hamblen J at [329]).

deal properly with security, estoppel, breach of duciary duty or condence, or fraud. A guarantor also can raise defences open to the borrower as against the lender. Before one gets to the anti set-o clause there is an anterior issue of whether the guarantors allegation is capable of giving rise to a set-o at all. If not, there will be no defence to the lenders liquidated debt claim. If it does, the question will be whether the eect of the clause is nevertheless that the lender can obtain immediate judgment with the guarantor having to litigate his own crossclaims later.

Two relevant clauses of the guarantees were relied upon by the Bank. The suspension clause (the anti set-o clause) provided: As long as any of the guaranteed money remains unpaid, you may not, without our consent: (a) Reduce your liability under this guarantee and indemnity by claiming that you or the debtor or any other person has a right of set-o or counterclaim against us (except to the extent you have a right of set-o granted by law which we cannot exclude by agreement); The preservation clause provided: Rights given to us [the Bank] under this guarantee and indemnity and your liabilities under it are not aected by any act or omission by us or by anything else that might otherwise aect them under law or otherwise, including: ... (b) The fact that we release the debtor or give them a concession, such as more time to pay. The Bank argued that these clauses prevented the guarantors, while the debt remained unpaid, from relying on its crossclaims to withhold payment.

OBRIEN V BANK OF WESTERN AUSTRALIA

In 2006 the Bank entered a facility agreement with a vehicle of property developer Rory OBrien for the funding of a luxury development in the Whitsunday Islands, Queensland. The facility was amended and extended several times. The guarantors were Mr OBrien and the borrowers parent company. The loans were not repaid and in due course the Bank demanded payment from the guarantors of over AU$150m. The Bank applied for summary judgment and the guarantors resisted on the basis of various cross-claims, including: alleged representations that the Bank would extend the facility and make further loans, giving rise to an estoppel; and unconscionable/deceptive conduct giving rise to relief under s 12GM of the

Typically a guarantor will raise cross claims such as misrepresentation, failure to

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CHALLENGING DEBT CLAIMS: PAY LATER AND LITIGATE NOW?

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OBRIEN : THE DECISION

The gravamen of the guarantors case was that due to the Banks conduct, and the relief the guarantors were consequently entitled to, the borrower was not liable for the loan as at the contractual termination date expressed in the facility, nor the date of the Banks demand. The borrower had not therefore failed to pay on time and the guarantors were not liable under the guarantee. This provided the answer to the Banks arguments on the preservation and suspension clauses. As to the former, Ward JA held that if the eect of the Banks alleged conduct was that the borrower did not become liable to repay the loan, there would be no liability to be aected by any act or omission. It would be dierent if (for example) the borrower had become liable to repay but had been granted a concession of more time to pay. As for the suspension (anti set-o) clause, Ward JA held that on its proper construction it only operated once a liability had arisen under the guarantees, hence the reference to that liability being reduced. Where however the defence was that there was no relevant failure to pay by the borrower, and there was therefore no liability under the guarantee at all, the clause did not operate. The suspension clause on its face only operated as long as ... money remains unpaid , and the guarantors defence was that at the relevant time it did not so remain. This line of reasoning gained some support from the distinction identied obiter by McDougall J (also the rst instance judge in OBrien) in St George Bank Ltd v Field [2007] NSWSC 902: There is an important distinction to be drawn between a defence that impeaches the guarantee itself, and a defence that impeaches the exercise of rights under the guarantee. Clauses of the kind to which I have referred may not prevent a defence being raised to liability under a guarantee where it is said (for example) that the taking of the guarantee was itself aected by some vitiating circumstance. But no

such issue is raised in this case. There is no challenge to the validity of the guarantee. The allegations that I have summarised seek to attack the exercise of rights under it. In my view that is the kind of exercise prohibited by the terms of guarantee which terms, as I have said, are to be enforced according to their wording. In the course of the decision in OBrien the Court touched upon a number of the key cases in this area. In each case however

work required on the ship which was to be security for the loan. The facility agreement contained an anti set-o clause in familiar form, requiring payment without set-o, counterclaim or condition whatsoever. The court (Mance J) found on the facts that borrower had not relied on the representations in question, and that rescission was barred by change of position. An interesting feature of the decision however is that the parties had agreed that

It is now extremely difficult for a borrower to succeed on UCTA arguments against an anti setoff clause.

the primary question was whether the words in the anti set-o clause were apt to exclude reliance on the type of point raised by the debtor ([106]): Those cases proceeded in eect on the basis that there was an admitted or underlying liability such that the claim sought to be raised against it would operate (as a counterclaim or set-o) to reduce or extinguish the liability; not where the claim was one going to the existence per se of the liability (which is closer to the situation where the claim is one that would vitiate or discharge the guarantee itself). Accordingly the position where the debtor/guarantor did raise arguable defences going to the existence of the liability was free from binding authority.

ENGLISH AUTHORITY: EMPEROR NAVIGATION

In Skipskredittforeningen v Emperor Navigation [1997] C.L.C. 1151 the lender claimant applied for summary judgment on a loan facility. The borrower crossclaimed for both rescission and damages for misrepresentation, claiming that the lender had misstated the cost of repair

if the borrower did have an arguable claim for rescission, it would need to be disposed of at trial. That must be correct; clearly an anti set-o clause in standard form could not on any reasonable construction deny a borrower the remedy of rescission. Further, to use the language of St George Bank v Field, the rescission defence impeaches the loan agreement, not merely rights arising under it. Conversely it was not suggested (nor could it be) that the claim for damages for misrepresentation could outank the anti set-o clause in the OBrien sense. Instead the borrower fell back on the Misrepresentation Act 1967 as amended by the Unfair Contract Terms Act 1977 (UCTA). That legislation (as well as the Unfair Terms in Consumer Contracts Regulations 1999) is commonly relied upon by borrowers in England seeking to avoid the eects of anti set-o clauses by striking them down. Mance J (at p 1164) cited with apparent approval, the lenders submissions that [s]uch a clause in a loan facility like the present is generally familiar, sensible and understandable, and held that it was fair and reasonable and, accordingly, declined to hold it unenforceable. That reasoning was upheld in WRM Group Ltd v Wood [1998] CLC 189 and January 2014

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Biog box Shail Patel is a barrister at 4 New Square specialising in commercial disputes with an emphasis on nancial services. Email: s.patel@4newsquare.com

applied more recently in Barclays v Kufner [2008] EWHC 2319 and Khan (below). It is now extremely dicult for a borrower to succeed on UCTA arguments against an anti set-o clause.

ENGLISH AUTHORITY: KHAN

The eect of an anti set-o clause came into focus recently in Deutsche Bank (Suisse) SA v Khan & Others [2013] EWHC 482 (Comm), handed down only days before OBrien. Loans of 50m had been advanced and not repaid. The borrowers raised a host of arguments including misrepresentation and breach of contract as to further advances which should have been made available, and absent which the borrowers lost the opportunity to carry out property development and earn substantial prots. The facility agreement contained a conventional anti set-o clause which the borrowers argued was unenforceable under the statutory regimes identied above as well as the Consumer Credit Act 1974. In rejecting these arguments Hamblen J relied upon the reasoning of Mance J in Emperor Navigation, making the remarks quoted at the start of this article in support of the reasonableness of the clause. Having emphasised the commercial utility of these clauses, his Lordship made the signicant observation ([329]) that it was also limited, in that: The clause does not prevent the debtor from contesting whether the sums claimed are actually due. It only comes into play if the sums are either admitted or, if contested, have been proven to be due. []

ANALYSIS
When considered in light of the comments of Hamblen J in Khan and the rescission argument in Emperor Navigation, the decision in OBrien emerges as both unsurprising and obviously correct. If the guarantor argues that there is no liability because, for example, he can rescind for misrepresentation, he is not seeking to set o sums from what is otherwise owed, and the

anti set-o clause is irrelevant. A damages claim, even where arising out of the very same misrepresentation (as in Khan) would however be caught by it. Yet OBrien has caused consternation amongst Australian nanciers. A circular issued by Ashurst Australia on 7 May 2013 advised that the decision would have a signicant impact on recovery claims, and warned of borrowers seeking to bring their defences within its scope. There is some force in this so far as true anti set-o clauses are concerned, because their practical eect is temporal as opposed to substantive. If guarantors are able to thwart summary judgment applications by raising spurious but arguable defences (such as those identied below), the clause will be denuded of all eect. The debt claim will have to be disposed of at trial, and the guarantor therefore achieves a set-o despite the clause. The incentive on desperate guarantors with little or nothing to lose to buy more time by fashioning such claims must be high. When considering the true impact of the OBrien decision, a key issue is the relief which is available to the guarantor; and therein lies a signicant distinction between the English and Australian positions. English law contains no equivalent to s 12GM of the ASIC Act 2001 (and successor legislation) which gives the court powers to order injunctions for breaches of the Act, including by engaging in misleading and deceptive conduct. Thus a suciently serious lie by a lender during the life of a loan could in principle result in retrospective nonenforceability. In England a borrower is largely conned to common law remedies. The main weapon provided by nancial services regulation is s 138D of the Financial Services and Markets Act 2000 (as amended) which provides that breaches of regulatory rules by nancial rms can ground a private law damages claim, though only by a private person. While the guarantors in OBrien also had their estoppel argument, that defence is more fact specic. What arguments then are available to an English borrower to take advantage of the jurisdiction exercised in OBrien and referred to in Khan? A number of possibilities arise: Fraud (ie, Derry v Peak deceit) but only if the fraud is pre-contract (or

pre-amendment) so as to vitiate the agreement. Later fraud will only sound in damages. Estoppel (eg, giving more time to pay), although as this is generally suspensory of rights only, it will only avail a guarantor where the lenders claim is premature. As in Emperor Navigation, rescission for misrepresentation would suce if available and not barred by change of position. If however it is not available, a claim for damages (including under the 1967 Act) would be caught by the anti set-o clause. Defences going to the formation of the loan agreement would also survive the clause; eg, duress, undue inuence and of course forgery or want of authority by the person executing the documents. Arguments that there is no liability because the loan has in fact been discharged should work; eg, where repayment to a third party or agent arguably constitutes valid discharge. Arguments that the loan has not become repayable because of technical defects in procedure, the form or timing of the demand (etc) may also suce provided that the defects cannot be remedied during proceedings. A nal question arises; could a clause be drafted so as to prevent even these arguments from enabling the borrower to litigate now and pay later? Given the repayment obligation is premised on a liability, and these arguments go to the existence of the liability, it is dicult to contemplate how it could be achieved in all cases. The borrower might be required to acknowledge (for example) that the loan has been received, but the acknowledgment is no better than the agreement it is written into. Further, it would seem unlikely that more aggressive clauses aimed at suspending these types of arguments would meet with the same judicial approval that anti set-o clauses have done, where statutory tools are available to strike them down. The anti set-o clauses esteemed status as a perfectly sensible provision depends upon it remaining so.  n

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