Guarantor becomes effectively the lender
Subrogation when considered in insolvency matters is: “the substitution of one person or group by another in respect of a debt, accompanied by the transfer of any associated rights and duties”.
In an insolvency context, this principle usually applies to guarantees and continues to apply even if some of the parties are insolvent estates.
Generally where a guarantor pays out (or pays money towards the total discharge of) the debt of another (the principal), once the debt is paid out the guarantor may ‘stand in the shoes’ of the original lender and obtain that lender’s rights as they relate to the loan and the principal.
Thus, if my guarantee of your debt is called up and I pay that debt I can then pursue you for the amount that I have paid. Also, I am entitled to the benefit of any security which you provided to the original lender. A practical example of how this works has arisen in a liquidation Worrells is appointed to. The facts are:
- Company A borrowed heavily from its Bank and gave a mortgage over land that it held.
- The Bank wanted more security (not an unusual scenario) and received a guarantee from company B, which supported that guarantee with a mortgage over land that it owned.
- Company B was wound up by another creditor and Worrells were appointed. We have sold the land owned by company B, but the sale proceeds have gone to pay company A’s bank debt under the security. The Bank is now paid in full.
As liquidators of company B we are insisting on having the Bank’s mortgage over company A assigned to us. In other words we are exercising our right of subrogation.
The director of company A does not appear to have understood the application of the right of subrogation and seems to have anticipated that company A would get a wind fall profit out of the winding up of company B and its assets being used to pay the Bank.
I suppose the easiest way to explain this principle in layman’s terms is: if someone else pays your debt under a guarantee, you are probably only changing creditors.