Guarantor security survival risks.
As many businesses struggle to survive COVID-19’s economic impacts, the best option for a company with an otherwise profitable business may be to consider a Deed of Company Arrangement (DOCA).
If you are a stakeholder of a company that is subject to a DOCA (or a proposal has been made), it is important to understand what happens if the DOCA is terminated. This article focuses on the effect of the termination of a DOCA in relation to personal guarantees provided to support the DOCA.
A DOCA proposal often includes a personal guarantee, usually from a director or their family member, to give some confidence to stakeholders that the proposal is genuine. If the DOCA proposal is accepted and the DOCA is later terminated however, the question arises as to whether the liquidator or the company can rely on the terminated DOCA terms to enforce that security.
Three case laws on this point offer some context and guidance on this front:
- Sutherland v Rahme Enterprises Pty Ltd [2003]
- Lombe v Wagga Leagues Club Ltd [2006]
- Garcia v National Australia Bank Ltd [1998]
In Sutherland v Rahme Enterprises Pty Ltd [2003], section 445H of the Corporations Act 2001 (the only statutory guidance on a DOCA termination’s effect) was interpreted to say that the persons “initially bound” by a DOCA cease upon its termination “to be bound as to their future conduct, rights and liabilities”.
Even if a term is explicitly included in a DOCA seeking to ensure the guarantor’s obligations survives its termination, it is apparent from Lombe v Wagga Leagues Club Ltd [2006] that a liquidator or the company “could not, after termination, look to the deed as a source of power and protection”.
It was further explained in that case that:
“[a] necessary consequence of termination is that the deed ceases to be binding in the ways specified in ss 444D and 444G. From and after termination, the deed does not bind any of the persons and classes of persons mentioned in the provisions.”
When a third party provides a personal guarantee (e.g. a spouse) who does not stand to receive any tangible benefit from a DOCA, whether the guarantee’s nature and effect was adequately explained could also be used to prevent enforcement (Garcia v National Australia Bank Ltd [1998]). That is, it could be held by a court to be ‘unconscionable’ to enforce a guarantee against a volunteer third party, if it could be shown that they did not understand the transaction and no steps were taken to explain it.
To overcome the above obstacles, it may be that stand-alone security documents are executed concurrently with the DOCA; and in the case of a third-party guarantor, ensure they get legal advice regarding the consequences of the guarantee and obtain a solicitor certificate to confirm that position.
