Challenging Debt Claims - Pay Later and Litigate Now

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30 January 2014 Butterworths Journal of International Banking and Financial Law CHALLENGING DEBT CLAIMS: PAY LATER AND LITIGATE NOW? Feature KEY POINTS “Pay now and litigate later” clauses in facility documents commonly deny offsetting rights to the borrower/guarantor. e recent decision of the NSW Court of Appeal in O’Brien 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 off 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 outflank the clause. PAY NOW, LITIGATE LATER n 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-off 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 guarantor’s rights by providing that he must pay the debt “ without set-off, counterclaim or other deductions” (or similar). It has been held that such a clause: “fulfils 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. is is a perfectly sensible arrangement intended to protect the lender’s liquidity/solvency by permitting it to know with confidence 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]). Typically a guarantor will raise cross claims such as misrepresentation, failure to deal properly with security, estoppel, breach of fiduciary duty or confidence, or fraud. A guarantor also can raise defences open to the borrower as against the lender. Before one gets to the anti set-off clause there is an anterior issue of whether the guarantor’s allegation is capable of giving rise to a set-off at all. If not, there will be no defence to the lender’s liquidated debt claim. If it does, the question will be whether the effect of the clause is nevertheless that the lender can obtain immediate judgment – with the guarantor having to litigate his own cross- claims later. O’BRIEN V BANK OF WESTERN AUSTRALIA In 2006 the Bank entered a facility agreement with a vehicle of property developer Rory O’Brien for the funding of a luxury development in the Whitsunday Islands, Queensland. e facility was amended and extended several times. e guarantors were Mr O’Brien and the borrower’s parent company. e loans were not repaid and in due course the Bank demanded payment from the guarantors of over AU$150m. e 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 fur- ther loans, giving rise to an estoppel; and unconscionable/deceptive conduct giving rise to relief under s 12GM of the Australian Securities and Investments Commissions (ASIC) Act 2001. O’BRIEN: CONTRACTUAL PROVISIONS Two relevant clauses of the guarantees were relied upon by the Bank. e “suspension” clause (the anti set-off 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-off or counterclaim against us (except to the extent you have a right of set-off granted by law which we cannot exclude by agreement);” e “preservation” clause provided: “Rights given to us [the Bank] under this guarantee and indemnity and your liabilities under it are not affected by any act or omission by us or by anything else that might otherwise affect them under law or otherwise, including: ... (b) e fact that we release the debtor or give them a concession, such as more time to pay.” e Bank argued that these clauses prevented the guarantors, while the debt remained unpaid, from relying on its cross- claims to withhold payment.

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Litigation Issues - Debt claims

Transcript of Challenging Debt Claims - Pay Later and Litigate Now

Page 1: Challenging Debt Claims - Pay Later and Litigate Now

30 January 2014 Butterworths Journal of International Banking and Financial Law

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Feature KEY POINTS�� “Pay now and litigate later” clauses in facility documents commonly deny offsetting rights

to the borrower/guarantor. �� The recent decision of the NSW Court of Appeal in O’Brien 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 off 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 outflank the clause.

PAY NOW, LITIGATE LATER

nLoan 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-off 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 guarantor’s rights by providing that he must pay the debt “without set-off, counterclaim or other deductions” (or similar).

It has been held that such a clause:

“fulfils 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 lender’s liquidity/solvency by permitting it to know with confidence 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]).

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

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

O’BRIEN V BANK OF WESTERN AUSTRALIAIn 2006 the Bank entered a facility agreement with a vehicle of property developer Rory O’Brien for the funding of a luxury development in the Whitsunday Islands, Queensland. The facility was amended and extended several times. The guarantors were Mr O’Brien and the borrower’s 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 fur-ther loans, giving rise to an estoppel; and �� unconscionable/deceptive conduct

giving rise to relief under s 12GM of the

Australian Securities and Investments Commissions (ASIC) Act 2001.

O’BRIEN: CONTRACTUAL PROVISIONSTwo relevant clauses of the guarantees were relied upon by the Bank. The “suspension” clause (the anti set-off 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-off or counterclaim against us (except to the extent you have a right of set-off 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 affected by any act or omission by us or by anything else that might otherwise affect 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 cross-claims to withhold payment.

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O’BRIEN: THE DECISIONThe gravamen of the guarantors’ case was that due to the Bank’s 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 Bank’s 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 Bank’s arguments on the preservation and suspension clauses. As to the former, Ward JA held that if the effect of the Bank’s alleged conduct was that the borrower did not become liable to repay the loan, there would be no liability to be “affected by any act or omission”. It would be different 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-off) 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 guarantor’s defence was that at the relevant time it did not so remain.

This line of reasoning gained some support from the distinction identified obiter by McDougall J (also the first instance judge in O’Brien) 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 affected 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 O’Brien the Court touched upon a number of the key cases in this area. In each case however

the primary question was whether the words in the anti set-off clause were apt to exclude reliance on the type of point raised by the debtor ([106]):

“Those cases proceeded in effect 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-off) 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 NAVIGATIONIn Skipskredittforeningen v Emperor Navigation [1997] C.L.C. 1151 the lender claimant applied for summary judgment on a loan facility. The borrower cross-claimed for both rescission and damages for misrepresentation, claiming that the lender had misstated the cost of repair

work required on the ship which was to be security for the loan. The facility agreement contained an anti set-off clause in familiar form, requiring payment “without set-off, 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

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-off 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 outflank the anti set-off clause in the O’Brien 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 effects of anti set-off clauses by striking them down. Mance J (at p 1164) cited with apparent approval, the lender’s 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

It is now extremely dif ficult for a borrower to succeed on UCTA arguments against an anti set-off clause.

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

ENGLISH AUTHORITY: KHANThe effect of an anti set-off clause came into focus recently in Deutsche Bank (Suisse) SA v Khan & Others [2013] EWHC 482 (Comm), handed down only days before O’Brien. 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 profits.

The facility agreement contained a conventional anti set-off clause which the borrowers argued was unenforceable under the statutory regimes identified 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 significant 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.

[…]”

ANALYSISWhen considered in light of the comments of Hamblen J in Khan and the rescission argument in Emperor Navigation, the decision in O’Brien 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 off sums from what is otherwise owed, and the

anti set-off 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 O’Brien has caused consternation amongst Australian financiers. A circular issued by Ashurst Australia on 7 May 2013 advised that the decision would have a significant 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-off clauses are concerned, because their practical effect is temporal as opposed to substantive. If guarantors are able to thwart summary judgment applications by raising spurious but arguable defences (such as those identified below), the clause will be denuded of all effect. The debt claim will have to be disposed of at trial, and the guarantor therefore achieves a set-off 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 O’Brien decision, a key issue is the relief which is available to the guarantor; and therein lies a significant 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 sufficiently serious lie by a lender during the life of a loan could in principle result in retrospective non-enforceability. In England a borrower is largely confined to common law remedies. The main weapon provided by financial services regulation is s 138D of the Financial Services and Markets Act 2000 (as amended) which provides that breaches of regulatory rules by financial firms can ground a private law damages claim, though only by a private person. While the guarantors in O’Brien also had their estoppel argument, that defence is more fact specific.

What arguments then are available to an English borrower to take advantage of the jurisdiction exercised in O’Brien 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 suspen-sory of rights only, it will only avail a guarantor where the lender’s claim is premature. �� As in Emperor Navigation, rescission

for misrepresentation would suffice 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-off clause. �� Defences going to the formation of the

loan agreement would also survive the clause; eg, duress, undue influence 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 dis-charged should work; eg, where repay-ment 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 suffice provided that the defects cannot be remedied during proceedings.

A final 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 difficult 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-off clauses have done, where statutory tools are available to strike them down. The anti set-off clause’s esteemed status as a “perfectly sensible” provision depends upon it remaining so. n

Biog boxShail Patel is a barrister at 4 New Square specialising in commercial disputes with an emphasis on financial services. Email: [email protected]