“In general, the public should be discouraged from giving guarantees. In the case of families and friends it is usually particularly harrowing…I think that commercial lenders often seek guarantees where it is not necessary and adds little to the real likelihood of closure/recovery of the debt. Often it adds to the expense of recovery without doing more than employing more lawyers and accountants. That is quite apart from the public resources consumed by the fierce/desperate resistance from a guarantor who stands to lose everything …”.1
THIS RESEARCH
1.1 Third party guarantees are often undertaken when a credit provider will not lend money, or will not extend a loan, unless the loan is secured by a guarantee provided by a person other than the borrower. This third person may not be involved in, or benefit from, the loan transaction itself. Third party guarantors are typically the wives, partners or parents of borrowers and often undertake the obligation due to their close relationship with the borrower. Borrowers are frequently involved in running small businesses, including family businesses.
1.2 A guarantee may be a personal guarantee, or it may be secured over property by a mortgage, or both. If the borrower defaults on the loan, the guarantor then becomes liable to repay all or part of the loan. The guarantor is very often also liable to pay for transaction costs – such as interest, and the bank’s recovery fees and legal fees – in addition to the principal sum.
1.3 Guarantor transactions are considered to be at high risk of unfair dealing for a number of reasons.2 Such contracts are typically undertaken in a relationship of emotional interdependence with the borrower of the primary loan. Unlike most contractual arrangements, this transaction is not an arm’s length transaction because of the close relationship between the borrower and guarantor. The existence of a relationship of interdependence may mean that the guarantor will become a guarantor without engaging in the usual inquiries that a person entering a business arrangement would; and instead agrees for “unbusinesslike” motives such as emotional attachment; or optimistic affirmation of the borrower’s decision. One judge who responded to our survey stated:
“Contracts of guarantee are the only contracts which parties enter into on the assumption that they will not be required to perform the contract. They accordingly give rise to human and psychological issues which are not present in other contracts.”3
1.4 Yet guarantees are clearly contracts with commercial implications, regardless of whether they were made for any commercial reason, or with the awareness that entering such a transaction entails an intention to be legally bound by the contract’s terms.4
1.5 Guarantee transactions have generated an enormous volume of litigation in the past 20 years. There have been numerous major reports referring to the problem of relationship debt in recent years as concern about guarantee transactions has grown.5 In March 1999 the New South Wales Attorney General asked the New South Wales Law Reform Commission (“the Commission”) to undertake a review of the law relating to third party guarantees. In 2000 the Commission released an Issues Paper that outlined the state of the law on guarantees, the operation of guarantees including the regulatory framework and industry practice, and identified a number of issues for consideration.6 It is expected that following the publication of this empirical research, the Commission will issue a final report which makes use of this research to formulate law reform proposals.
1.6 This project was carried out in partnership between the Faculty of Law at the University of Sydney and the Commission between 2000 and 2003 with funding made available by an Australian Research Council Strategic Partnerships in Industry, Research and Training grant.
1.7 In the early 1990s Belinda Fehlberg conducted the first empirical research into the issue of third party guarantees when she undertook a small-scale qualitative study in the United Kingdom. Fehlberg’s in-depth research comprised interviews with 22 guarantors (whom she refers to as “sureties”), five borrowers, nine lenders and 13 lawyers.7 Fehlberg’s research focused only upon guarantors who had supported the loan of a spouse or de facto partner.
1.8 Fehlberg noted that the most common situation in the reported case law on disputed third party guarantees was that of a wife who:
“under some emotional pressure or misunderstanding caused by her husband, signs a charge over the family home in order to provide financial assistance to a business, usually conducted by her husband, but often providing the family’s income.”8
Fehlberg’s research found that this scenario was borne out by the guarantors she interviewed. A major theme to emerge from the interviews was that the guarantors viewed themselves as having no real choice about providing security for the borrower’s debt. Reasons for this ranged from emotional pressure to threats and physical violence, and Fehlberg noted that economic dependence on the borrower was a key aspect in constraining the guarantors’ choice. Fehlberg noted that third party guarantees sit at an uncomfortable intersection of the private sphere (family and relationships) and the public sphere (business, law, finance), and argued that the perspectives of guarantors must be more thoroughly integrated into legal and policy reform of this area.
1.9 Our project is the first comprehensive Australian empirical research into the law and practices governing third party guarantees. We were particularly interested to see whether the Australian experience was similar and whether many of Fehlberg’s key findings would be repeated in a larger and more broadly recruited sample. We were also interested in determining whether there were other vulnerable groups affected by guarantees, such as elderly parents and family members in families from non-English speaking backgrounds. We considered that issues of power, choice and economic dependence identified by Fehlberg in the context of couple guarantors may also be active in other contexts.
1.10 This report is divided into chapters that follow the inception, life and death of a guarantee transaction, beginning with the original loan and following it through to the resolution of disputes about the guarantee of the loan. Chapter 2 discusses who is borrowing and why, Chapter 3 gives an overview of who is providing guarantees and why, Chapter 4 outlines the context in which credit is provided, what regulation governs credit providers and available information about lending practices. Chapter 5 considers the form of guarantee documents and the process of the guarantee transaction, Chapter 6 gives information on what happened when the loan went wrong, including non-litigated dispute resolution, while Chapter 7 discusses what is occurring in litigation. Chapter 8 discusses the implications of the research findings.
WHAT WE WANTED TO DISCOVER
1.11 This research was directed to finding out more about the experiences of the people who agree to guarantee the loans of others. Why do they sign on, how do they get into trouble in those transactions and what might have assisted them in avoiding such difficulties?
1.12 While we learn some things about guarantee transactions from reported judgments of cases that are litigated when things “go wrong”, these cases are not necessarily helpful in gaining an understanding of what is occurring more broadly. Litigated cases represent a very small percentage of disputed matters, the vast majority of which settle prior to, or during, litigation. Reported cases also do not give any sense of transactions that are not disputed; either because they are unproblematic, or because the guarantor did not dispute the loan when it was called upon (for example if they sold their property to pay it, or went bankrupt). Therefore, drawing information only from cases that proceed to litigation may be misleading when policy-makers and researchers are trying to determine what the key issues are in guarantee transactions.
1.13 This research sought to learn as much as possible about the practice of guarantee transactions from those who had undertaken them. The project sought to gauge the experience of guarantors through the life cycle of the transaction. We sought demographic information about guarantors and their relationship with the primary borrower, their age and the cultural backgrounds. We also wanted information on the “point of sale” – that is, how the transaction was executed, who organised the guarantee, where it was signed, who was present, what information the guarantor had and the guarantor’s understanding of the transaction at the time they signed. We elicited information on how the guarantor found out there were problems with the transaction, what they did, who they sought assistance from and what kind of dispute resolution mechanism (if any) they pursued. As a fundamental question, we also wanted to know, from the guarantors themselves, why they entered into this kind of inherently risky transaction.
1.14 We wanted to ascertain whether widespread assumptions about the make-up of guarantors – that they are largely women, predominantly the wives of men operating small businesses and frequently from non-English speaking backgrounds – could be confirmed. We also wanted to consider whether numerous solutions that have been proposed to address the problems of guarantee transactions – such as “cooling off” periods after signing a guarantee, allowing for a guarantor to withdraw, or requiring the provision of legal advice or financial advice before signing – would make any difference to whether and how guarantors entered into such transactions.
1.15 There is clearly a paucity of comprehensive statistical data about the prevalence of third party guarantees. This study sought to address that absence, and to provide reliable data so that lenders, borrowers, guarantors, litigants and legislators alike could assess the situation with more clarity. It has been remarked that in the absence of solid statistics, courts and policy-makers have relied on partial, anecdotal or qualified data.9 Certainly, the lack of solid empirical data has, in no small way, led to reliance on stereotypes about strong and weak parties or outdated assumptions about “special protection” which should be afforded to married women. The research team was aware that in collecting empirical evidence about the gender breakdown of those involved in guarantee transactions, we should be mindful that we not simply reify the gender stereotyping that has, to date, been problematic.10
1.16 There has been considerable concern within the legal profession about the duties owed by lawyers engaged to advise guarantors in these circumstances. The researchers considered it important to understand what is occurring in practice in the provision of legal advice. This is particularly important as we expected more lenders to rely on the provision of independent legal advice as a defence to claims from guarantors following the High Court’s decision in Garcia v National Australia Bank Ltd.11 The research set out to analyse the extent and nature of legal advice, including situations where advice was given before people enter into such transactions, and also advice received after guarantees were called upon. We also sought opinions from lawyers on what they perceive to be their role and obligations in relation to the provision of legal advice about third party guarantees.
WHAT WE DIDN’T EXPLORE
1.17 This is a research-based project which aims to present data to form a clearer picture of what is currently occurring in practice. This report does not restate in any detail the laws that govern the setting aside of unfair guarantee transactions. Legislation and common law on these issues is explained in detail in the Commission’s Issues Paper.12 Nor do we make recommendations about how the law in this area could or should be changed. Recommendations for change will be part of the Commission’s final report, which will follow on from this project. This report will not make recommendations but will instead highlight issues for consideration, both for the Commission and for any other legal or policy body considering these issues.
1.18 During the course of this project it became apparent that problems with third party guarantees cannot be neatly defined, analysed or compartmentalised in terms of credit provision, the taking of security and enforcement thereof. Other major issues include the complex intersection of family law, bankruptcy and other aspects of relationship debt. Such problems and questions were beyond the scope of our research. While the research obtained useful data on the circumstances surrounding the signing of a guarantee, and the setting aside of third party guarantees, the scope of our research did not extend to consider in detail what happened after litigation had concluded. It is clear, however, that the difficult intersection between credit provision, debt and family law is an area warranting further investigation.
HOW WE WENT ABOUT LOOKING
1.19 This project used a variety of methods to collect information from individuals and organisations, taking into account the objectives of the project, time frame and exploratory nature of the research. Both qualitative and quantitative data collection techniques were selected to suit the target group from which the information was sought.
1.20 A flexible approach was adopted for data collection to allow inclusion of information from a variety of sources and addition of extra respondents where early results indicated the need. Our focus was upon NSW, but responses from elsewhere were not excluded. This report also makes use of lenders’ non-confidential responses to the Commission’s Issues Paper.
1.21 Qualitative data was collected primarily by interviewing guarantors. Information about guarantee transactions was also sought from legal advisers who had acted for guarantors during the transaction and also those who had acted for either guarantors or lenders when post-transaction difficulties arose. The views of barristers and judges were sought specifically about the litigation phase of guarantee disputes.
1.22 Quantitative data was collected by use of tick box questionnaires which were sent directly to solicitors and barristers, made available on the Commission’s website, and publicised to the general community through avenues such as radio advertisements, radio talk-back and news features.
1.23 Of the 87 guarantors who responded to our survey, we had broad geographical coverage. Of 71 respondents who were resident in New South Wales, 30 came from regional NSW.
1.24 Of the 89 solicitors and 47 barristers who responded to our surveys, there was an even division between those who had acted last for a guarantor and those who had acted for a lender. The fact that we had lawyers who had acted for both sides in disputed transactions assisted us in gaining a more representative view of transactions. The fact that demographic data about guarantors drawn from legal representatives largely mirrored that drawn from guarantors themselves and from litigated cases enhances the validity of this data. A total of 46 judges responded to our judge survey, giving us a further point of comparison.
1.25 The data collected from guarantors and their advisers was compared with data collated from judgments from the courts (including those in published reports and unreported cases available through internet sources) in order to consider if there was significant variation between the demographics and experiences of litigants and non-litigants.
1.26 The project sought information from lenders about their practice through a confidential survey, but received very little assistance or input. Survey documents were sent to 112 lenders including banks, building societies, credit unions and finance companies, responses were received from only two major banks, two smaller bank lenders and three finance companies. We were also assisted by responses from two peak bodies.
1.27 A detailed Methodology appears in Appendix A.
FOOTNOTES
1. Judge Survey, Respondent 1.
2. Reg Graycar, Robyn Johansson and Jenny Lovric, “Guaranteeing Someone Else’s Debts” (2001) 12 Journal of Banking and Finance Law and Practice 181.
3. Judge Survey, Respondent 36.
4. Mary Keyes and Kylie Burns, “Contract and the Family: Whither Intention?” (2002) 26 Melbourne University Law Review 577.
5. See for example, Australia, Trade Practices Commission, Guarantors: Problems and Perspectives (Discussion Paper, 1992); Australia, House of Representatives Standing Committee on Finance and Public Administration, A Pocket Full of Change: Banking and Deregulation (AGPS, Canberra, 1991); The report of the Expert Group on Family Financial Vulnerability Good Relations, High Risks – Financial Transactions within families and between friends (Commonwealth Attorney General, 1996); Australian Law Reform Commission, Equality Before the Law: Women’s Equality (Report 69, Part 2, 1994); Radmila Jukic, Till Debt do us Part (Consumer Credit Legal Service, Melbourne, 1994); Supriya Singh, For Love Not Money: Women, Information and the Family Business (Consumer Advocacy and Financial Counselling Association of Victoria Inc, Melbourne, 1995).
6. New South Wales Law Reform Commission, Guaranteeing Someone Else’s Debts (Issues Paper 17, 2000).
7. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997).
8. Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, 1997) at 2.
9. Richard Haigh and Samantha Hepburn, “The Bank Manager Always Rings Twice: Stereotyping in Equity After Garcia” (2000) 26 Monash University Law Review 275 at 303-304.
10. Richard Haigh, Samantha Hepburn, “The Bank Manager Always Rings Twice: Stereotyping in Equity After Garcia” (2000) 26 Monash University Law Review 275.
11. Garcia v National Australia Bank Ltd (1998) 194 CLR 395.
12. New South Wales Law Reform Commission, Guaranteeing Someone Else’s Debts (Issues Paper 17, 2000), Chapter 2.
