Release Of Guarantee By Variation Of Original Contract

Guarantees and indemnities are commonplace in finance arrangements. The drafting of these documents tends to come under scrutiny when the principal debtor defaults and the surety is asked to pay.

Brown-Forman Beverages Europe Ltd v Bacardi UK Ltd [2021]

Background

In the case of Brown-Forman Beverages Europe Ltd v Bacardi UK Ltd, the Court had to consider the preliminary issues in respect of:

  • Whether a variation to the original contract had discharged the obligations of the surety; and
  • Whether, should such obligations survive, the surety was entitled to exercise a set-off, resulting in the underlying debt being extinguished.

The facts in the above case are sparse in the judgment as the underlying case was being dealt with in a confidential arbitration process. What is clear is as follows:

  1. The Defendant was one of the Bacardi group of companies and the parent company of Bacardi-Martini Ltd (BML);
  2. BML entered into a cost-sharing arrangement with the Claimant but this agreement was subsequently varied by agreement between BML and the Claimant (but without consulting formally with the Defendant);
  3. The Claimant claimed £50m from BML, who refused to pay, claiming that they were entitled to set off sums due to them against the sums claimed; and
  4. The Claimant, therefore, sought to enforce the suretyship provisions in the costs sharing agreement against the Defendant.

The first point to note is that the rule in Holme v Brunskill [1877] confirms that a guarantee will no longer be enforceable against a guarantor if:

  • There has been a variation of the original contract guaranteed without consent of the guarantor; and
  • The creditor asserting the guarantee fails to demonstrate that the nature of the variation is only beneficial to the guarantor.

Judge Pelling QC in the Bacardi case refers to a useful passage from the practitioner’s text Chitty on Contract, as follows:

“It is immaterial that the variation has not in fact prejudiced the surety, or that the likelihood that it may do so is remote. … The principle is applied very strictly so that even the most trifling variation may discharge the surety.”

This rule however only applies to guarantees and not to indemnities. Judge Pelling QC sets out a useful summary of the distinction between a guarantee and an indemnity in paragraph 10 of the judgment in the Bacardi case as follows:

“10. The legal consequences that flow from the distinction between an indemnity and a true guarantee are well known. Indemnities and guarantees are both contracts of suretyship. A contract of guarantee is a contractual obligation by the surety either to discharge a debt owed by the principal debtor in the event that the principal debtor does not discharge it and has not ceased to be liable to pay it; or a contractual obligation by the surety to “see to it” that the principal debtor complies with its guaranteed obligations with the result that if the principal fails to comply with its obligations the surety thereby is placed in breach of its contractual obligations and becomes liable in damages…By contrast, an indemnity obligation is a security obligation that imposes on the surety a primary obligation that is wholly independent of the liability (if any) that arises between the principal debtor and the creditor.”

Judge Pelling QC determined that the costs sharing agreement contained both indemnity and guarantee provisions. It is possible to contract out of the rule in Holme v Brunskill and often finance agreements contain such an exclusion.

Remarkably in this case, notwithstanding the Claimant having experienced lawyers acting for them when the contract was negotiated, the rule was not contracted out of. The Claimant tried to argue that, as the Directors that signed the variation documentation were also Directors of the Defendant, they had the authority to also bind the Defendant. The Judge dismissed that point on the basis that it had not been pleaded or evidenced by the Claimant but also made it clear that it was an unattractive argument in any event. This shows to a point that Judges will be slow to come to the rescue of a creditor that has sought a variation to a guaranteed contract but not obtained the express consent of the guarantor.

In respect of set-off (i.e. that the debt is equal to or less than sums owed by the creditor to the principal debtor and accordingly the principal debtor is entitled to off-set one against the other), the Court found that the Defendant was entitled to rely upon a set off by BML on the basis that a principal debtor that has asserted a valid set-off against a creditor results in the debt not being owed by the principal debtor and so there is no debt to enforce against the guarantor. Again, it is possible to exclude a set-off from taking effect contractually (note this would not prevent there from being two distinct counterclaims in respect of each party alleging that the other owes them a debt) but in this case, again remarkably, there was no such provision in the agreement. Accordingly, the Claimant’s claim that BML had defaulted was found to be unsustainable.

Brown-Forman BacardiHow Nelsons can help

Kevin Modiri is a Partner in our expert Dispute Resolution team.

Should you be affected by any issues in relation to a guarantee, please do not hesitate to contact Kevin or another member of the team in Derby, Leicester or Nottingham on 0800 024 1976 or via our online enquiry form.