When is a Guarantee Not a Guarantee?

A debtor who gives a guarantee, then becomes a bankrupt (or subject to a Part X Arrangement) can avoid their obligations under the guarantee post bankruptcy if they take certain steps.  If they fail to take those steps, the debtor may face liability pursuant to the guarantee for goods and services provided after the date of the bankruptcy, ie the guarantee is still on foot.

This is not a “one size fits all” scenario.  It applies to guarantees given in relation to the supply of goods and services.  

The arguments revolve around the question of what is a “provable debt in bankruptcy”.  

The Supreme Court of South Australia (Full Court) in the matter Darwin Food Pty Ltd v Gray [2018] SASCFC 84 considered the situation where a supplier who held a personal guarantee sought to enforce that guarantee against Mr Gray.  The guarantee was given in November 2010 Mr Gray became subject to a Part X Agreement (“PIA”) under the Bankruptcy Act (“the Act”) in January 2012.  The PIA was successfully completed.

The key parties in this dispute are:

• The Supplier (Darwin Food Pty Ltd)
• The Customer (Omnyx Pty Ltd)
• The Guarantor (Mr Gray)

Between April and May 2012, (a date after Mr Gray had entered into the PIA), the Supplier supplied goods to the Customer, to the value of approximately $87,000.  The Customer was placed into Receivership in May 2012, and ceased trading. As a result of the non payment of the debt by the Customer, the Supplier demanded from the Guarantor $87,000, pursuant to the personal guarantee he gave in 2010.

The Guarantor challenged the matter when it was heard before the Magistrate.  The Guarantor contended that he was released from all obligations relating to the guarantee, as any funds owing to the Supplier would represent a provable debt, and that he was otherwise released from any such claims as a result of the completion of the PIA.  The Supplier submitted that the amount owing to it did not represent a provable debt, and that they were entitled to enforce their claim.  

The Magistrate found in favour of the Supplier.  The matter was appealed to the Supreme Court of South Australia, and heard before a single Judge, who held in favour of the Guarantor.  The single judge ruled that the debt to the Supplier was a provable debt, and Mr Gray was released from the debt following the completion of the PIA.  

The matter was appealed again, before the Full Court.

All three (3) Judges in the Full Court found in favour of the supplier.

Section 82(1) of the Act states “subject to this Division, all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy.”

Section 82(4) of the Act states “The trustee shall make an estimate of the value of a debt or liability provable in the bankruptcy which, by reason of its being subject to a contingency, or for any other reason, does not bear a certain value.”

Section 82(6) of the Act states “If the Court finds that the value of the debt or liability cannot be fairly estimated, the debt or liability shall be deemed not to be provable in the bankruptcy.”

Section 230(1) of the Act states “If a personal insolvency agreement provides for a debtor to be released from a provable debt, the agreement operates to release the debtor from that provable debt unless the agreement is set aside or terminated under this Part.”

The consideration of whether the obligation to the Supplier is considered to be a provable debt was paramount.  Under the Bankruptcy Act, if the debt is not considered to be a provable debt, the Guarantor has not been released from any obligation, and therefore, the Supplier should otherwise be free to continue with their pursuit of recovery against the Guarantor under the terms of the guarantee for the goods delivered after the date of bankruptcy of the Guarantor.

Blue J in the Full Court, considered the definition of a provable debt in its two limbs:

• Liabilities to which a bankrupt was subject at the date of bankruptcy; and

• Liabilities to which a bankrupt may become subject before his or her discharge by reason of an obligation incurred prior to the date of bankruptcy.

In respect to the first limb, Blue J noted that for debts incurred by the Customer on or before the execution of the PIA, but not paid, the Guarantor had a contingent liability pursuant to the guarantee in accordance with the first limb of a provable debt.  In this case, the liability was contingent upon the Customer not making the payment of the debt, and upon a demand being made upon him by the Supplier.  It was accepted that there were no such debts outstanding at the time the Guarantor entered into the PIA.  

Blue J went on to state “The second limb applies to a liability to which a bankrupt may become subject before his or her discharge. As observed above, the liability might be certain or contingent, but it must arise by reason of an obligation incurred before the date of bankruptcy.”

The Guarantor would only become liable to the Supplier if the Customer placed an order for goods in the future (ie after the date of the PIA) that were not paid for, and the Guarantor did not revoke the guarantee.  As at 12 January 2012 (the time of the execution of the PIA) there were no such obligations or debts.

There were no obligations on the Customer to place minimum orders with the Supplier for the provisions of goods.  It follows that at the provision of goods by the Supplier during April and May 2012, were not obligations that arose prior to the Part X.

Given the above, the second limb of what is a provable debt, was not satisfied.

Accordingly, the debts subsequently incurred by the Customer, in April and May 2012 were not considered to be provable debts in the Guarantor’s PIA. Therefore he was not released from those debts as a result of the execution and completion of the PIA. The Supplier was able to continue in their pursuit of the Guarantor pursuant to the personal guarantee executed by him.  

In other words, it was held that the date of the order and supply of the goods was an overriding factor, and not just the date of the PIA / Bankruptcy.

The takeaway points from this article are:

• the completion of an agreement under Part IX or Part X of the Act, or being discharged from Bankruptcy, may not release the individual from future obligations contained in agreements entered into before the date of the bankruptcy;

• a Guarantor who seeks protection under the Act should write to all parties to whom he/she has provided a guarantee and advise them that he/she revokes their guarantee for all goods and services delivered after the date of bankruptcy; and

• suppliers who receive notice that a guarantee is revoked, should reconsider their credit risk with the customer before delivering any further goods or services.