Guarantors right of subrogation after making payments towards a debt

18 December 2009

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The High Court recently in Bofinger v Kingsway Group Limited [2009] HCA 44 found that a guarantor’s right of subrogation arising from payment under the guarantee took priority over the rights of subsequent mortgagees. This finding overturns the contrary position that was reached by the NSW Court of Appeal, in respect of which we reported in February this year (see link)

Facts

B & B borrowed money from Kingsway to develop some townhouses. Kingsway held a first mortgage over the townhouses (and other property) as security and second and third mortgages were eventually granted to other lenders. All three loans were further secured by personal guarantees given by the Bofingers, the directors of B & B.

B & B defaulted on the Kingsway loan and, without any call to do so from Kingsway, the Bofingers used their own funds to reduce the amount owed by B & B to Kingsway.

Kingsway later took possession of the townhouses and put two lots on the market. The proceeds from the first lot sold were sufficient to discharge the remaining debt to Kingsway (which had already been reduced by the Bofingers’ payment), and Kingsway passed the balance of the proceeds of sale to the second mortgagee and released its remaining security.

Decision

The High Court found that, as the Bofingers had made payments under the guarantee, they had an equitable right to step into Kingsway’s shoes as creditor and security holder once the debt to Kingsway had been discharged, so that they could recoup the contributions they had made. Accordingly, Kingsway had held its remaining security and the proceeds of sale in trust for the Bofingers. It was held that, by releasing its security and passing the surplus proceeds of sale on to the second mortgagee, Kingsway had breached that trust.

As it was too late to undo the payment to the second mortgagee or the discharges of the mortgages, Kingsway was ordered to pay equitable compensation to the Bofingers in the amount that the Bofingers had paid into the loan from their personal funds.

Issues to consider

In making this decision, the High Court considered the terms of the guarantee given by the Bofingers to the second mortgagee. The analysis leaves open the possibility that such clauses could be drafted so that the guarantors gave priority to the second mortgagee; however in this case it was found that this clause did not.

It should also be noted that, although the second and third mortgagees (and their shared solicitors) were respondents in the appeal, no orders were made requiring the second mortgagee to repay the money it had received from the first mortgagee. There were, however, allusions to equitable principles which could have led to orders against the second mortgagee if the case before the courts had been framed in the appropriate terms and if it could have been proved that the circumstances were such that the second mortgagee knew, or wilfully shut its eyes to the possibility, that the first mortgagee was acting in breach of its obligations to the Bofingers by passing on the proceeds of sale.

The final effect of the High Court’s orders is that Kingsway must make good to the Bofingers but has little or no prospect of recovering the money from the second mortgagee.

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