The scope of a creditor’s equitable duty (General Mediterranean Holding SA spf v Qucomhaps Holdings Ltd and others)

The scope of a creditor’s equitable duty (General Mediterranean Holding SA spf v Qucomhaps Holdings Ltd and others)

Discussing the judgment in General Mediterranean Holding, Richard Spearman QC, barrister at 39 Essex Chambers, advises that the Court of Appeal has clarified the extent of a creditor’s obligations to a surety and a debtor under English law.

What was the background?

The case concerned a claim by a commercial lender (GMH) to recover multi-million dollar loans that GMH made to a company (QHL)—the repayment of which was guaranteed by a director of QHL, Mr Harkin, and secured by a charge over the assets of a subsidiary of QHL (Moravan). GMH obtained summary judgment before the Master, and that decision was upheld by Sir David Eady on appeal by the High Court.

QHL and Mr Harkin obtained permission for a second appeal to the Court of Appeal on the ground that the case raised an important point of principle concerning the extent of a secured creditor’s equitable duty to a surety. They argued that the decided cases establish no more than:

  • that the creditor has a duty to perfect the security
  • that the creditor has no duty to enforce the security, and that the authorities left open the question of whether the creditor is under a duty to preserve the security—thus the surety’s right of recourse to the security

They formulated the equitable duty for which they contended as a duty for the creditor:

‘to take such reasonable steps as are required to maintain the surety’s right of recourse to [the] security in the event that the creditor requires payment from the surety without first enforcing its rights to [the] security.’

They contended that GMH had failed to take reasonable steps to protect the security it had been granted and that, as a result, neither of them had any liability to GMH.

GMH contended that the authorities were at one in placing emphasis on the limited scope of the creditor’s equitable duty, which could be summarised as comprising a duty to perfect the security and a duty—when exercising a power of sale—to take reasonable steps to obtain a proper sale price for the security. There is no other duty to take positive steps which have not been expressly stipulated by the debtor or the surety—in particular, no duty to preserve the security at the peril of the creditor.

GMH further contended that, on the facts, it was entitled to summary judgment in any event.

The main authority on which QHL and Mr Harkin relied was Wulff v Jay (1872) LR 7 QB 756 (QB). GMH mainly relied on China & South Sea Bank v Tan [1990] 1 AC 536, [1989] 3 All ER 839, Yorkshire Bank plc v Hall [1999] 1 WLR 1713, [1999] 1 All ER 879, and Silven Properties Ltd v Royal Bank of Scotland plc [2003] EWCA Civ 1409, [2003] All ER (D) 335 (Oct).

What did the court decide?

The judgment of the Court of Appeal was given by Newey LJ—with whom Lewison LJ and Henry Carr J agreed. On the one hand, Newey LJ considered that while there was considerable force in GMH’s contentions, GMH’s summary of the law somewhat understated the equitable duty of a creditor unless the ‘duty to perfect the security’ is recognised as having a degree of flexibility. For example, if a security would be valid only if the creditor both registered it at the outset and subsequently paid a modest annual fee, it was very doubtful if effecting the initial registration would exhaust the creditor’s obligation. On the contrary, there would be a strong case for saying that the creditor also had to pay the annual fee. On the other hand, Newey LJ stated that any duty of a creditor to preserve or maintain a security could not be an onerous one.

In particular, Newey LJ held that:

  • there could be no question of a creditor having an absolute duty to ensure that a surety can have recourse to a security
  • a creditor could not be obliged to incur any sizeable expenditure or to run any significant risk to preserve or maintain a security
  • it was doubtful whether a creditor could ever have an equitable duty to the principal debtor (as opposed to a surety) to take steps to preserve or maintain a security granted by a third party

In deciding whether there was any real prospect of QHL and Mr Harkin successfully defending GMH’s claims on the basis of breach of equitable obligation, the Court of Appeal applied the following well-known principles.

Lord Hobhouse in Three Rivers DC v Bank of England (No 3) [2003] 2 AC 1, at para [158] said:

‘The criterion which the judge has to apply under CPR Part 24 is not one of probability—it is absence of reality.’

Lord Woolf MR in Swain v Hillman [2001] 1 All ER 91, at para [95] pointed out that:

‘Proper disposal of an issue under CPR Part 24 does not involve the judge conducting a mini-trial.’

On the other hand, Potter LJ in ED&F Man Liquid Products Ltd v Patel [2003] EWCA Civ 472, [2003] All ER (D) 75 (Apr) at para [10] expressed:

‘That does not mean that the court has to accept without analysis everything said by a party in his statements before the court. In some cases, it may be clear that there is no real substance in factual assertions made, particularly if contradicted by contemporary documents.’

Further, Potter LJ in ED&F Man Liquid Products Ltd v Patel, at para [8] stated that:

The defence ‘must carry some degree of conviction.’

Lewison LJ in Calland v Financial Conduct Authority [2015] EWCA Civ 192, [2015] All ER (D) 158 (Mar) at para [29] said:

‘The judge is not required to abandon her critical faculties.’

Applying these considerations to the facts, QHL and Mr Harkin did not have a real prospect of successfully defending GMH’s claims—the appeal was therefore dismissed.

What are the practical implications of this case?

The point was made in argument on behalf of QHL and Mr Harkin that it is open to a lender to include an express provision in the guarantee to the effect that the surety’s liability shall not be diminished by the lender’s failure or refusal to perfect, take up or enforce any rights against, or security over assets of the debtor or any other person. They suggested that in the absence of such an express exclusion, the equitable duty to take reasonable steps to protect the security could be, and should readily be, implied.

GMH’s response was that it is open to the surety to stipulate that the lender should have a duty to take positive steps to that effect. Moreover, as Lord Templeman observed in China & South Sea Bank v Tan, it is open to a surety who is concerned about a security to pay off the debt and take over the security. There was thus no need to introduce an equitable duty to take reasonable steps to protect security.

GMH further contended that recognising a duty to protect security would:

  • introduce undesirable uncertainty
  • be inimical to the ability of a lender to carry on business
  • be anomalous when the law does not require a creditor to do anything to prevent a security losing its value

In preferring GMH’s arguments, the Court of Appeal clarified the extent of a creditor’s obligations to a surety and a debtor under English law. In the absence of express terms, there is no broad equitable duty to ‘take reasonable steps to protect the security’.

Richard Spearman QC has appeared in many reported and high profile cases, including several cases in the House of Lords and Supreme Court, and numerous cases in the Court of Appeal and all divisions of the High Court. Spearman has advised on and appeared in litigation overseas (Bahamas, Cayman Islands, Hong Kong, Malaysia) and appearing and sitting as an arbitrator in commercial, media and sport arbitrations. Spearman is a Recorder of the Crown Court and the County Court and a Deputy High Court Judge. Spearman was leading counsel for the successful respondent in General Mediterranean Holding.

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About the author:

Miranda is a solicitor specialising in leveraged and acquisition finance. She trained at Hogan Lovells International LLP and qualified into the international banking and finance team. During her time at Hogan Lovells she worked on a variety of domestic and cross-border transactions, acting for both borrowers and lenders. She also experienced secondments to Barclays Bank PLC and Kaupthing Bank hf.