Be careful when you release a joint debtor - you may release each other joint debtor

The High Court has confirmed that a creditor's release of one joint and several debtor will release the other debtors from the same obligation unless the release is qualified by reservation of rights against the other debtors.

In this case1, the company had borrowed $176,000 and its shareholders had guaranteed the loan.

The company failed to pay amounts due under the loan and the creditor sought repayment from the shareholders pursuant to the guarantee.

The creditor and one of the guarantors (the 1st Guarantor) entered into a written agreement (the June Settlement) pursuant to which the guarantor agreed to pay $200,000 in two equal payments of $100,000, in full and final settlement of the creditor's claims.

Without the 1st Guarantor's knowledge, the creditor purported to settle its claim against the other guarantor (the 2nd Guarantor) the following month (the July Settlement). Under the July Settlement, the 2nd Guarantor agreed to transfer a residential property valued at $153,000 to the creditor, who agreed to settle its claim against the 2nd Guarantor separately from the 1st Guarantor.

The 1st Guarantor was subsequently advised that, because it and the 2nd Guarantor were joint and several guarantors, the July Settlement effectively cancelled the 2nd Guarantor's obligations to the 1st Guarantor (extinguishing the 2nd Guarantor's obligation to contribute to the 1st Guarantor's settlement).

In the District Court, the Judge found that the 1st Guarantor was entitled to cancel the June Settlement and was entitled to relief under section 9 of the Contractual Remedies Act for the sum of $100,000 (being the amount the 1st Guarantor would have been entitled to recover from the 2nd Guarantor).

In the High Court, Priestly J set out the following general principles on release of guarantors:

• The release of one joint debtor is the release of all. The release (whether express or implied) of one of a number of joint or joint and several guarantors, without the consent of the others, and without reserving remedies against the other, will bar the creditor's right of action against other guarantors.



• Where a guarantor pays more than his rateable proportion of a joint debt between himself and a co-guarantor, he is entitled to exercise a right of contribution against his co-guarantor, because he has discharged the obligations of the co-guarantor to the creditor.



• The right of contribution arises in the following circumstances:
  • first, the guarantor and co-guarantor must have guaranteed a common liability;
    
  • secondly, the guarantor must have paid more, or be about to pay more, than his rateable proportion of the total guaranteed debt. Contribution is also available to a guarantor who pays the whole debt or a part in satisfaction of the whole debt, even if the amount paid is less than the limit of the guarantor's liability; and
    
  • thirdly, the right to contribution must not have been contractually excluded or lost.

The High Court determined that the effect of the June Settlement was to:

• settle the 1st Guarantor's liability to the creditor at $200,000;



• release both guarantors from ongoing exposure to the creditor; and



• create a right of the 1st Guarantor to seek contribution from the 2nd Guarantor of $100,000.

The High Court determined that the July Settlement did not affect the rights of the 1st Guarantor against the 2nd Guarantor.

The Court concluded that equity and justice required that the 1st Guarantor be indemnified against a possible contribution claim from the 2nd Guarantor. An award of costs was made to place the 1st Guarantor in the same position as it was when it settled with the creditor under the June Settlement.

1 Perry Developments Limited v Catley (High Court, Hamilton, CIV 2003-419-001684, 28 September 2004, Priestley J)

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