Guarantors as ‘privies’ of a principal debtor – can they be bound by a decision of a Court in circumstances where they are not a party to litigation?

Co-authored by Andrew Kirby and Kieran Hickie

Portbury Development Co Pty Ltd v Ottedin Investments Pty Ltd [2014] VSC 57

Guarantors commonly have some association or relationship with a principal debtor.  If proceedings are taken against a principal debtor, but not a guarantor, resulting in a binding judgment, the Victorian Supreme Court has recently held that in subsequent proceedings against a guarantor, the guarantor is not a ‘privy’ of the principal debtor and therefore is not bound by the determination of issues in the earlier proceeding.

This proceeding concerned a property transaction.  Portbury Developments Co Pty Ltd (‘Portbury’), the vendor of 8.14 hectares of broadacre land in Officer, Victoria, sold the land to Ottedin Investments Pty Ltd (‘Ottedin’) as purchaser.  Ottedin nominated a related company, Goldcare Developments Pty Ltd (‘Goldcare’), to take the transfer of the property.  The performance of the contract was secured by two guarantors, Messers Ottewell and Kosta, who controlled Ottedin and Goldcare and were the only directors of these companies.  The parties agreed to vary the payment of the purchase price, however the purchaser failed to settle the contract on the basis that it had validly rescinded the varied contract because by the variation it had become a terms contract.  Portbury in turn rescinded the varied contract of sale for non payment of the balance of the purchase price.

The purchaser (Ottedin) brought a case that it had validly rescinded the contract and sought repayment of its deposit monies. The proceeding was heard and determined by Dixon J in Ottedin Investments Pty Ltd v Portbury Developments Co Pty Ltd (2011) 35 VR 1; [2011] VSC 222.  On an application for summary dismissal by the vendor, Dixon J summarily dismissed the proceeding, finding that the varied contract of sale was not a terms contract, and was lawfully rescinded by Portbury.

Following this decision, Portbury) resold the property at a net loss of $3.075 million.  Portbury subsequently commenced proceedings against Ottedin, Goldcare  and the two guarantors, Messers Ottewell and Kosta, claiming loss and damage resulting from the resale of the property.  In addition to the amount of the net loss, Portbury also made a claim for associated selling expenses.

In its defence to the present proceeding, the defendants (including the guarantors) in part sought to rely on the purported avoidance of the varied contract of sale, and disputed the rescission of the varied contract of sale by Portbury.  While Ottedin was bound by the earlier decision of Dixon J in respect of these issues (pursuant to the principles of res judicata and issue estoppel), one question (among others) that arose for consideration was whether the guarantors – who were not parties to the earlier proceeding – were bound by the determination of these issues as ‘privies’ of Ottedin.

It was submitted on behalf of Portbury that Messers Ottewell and Kosta (as the sole directors, shareholders, controlling minds and guarantors of Ottedin) were privies of Ottedin and bound by a species of estoppel in respect of their defence of the present proceeding.  Portbury argued that in this case, the guarantors were on notice of the earlier proceeding and elected to ‘stand by and watch’ (and not take any steps to advance their interests in the earlier litigation).  For this reason, Portbury argued the guarantors ought to be bound by the judgment of Dixon J in respect of those issues decided by his Honour.

The general rule is that a judgment does not bind a person who is not a party to the proceedings in which it is granted unless they are directed to be bound by it, or are a ‘privy’ of one of the parties.  In order to establish the relationship of party and privy, it is not enough that the two persons have a similar interest in the property to which the estoppel relates; the privy must derive title from the party (to be a privy in estate), or claim their interest under or through the person of whom he is said to be privy (to be a privy in interest).

In the context of a principal debtor and guarantor relationship, and having regard to a number of authorities, Garde J observed that while a guarantor may have a similar interest to that of the principal debtor, the interest is not identical.  His Honour held that the interest of a guarantor is not derived under or through the interest of the principal debtor; rather it is typically a concurrent relationship, meaning the liability of a guarantor is not identical to the liability of the principal debtor.

In the circumstances of this case, while Messers Ottedin and Kosta’s relationship to Ottedin was to guarantee the performance of the varied contract of sale, this relationship was not sufficient to establish them as a privy of Ottedin.  His Honour held that their obligations as guarantors of the varied sale contract are not obligations that were concurrently assumed by them in favour of the vendor.  The Court explained that while the obligations under the guarantee were similar, they were not identical to the obligations of Ottedin or Goldcare which arose under the varied contract of sale.

For these reasons, Garde J held that the guarantors should not be bound by the earlier judgment of Dixon J under the doctrines of res judicata or issue estoppel.  His Honour also noted that while Messers Ottedin and Kosta were involved and active at or around the time of the earlier proceeding, it was not clear at the time of the earlier proceeding that the guarantees would be relied upon, or would be the subject of litigation by Portbury.  At the time of the earlier proceeding, the property had not been resold, and may have been sold for such a price or in a manner which may have obviated the need for Portbury to rely on the guarantees.  For these reasons, Garde J considered it would be unfair to treat the parties as estopped from contesting their liability at a later stage when at the time the earlier proceeding was heard and determined, it was not clear whether the guarantors would be involved in legal proceedings at all.

This aspect of the judgment has relevance in a banking and finance context.  It is common for many guarantors to have a close association or relationship to the principal debtor to which their guarantee relates.  If proceedings are commenced against the principal debtor (such as a purchaser of land under a contract of sale), a guarantor will not be bound by the outcome of that judgment or order in respect of subsequent proceedings commenced against it.  Subject to the terms of the particular transaction documents, the obligations of guarantor under the guarantee are likely to be similar but not identical to the obligations of the principal debtor under the agreement (such as a contract of sale of land).  Further, the Court has emphasised that it would not be fair to bind guarantors to the outcome of a judgment against a principal debtor in circumstances where at the time of the earlier judgment, the guarantee had been called upon.

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