Undue influence: the risks for personal guarantees and third party security

Under English law a personal guarantee or a security instrument can be set aside if the surety proves that he or she was “unduly influenced” by the debtor to provide the guarantee or the security and that the lender was “put on inquiry” as to the existence of such undue influence but failed to take all reasonable steps to determine its existence. Therefore, undue influence could result in an individual being able to avoid its liability under the said contracts and, thus, care needs to be taken by a financier when a personal guarantee or third party security is obtained as part of the security package. However, to do so one needs to clarify when a lender is considered to have been “put on inquiry” as to the existence of undue influence and which are the “reasonable steps” a financier needs to take to satisfy itself whether the guarantor or security provider has been unduly influenced or not. The leading case on the matter is Royal Bank of Scotland plc v Etridge (No.2) and others¹ which clarified the following:

When a lender is 'put on inquiry' that the giving of the guarantee or security might be the result of undue influence.

A lender is put on inquiry when the relationship between the surety and the debtor is non-commercial. This will include situations where a husband or wife, civil partner (or unmarried partner, where the lender is aware of the relationship) stands surety for their partner's debts. This could even be the case when a wife stands surety for the debts of a company of which she is a director, secretary or equal shareholder. It will also be the case where the relationship is one between an employee and their employer. However, where a loan is granted to a husband and wife jointly, the lender is not considered to be put on inquiry, unless it is aware that the loan is not being made for joint purposes, but for the purposes of one person only. 

The steps a lender should take when it has been put on inquiry.

All a lender can be expected to do is take reasonable steps to satisfy itself that the surety understands the practical implications of the proposed transaction. The court has set out a number of steps for this, with the most significant being known as Independent Legal Advice or 'ILA'.

Independent Legal Advice

The court proposed that, if a lender is put on inquiry, then the lender should contact the surety explaining that, for the lender's protection, the lender will require a written confirmation from a solicitor confirming that the solicitor has fully explained to the surety the nature of the documents and the practical implications that they will have for him or her. 

The lender should not proceed to instruct the solicitor directly as then such solicitor is likely to be the lender's agent. Interestingly, it was held that the same solicitor can act for both the debtor and the surety, if the solicitor is satisfied that this is in the surety’s best interests and that this will not give rise to a conflict of interests.

The lender should not proceed with the transaction, until it has obtained a written confirmation from the solicitor that the solicitor has fully explained to the surety the nature of the documents and the practical implications that they will have for the surety. To be able to give this advice to the surety, the solicitor should obtain such information as they need from the lender and the solicitor should not provide the confirmation, unless such information is so provided.

¹ [2001] All ER.

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