A company borrowed money from two lenders and granted a first and second-ranking charge to the first and second lender respectively. The guarantor guaranteed the obligations of the company to the first lender. When the company got into financial difficulty, the guarantor advanced funds to the company to enable the completion of the project. Receivers were appointed and the assets of the company sold. The proceeds discharged the first loan in full and the surplus proceeds were paid to the second lender. The guarantor argued that it had first claim on the surplus proceeds as it had provided funds in its capacity as guarantor under the first loan and was subrogated to the position of the first lender.
The court rejected this and found that the second lender had first claim on the surplus proceeds.
In order to benefit from the right of subrogation, the guarantor must establish that the funds were advanced pursuant to the guarantee and resulted in the reduction or discharge of the principal debtor’s liability to the creditor. The court said:
The test is not a standalone yardstick of unconscionability…subrogation will be permitted outside the established categories only when necessary in order to avoid the unconscionable result of double recovery by the creditor or the inequitable discharge of the liability of the debtor.
The court found that the guarantee did not require the guarantor itself to perform the obligations of the company to the first lender but required the guarantor to pay any debt or damages arising from the company defaulting on its obligations to the first lender. By advancing funds to the company to enable it to complete the project, the guarantor did not act pursuant to the guarantee and did not, in substance or effect, reduced the company’s indebtedness to the first lender at any time. The guarantor was therefore unable to benefit from the right of subrogation and did not have a right to be paid the surplus funds ahead of the second lender.
The appeal was dismissed.