It is an integral part of doing business to have the following documents in place:
Terms of trade
Guarantee and Indemnity
These documents generally provide a level of security for a business when providing goods or services on credit terms. This security is usually provided through the Personal Property Securities regime and/or by requiring a Guarantee and Indemnity from the directors of the customer.
However, it is not enough to prepare these documents on a standalone basis without considering the following issues:
- whether each document is incorporated into the other;
- whether the security provided under the documents is actually incorporated into the transaction;
- whether the correct document gives rise to the security interest; and
- whether the guarantee and indemnity is enforceable.
Effectiveness of a Personal Property Securities Clause
The recent decision of the court of appeal in Central Cleaning Supplies Pty Ltd v Elkerton  VSCA 92 examined the combined effect of these contractual documents. Specifically considered was whether the clause giving rise to a security interest under the Personal Property Securities Act applied to a particular supply transaction. At first instance, it was held that the clause in the invoices giving rise to a security interest was not incorporated into the transaction as it was not included in the terms of trade. However, on appeal this decision was overturned and it was held that even though the clause giving rise to a security interest was not incorporated into the terms of trade, it was accepted as a condition of the sale.
While this case eventually upheld the security in favour of the supplier, it demonstrates the importance of ensuring your commercial documents work as intended to save costly and lengthy court proceedings.
Enforceability of a Guarantee and Indemnity
In the case of Alceon Group Pty Ltd v Rose  NSWSC 686, a guarantee was provided by both a mother and father to secure their son’s credit facility. The guarantors were required to obtain independent legal advice on the effect of giving the guarantee. The guarantee provided by the mother was found to be invalid as the son’s solicitor gave the mother advice. The solicitor was, therefore, not able to give independent and adequate advice.
The outcome of this case may have been different if the credit application provided various warranties and undertakings by the guarantors, including that the guarantor:
- received independent legal advice on the effect of giving the guarantee;
- was aware of the intricacies of the transaction; and
- had knowledge of the financial position of the borrower.
Even if the inclusion of these warranties did not change the outcome of the case, it could have provided the credit provider with recourse against the guarantor for breaching the contractual warranties.
Lessons to Learn
To ensure your business does not find itself in either position demonstrated in these cases, your business should ensure that:
- there is adequate incorporation of terms when using multiple contractual documents, such as terms of trade, credit applications and guarantees and indemnities;
- a credit application contains relevant warranties and undertakings in relation to the giving of guarantees and indemnities; and
- guarantors seek independent advice before guaranteeing a customer’s debts.
If you would like us to review your contract documents to ensure they work how you intend them to work, please contact: