The un-palletable consequences of taking guarantees on trust

On the very first page of the leading Australian textbook on the law  of trusts, you will find the statement that, “a trust is not a juristic person with the legal personality distinct from that of the trustee and beneficiary”.  This is a lawyerly way of saying “a trust is a relationship – it is not actually a thing”.  The misconception that a trust is a thing is, however, widespread – especially because of the fact that since the introduction of the GST, a trust can have an ABN which differs from the ABN of the trustee.

However, confusing the ABN of a trust and the ABN of a trustee is A Big No-no, which can have serious consequences for the enforcement of agreements in which the confusion arises.  In a recent decision in the District Court of New South Wales, confusion at the time that a director’s guarantee was given left the pallet supplier CHEP Australia Pty Ltd (CHEP) unable to recover nearly $700,000 under a guarantee.

The facts were those of a classic guarantee enforcement case – the company (Flynn Transport) had gone broke, and one of the directors was bankrupt, so CHEP sued the other director on a guarantee given as part of an application for commercial credit. (Guarantee cases like this might not quite be as old as time itself, but given that it is possible to trace the giving of guarantees back to the Code of Hammurabi in 1792 BCE, there has been a fair amount of time for the various permutations to play themselves out).

Timing was especially important in this case. At the time that the guarantee was given in 2007, Flynn Transport conducted a transport business as the trustee of a discretionary trust.  The trust business had its own ABN distinct from the ABN of the company, and importantly, the guarantee documents referred to the trust ABN and indicated that Flynn Transport was contracting as trustee, not its own right.

The trust vested (that is, “ceased”) on 30 June 2015, but CHEP continued to deal with Flynn Transport after this time. As the trust had ceased to be, all dealings with Flynn Transport after 30 June 2015 must have been dealings with Flynn Transport its own right, rather than trustee. This was confirmed by the fact that all the invoices on which CHEP sued referred to the ACN of Flynn Transport, not the ABN of the trust.

However, it seems that nobody stopped to consider the consequences of the vesting of the trust up to the point at which CHEP sought to enforce the guarantee.  At that point, CHEP was met with the argument that in the proper construction of the guarantee, the director was only guaranteeing the obligations of Flynn Transport incurred as trustee.  As the amounts claimed by CHEP were all incurred after the vesting of the trust, the director argued that they were not trust debts and were outside the scope of the guarantee.

This argument was accepted by the Court, and CHEP’s complaint that it wasn’t told about the vesting of trust fell on deaf ears – the Court took the view that appropriate due diligence by a creditor should have identified the party with whom the creditor was dealing.  Accordingly, CHEP’s claim was dismissed.

The decision (which we have so far avoided referring to as a CHEP-wreck, a state of affairs which will hopefully continue) demonstrates the importance of identifying the correct counter-party in commercial transactions.  This is particularly important in relation to guarantees, because guarantees are subject to strict construction, so that any doubt or confusion accrues to the benefit of the guarantor.

The risk when guarantees are given is usually perceived to be mostly on the side of the guarantor (indeed, one frequent, although unkind, description of a guarantor is “a fool with a pen”).  However, the risk in extending credit is on the side of the creditor, and a guarantee which does not capture the credit extended will raise a question about which side of the transaction the fool is actually on.  During arms control negotiations, Ronald Reagan frequently used a Russian proverb, Доверя́й, но проверя́й (Doveryáy, no proveryáy) which translates as “Trust, but verify”.  The present case teaches us that before extending credit, an updated version of the proverb (“trust, but guarantee”) might well be apposite.

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November 24
2019
Commercial Law Litigation and dispute resolution