Paul Matthews v BSN: Court of Appeal Clarifies the Law on Guarantees and Bankruptcy

What did the Court of Appeal decide?

The Court of Appeal allowed Mr Matthews’ appeal against the bankruptcy order. The central issue was the proper construction of clause 4.4 of a share purchase agreement relating to the sale of Chip Shack, a company whose loans were to be repaid following the transaction.

The court held that the clause created a “see to it” guarantee. Under this type of guarantee, the guarantor promises that the principal debtor will perform its obligations. If the debtor fails to pay, the guarantor is in breach of that promise and may be liable in damages. This is legally different from a conditional payment guarantee, under which the guarantor promises to pay the creditor if the principal debtor defaults.

Because the guarantee was a “see to it” guarantee, the claim against Mr Matthews was a claim for unliquidated damages rather than a debt for a liquidated sum. It therefore did not satisfy the statutory requirement for a creditor’s bankruptcy petition.

How did the guarantee arise?

The dispute arose from the sale of Chip Shack and the arrangements for repayment of loans made to the company. Mr Lang had been in control of the company as its director. As part of the transaction, the parties agreed that the loans would be repaid once Mr Lang ceased to control the company.

Clause 4.4 of the share purchase agreement contained a guarantee relating to repayment of the loans. The question was whether Mr Matthews had promised to pay the loans himself if Chip Shack did not, or whether he had promised that Chip Shack would fulfil its own repayment obligations.

The distinction mattered because the bankruptcy petition depended on the legal nature of the obligation. The court had to decide whether the guarantee created a direct payment obligation for a fixed debt or a secondary liability in damages arising from a failure by the principal debtor to perform.

What is the difference between the two types of guarantee?

The Court of Appeal explained that the two forms of guarantee may produce a similar practical result, but they create different legal obligations.

The court explained that the practical result may look similar: the creditor may ultimately recover the unpaid amount from the guarantor. But the legal route to that payment is not the same. Under a conditional payment guarantee, the guarantor owes the money as a debt. Under a “see to it” guarantee, the guarantor’s liability arises in damages for breach of the promise that the principal debtor would pay.

“The difference between the two forms of guarantee” is whether the guarantor must discharge the debt itself or is liable in damages for the principal debtor’s failure to pay.

— Summary of the Court of Appeal’s analysis

Why was the guarantee not a petitionable debt?

Section 267(2)(b) of the Insolvency Act 1986 requires a creditor’s bankruptcy petition to be based on a debt for a liquidated sum, payable immediately or at a certain future time, and unsecured. Although the legislation gives “debt” a broad meaning for insolvency purposes, not every liability can found a bankruptcy petition.

The Court of Appeal considered its earlier decision in McGuinness. In that case, the court concluded that a “see to it” guarantee does not create a debt for a liquidated sum. The fact that the amount of the loss may be readily ascertainable by reference to the unpaid loan does not convert a damages claim into a contractual debt or a pre-agreed sum of damages.

Applying that approach, the court held that clause 4.4 was not a conditional payment guarantee. Its wording guaranteed repayment of the loans “by the Company”. It did not say that Mr Matthews would pay the lenders the guaranteed obligations if Chip Shack failed to do so.

The respondents argued that other provisions of the agreement supported a conditional payment interpretation. In particular, clauses 8.1 and 10 referred to the buyer’s and company’s agreement to repay the loans and to set-offs against loan repayments. The court considered that these provisions showed that the drafter may have assumed Mr Matthews would have to repay the loans, but they could not change the clear meaning of clause 4.4.

The court also rejected the argument that commercial context required a different interpretation. Whether the parties wanted the comfort of a guarantee did not determine which legal form of guarantee they had agreed. The wording of the clause remained decisive.

Could Matthews raise the point on appeal?

Mr Matthews had not argued before the County Court that the guarantee did not create a liquidated debt. The point was raised later in his appeal to the High Court, which declined to determine it on the evidence before it. The Court of Appeal therefore considered whether he should be permitted to advance the point on the second appeal.

The respondents said that they might have adduced further evidence had the argument been raised earlier, including evidence about the drafting of clause 4.4. The Court of Appeal was not persuaded. The question was one of contractual construction. Evidence of what the parties subjectively intended or of their negotiations would generally be inadmissible, and the surrounding factual background could not alter the words used in the clause.

Lord Justice Nugee considered that the point should be allowed because it went to the court’s jurisdiction to make a bankruptcy order. If the guarantee did not create a petitionable debt, Mr Matthews had been made bankrupt on a basis that did not satisfy the statutory requirements.

The respondents also relied on Mr Matthews’ statements at an earlier County Court hearing, where he accepted that he had given a guarantee and that he would be liable if the company did not pay. The Court of Appeal rejected the estoppel argument. His admission that a guarantee existed did not amount to an admission that it was specifically a conditional payment guarantee giving rise to a petitionable debt.

What happened to the set-off arguments?

The court briefly considered two further grounds concerning set-off, although it had already concluded that the appeal should be allowed on the guarantee issue.

First, Mr Matthews argued that an indemnity in clause 7.1 of the share purchase agreement, read with clause 10, allowed him to set off liabilities against the loans. The court rejected that interpretation. It would effectively remove any obligation to repay the loans, making the express repayment provisions and the full and final settlement clause in the agreement nonsensical. The indemnity was directed at undisclosed liabilities discovered after the sale, not the loans which were specifically identified and addressed in the agreement.

Second, Mr Matthews argued that other liabilities of Chip Shack should also be set off. The Court of Appeal did not determine that issue finally. It considered that the evidence and procedural history were unclear and said it would remain open to Mr Matthews to rely on the point if the respondents pursued him on the guarantee.

What does the judgment mean for creditors and guarantors?

The decision underlines the importance of the precise wording used in guarantees. A clause described as a guarantee does not automatically create a debt for a liquidated sum. The court will examine the substance of the promise: whether the guarantor undertakes to pay the creditor on default, or instead promises that the principal debtor will perform its own obligation.

For creditors, the distinction is significant when considering insolvency proceedings. A “see to it” guarantee may still give rise to an enforceable claim for damages, but that does not necessarily make it suitable as the debt on which to present a bankruptcy petition. The statutory requirement for a liquidated sum must be satisfied.

For guarantors, the judgment confirms that the legal character of the guarantee may be central to whether a bankruptcy order can be made. It also demonstrates that a court may allow a new point on appeal where it concerns the jurisdiction to make such an order, even if the argument was not advanced at the earliest opportunity.