Some people think independent legal advice requirements for personal guarantees and security don’t apply to partners in partnerships however a recent decision outlines why banks should still be on their guard when providing loans to a family partnership.
Mr O’Neill was a self-employed builder, who operated his business on a modest basis, mainly carrying out renovations and one-off new builds using small loans obtained from Ulster Bank.
In 2005, his wife Mrs O’Neill, along with their sons, was made partner in the business but Mrs O’Neill actually had no formal dealings with the business.
In 2006, the nature of the business changed and Mr O’Neill obtained loans totalling almost £1.5 million, to buy and develop land. The loans were secured against the family home and properties belonging to the business.
Unfortunately, the business ran into financial difficulties, and when repayments were not made, the Bank issued a statutory demand against Mrs O’Neill as a partner. This was on the basis that the loans were for the joint benefit of all partners of the business.
The demand was set aside by the court, on the grounds that it was arguable that a loan to a partnership, including a wife, was similar to a loan to a company in which a wife was a shareholder, and that the change of character of the business and the increased loan amounts should have placed the Bank on inquiry as to the possibility of undue influence exerted on Mrs O’Neill by Mr O’Neill. Effectively, the court was suggesting that an Etridge situation had occurred.
Etridge is the short hand name for a key case that sets out when a bank should be on-notice of possible undue influence and the requirements for giving independent legal advice to guarantors in those circumstances. It states the bank is “put on inquiry” in every case where the relationship between the guarantor and borrower is non-commercial. But that case also reminds us that where money is being advanced to husband and wife jointly the bank is not put on inquiry, unless it is aware the loan is being made for one person’s purposes, as distinct from their joint purposes. This is where things become unclear…
The Bank argued that there was nothing to indicate that the loans were for anything other than the joint benefit of the partners; therefore it had no constructive notice and so was not placed on any inquiry as to any possible undue influence.
The Bank appealed the decision.
The Court’s decision
The appeal was dismissed meaning that the decision to set-aside the statutory demand remained.
The court was of the view:
(a) that the observations in the Etridge case did not necessarily exclude transactions such as those in this case from the lender’s obligation to inquire.
Also it was arguable that the partnership arrangement here was, in substance, no different from the provision of a guarantee by a wife with shareholding in a borrower company, but where the activities of the company were in reality conducted by and for the husband alone. There was an arguable case that the Bank had been put upon inquiry as to whether the loans were in fact for the husband’s sole purposes (as opposed to joint purposes) and Etridge applied.
(b) that matters that supported that case, including the modest nature and extent of Mr O’Neill’s previous business; the historic low level of bank borrowings by the business; the minimal personal relationship between Mrs O’Neill and the Bank, consisting of only one previous visit; and the very significant alteration in the scale and intended purposes of the loans negotiated solely by Mr O’Neill and all advanced during the period of one year, were not matters upon which the court had reached any conclusion.
The court made clear that it was not its role in relation to statutory demand proceedings to decide that issue; it simply had to ask itself whether an arguable defence, namely a defence with some prospect of success, had been raised and the answer to that was yes – Etridge applied.
The case serves as a reminder that it is better to err on the side of caution and, unless you are very certain borrowing is genuinely for joint purposes, where there is any non-commercial relationship between the parties involved, ensure any guarantor or provider of third party security takes independent legal advice.
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