Release of bank (and non-bank) loan guarantor

Legal Insight

September 2017

George Psarakis LL.M. (mult.), PgCert

Summary: Further to earlier briefing notes in relation to guarantor liability (see here) and guarantor liability following additional acts in a mutual debt contract (see here), in this note we discuss in particular the issue of the guarantor's discharge on the basis of a so-called "release objection". As the relevant article of the Civil Code (CC 862) states: 'The guarantor is released if the creditor's fault has made it impossible for the debtor to satisfy him'.

The first reaction of the guarantor in favour of another borrower, if he is called upon to pay all or part of his debt because of the insolvency of the latter, is to call upon the creditor to satisfy himself first from the property of the first debtor before turning against him. This natural, instinctive defence of the guarantor is also expressed in the text of the Civil Code, where it is known as the 'defence of recovery' (855 CC).

This defence, however, is rarely used in court practice, as the vast majority of guarantees are provided to secure bank credit agreements, where the waiver of the right to invoke it has been established as a general condition of transactions. The result is that the guarantor has validly forfeited (CC 857(1)), subject to the provisions of the Consumer Act (Law 2251/1994), the protection afforded to him by the provision as soon as the guarantee contract is signed.

Nevertheless, the protection reserved by the legislature for the guarantor, who is generally altruistic, is not exhausted there. A strong defence in the event of the consequent insolvency of the principal debtor, which is what usually happens when the creditor triggers the liability arising from the guarantee, may be provided by the provision of Article 862 of the Civil Code, which establishes the guarantor's right to be released. Under that provision, which has been described as equivalent to that of the abuse of a right in the law of suretyship, the guarantor is released if the creditor's fault has made it impossible for the debtor to satisfy him. This is, in fact, the reverse of the plea in law, since it is precisely because the primary debtor is now insolvent, and the other conditions of the article are also fulfilled, that the guarantor is released from his liability. 

Two are the main advantages of the arrangement: 

a) Firstly, the release means the complete and definitive extinction of the obligation arising from the guarantee, i.e. the impossibility for the creditor to proceed against the guarantor in perpetuity from this relationship. 

b) Secondly, a waiver by the guarantor of this objection will be invalid to the extent that it releases the creditor from fraudulent intent and gross negligence (CC 332§1). However, in the case of banking contracts, which is of most practical interest, the exemption from slight negligence will also be invalid, as the provision of Article 332§2 b of the CC will apply, according to which such an exemption is not permitted if the relevant term was not the subject of individual negotiation. Therefore, even if such an exemption clause is contained in the bank's General Terms and Conditions of Business - which by definition are never negotiated - the guarantor is not validly waiving that right, irrespective of whether or not he is a consumer. Consequently, unlike the waiver of a plea in law, where it is difficult to raise the question of its invalidity, in the field of the plea for release, it is usual for any waivers to be rendered invalid.

The conditions for the application of the provision, and therefore the basis of the plea in law, are: (a) the creditor's inability to satisfy the debtor's claim out of the debtor's assets and (b) the creditor's fault which ultimately led to the inability to satisfy the claim.  

The inability of the debtor to satisfy the creditor is understood to mean not only the lack of liquidity, but the complete inability to cover the claim from the total assets of the debtor's property, even by means of enforcement. Thus, if the first debtor has become bankrupt or is in a similar legal or factual situation which does not in fact allow the creditor's claim to be satisfied, this condition is satisfied. On the other hand, if there is sufficient security, whether in rem or otherwise, in favour of the creditor, the impossibility of satisfaction is not accepted. In other words, the crucial element is that the creditor is unable to recover his claim in any way, including through legal proceedings, simply because the full value of the debtor's assets can no longer cover it. In this respect, the case-law has made the declaration of bankruptcy a presumption, which is a sufficient but not necessarily necessary condition for establishing the creditor's inability to pay, which, as we have said, may be based on other factual or legal grounds.

An example of such a factual situation from the history of a recent case we dealt with was the cessation of business of a debtor company in the automobile sector, the sale at an extremely low price of all its assets (tools, machinery, spare parts, etc.) and the abandonment of its headquarters by transferring it to a fictitious address, namely to an address where there was only a sealed warehouse. Also, in another case, elements that contributed to the insufficiency of the primary debtor company were its negative equity, the near-zero liquidity evidenced by its balance sheets and its continued loss-making operations.

As regards the fault of the creditor (its 'fault'), any degree of fault, even slight negligence, is sufficient. The creditor's fault need not, of course, necessarily relate to his causing the debtor's insolvency but mainly to his inability to satisfy his claim because of it. In other words, in order for a plea for release to be admissible, it is not necessary for the creditor (usually a credit institution) to have caused the insolvency of the primary debtor, but it is sufficient that he has neglected to take appropriate measures to secure and/or collect his claim in good time, with the result that by the time he now requires the guarantor to satisfy it, the primary debtor has become insolvent in such a way that any attempt to do so is a priori futile. 

This is the case, for example, with the excessive granting of credit to the primary debtor, which has resulted in an excessive increase in the debtor's liabilities, or the long-term negligence in the registration of charges, in particular mortgages or mortgage liens, and the taking of other protective measures, such as or even the consent to repeated extensions of the time for repayment of the debt without the guarantor's knowledge, and the passage of a long period of inactivity without the debtor having sought to recover the debt in court, despite the fact that the debtor was in default or his imminent financial weakness was apparent. The creditor must therefore either have contributed to the debtor's consequent inability to meet his obligations or must have allowed, usually by adopting a passive attitude, the expropriation of the debtor's property, even from his third-party creditors, with the result that he is unable to obtain satisfaction, even if only by force.

A relevant example: in another recent case, the credit institution gradually extended the repayment period of a loan for more than 8 years without providing any security and in the absence of any judicial action. At the same time, even after the borrower was in definitive default, it failed to terminate the contract for 3 years, as well as to pursue its now overdue debts for a further 3 years, during which time the borrower company was dissolved and entered into liquidation and third party creditors satisfied their respective claims by accelerating the auction of its assets. Therefore, now that the credit institution is now claiming its claim from the natural person guarantor, the latter is legitimately and properly raising an objection for release, with the result that it is relieved of its liability as guarantor, since it was negligent of the bank that, when it could have been satisfied by the debtor company, it did not do so by means of enforcement measures, including seizures in the hands of its third-party customers. 

It follows from the above that the guarantor bears a number of procedural burdens in order to obtain judicial relief on the basis of the plea for release. He must plead and prove the above elements in order for the court to be fully satisfied as a matter of law that the factual requirements of the provision have been met and to recognise the discharge of the guarantee. Thus, good preparation of the pleading and collection of necessary evidence is required. This must be used to prove the critical point in time before which the lender was able to satisfy the creditor from the property of the first debtor and after which the latter was definitively and irrevocably lost, and this point in time must follow and be covered by the lending bank. In the classic example, therefore, the guarantor must prove the bankruptcy of the primary debtor and when it occurred and, before it was declared, the existence of assets capable of satisfying the creditor bank's claim (equipment, real estate, claims against third parties, etc.), even if they were forcibly sold, and the failure of the latter to secure its claim or to pursue it through the courts for a sufficient period of time. Thus, for example, it is not sufficient simply to invoke the initial possibility of the debtor being satisfied by the creditor before the debtor becomes insolvent, but it is also necessary to refer to specific assets and their corresponding value, which must exceed the amount of the bank's guaranteed claim. However, this obstacle can be overcome by an in-depth study of the case and a thorough collection of information and evidence (sometimes by obtaining a prosecutor's order for documents).

Finally, brief mention should also be made of the specific case where the guarantor, without his knowledge, provides a guarantee for a primary debtor who is insolvent from the outset, i.e. already at the time the loan agreement is drawn up, in such a way that it is certain that the lending bank will not be satisfied by him. This is a different situation from that of a consequential default, which is manifestly unfair to the guarantor, who, this time, without knowing it, is in effect committing himself to being the one who will certainly pay the primary debtor's debt. If the legal system devalues the guarantor's pursuit of debts on the basis of the consequent inability of the primary debtor to satisfy the creditor, it is obvious that this will also apply much more so to the existence of this factual element in the first place. Otherwise, we would end up with the inappropriate treatment of similar cases and the treatment of the institution of the guarantee, contrary to its securing purpose and the principles of subsidiarity and subsidiarity which govern it, as a method of lateral construction of co-debtors. It goes without saying that the fault of the creditor is still required. In this case, this would normally consist of the bank's negligence in checking the creditworthiness of the primary debtor, thereby granting him credit that the guarantor is certain to repay from the outset. In order to avoid the resulting conflict of interests, it is therefore preferable to apply Article 862 CC on a pro rata basis, so that the guarantor can be fairly discharged even if the primary debtor was already insolvent when the contract was signed. The issue is different where the guarantor provides the guarantee with knowledge of the insolvency of the primary debtor. However, when he is unaware of this fact, the legal system must protect him because to admit otherwise would distort his true legal will: if he really wanted to take on a different debt, he would not simply guarantee it, but would enter into a contract of subrogation.