Bank of Montreal v. Korico Enterprises Limited et al. [Indexed as: Bank of Montreal v. Korico Enterprises Ltd.]

50 O.R. (3d) 520

[2000] O.J. No. 3290

Docket No. C33169

Court of Appeal for Ontario

McMurtry C.J.O., Morden and Moldaver JJ.A.

September 8, 2000

*Application for leave to appeal to the Supreme Court of

Canada dismissed with costs May 3, 2001 (Gonthier, Major and

Binnie JJ.). S.C.C. File No. 28224. S.C.C. Bulletin, 2001,

p. 823.*

Guarantee and suretyship -- Interpretation -- "Clear wording" test -- Contra proferentem rule -- Guarantee providing that secured creditor may deal with securities as it sees fit -- Creditor selling secured assets -- Creditor suing to enforce guarantee -- Guarantor alleging improvident sale -- Guarantee not precluding guarantor from defending action on ground that creditor had acted improvidently in selling its security.

After the default in repayment of a loan, the plaintiff bank sued the borrower company and several individual defendants who had signed guarantees of the company's indebtedness. The company and the guarantors defended the action on the basis that the bank had acted improvidently in selling its security. The bank moved for summary judgment and, for the purposes of the motion, it conceded the allegation of improvident sale. Stinson J. dismissed the bank's motion as against the company because of Part V of the Personal Property Security Act, which required the bank as against the principal debtor to dispose of the security in a commercially reasonable manner. However, he granted judgment against the guarantors on the ground that they had contracted out of the right to complain about an improvident sale because the written guarantee provided that the bank "may otherwise . . . deal with . . . the securities . . . as it sees fit." The guarantors appealed.

Held, the appeal should be allowed.

The parties to a contract may contract out of the protections provided to them by the common law or equity. However, clauses that purport to eliminate the rights of guarantors should be clearly worded. This "clear wording" test applies to all clauses that purport to eliminate the rights of guarantors. Where a clause that purports to eliminate the rights of a guarantor is framed in broad, sweeping language that is reasonably capable of more than one interpretation, then any ambiguity should be construed against the party that drew the clause. In the immediate case, it was not plain and obvious that by agreeing to permit the bank to deal with secured assets as it may see fit, the guarantors intended to relieve the bank of its common law duty to take reasonable steps to obtain a fair price for them. This was especially so considering that the bank was required under the Personal Property Security Act to dispose of the secured assets in a commercially reasonable manner. The guarantors were not preclud ed as a matter of law from relying on the improvident sale defence, and the motion for summary judgment should not have been granted. Accordingly, the appeal should be allowed.

APPEAL from a summary judgment on a action to enforce a guarantee.

Cases referred to Bank of Montreal v. Bauer, 1980 CanLII 12 (SCC), [1980] 2 S.C.R. 102, 110 D.L.R. (3d) 424, 32 N.R. 191, 10 B.L.R. 209, 33 C.B.R. (N.S.) 291 (sub nom. Bauer v. Bank of Montreal); Bank of Montreal v. Soja, [1982] O.J. No. 85 (C.A.); Bank of Nova Scotia v. Buckingham, [1983] O.J. No. 1347 (H.C.J.); Manulife Bank of Canada v. Conlin, 1996 CanLII 182 (SCC), [1996] 3 S.C.R. 415, 30 O.R. (3d) 577n, 139 D.L.R. (4th) 426, 203 N.R. 81, 30 B.L.R. (2d) 1, 6 R.P.R. (3d) 1 Statutes referred to Personal Property Security Act, R.S.O. 1990, c. P.10, Part V Authorities referred to McGuinness, The Law of Guarantee, 2nd ed. (Toronto: Carswell, 1996), pp. 547, 612-13

Frederick S. Hawa, for appellants, Issam Awad, Wadih Khoury, Claude Awad and Silva Khoury. Mark Hartman, for respondent.

[1] BY THE COURT: -- By summary judgment dated October 12, 1999, Issam and Claude Awad and Wadih and Silva Khoury ("the guarantors") were found jointly and severally liable on their guarantees and ordered to pay the Bank of Montreal ("the bank") the sum of $54,324.53 plus prejudgment interest. Two of the guarantors, Issam Awad and Wadih Khoury, were also found jointly and severally liable on a separate guarantee and ordered to pay the bank $3,346.79 plus prejudgment interest.

[2] The guarantors appeal from that judgment on the sole ground that the motions judge erred in holding that they were precluded, as a matter of law, from relying upon the defence of improvident sale because of a clause in the guarantee agreements which permitted the bank to deal with assets it was holding as security "as the Bank may see fit".

Background Facts

[3] On December 6, 1993, Korico Enterprises Limited ("the company") borrowed $220,000 from the bank to purchase certain equipment needed to start up a Baker's Dozen Donut franchise. The loan was for a term of five years and it was secured by a chattel mortgage over the equipment, leasehold improvements and signage of the company. The bank also provided the company with an operating line of credit in the form of a demand loan.

[4] The loans were further secured by guarantees executed by the guarantors on November 23, 1993. Under the guarantee agreements, the guarantors agreed to be jointly and severally liable for all present and future debts and liabilities of the company up to a limit of $55,000, plus interest from the date of demand. In addition, on April 1, 1998, two of the guarantors, Issam Awad and Wadih Khoury, executed a separate guarantee agreement in which they agreed to be jointly and severally liable for all present and future debts and liabilities of the company up to a limit of $5,000, plus interest from the date of demand.

[5] On October 1, 1998, the company defaulted on its loan payments. On November 2, 1998, the bank sent letters to the company and the guarantors demanding payment. The bank also notified the company of its intention to enforce its security.

[6] Following these demands, the bank received no payments from the company or the guarantors. Accordingly, on December 18, 1998, the bank sold the assets secured by the chattel mortgage to Baker's Dozen Donuts Corporation for $16,250.

[7] On March 24, 1999, the bank commenced an action against the company and the guarantors. As of that date, after reducing the net amount obtained from the sale of the assets, the company remained indebted to the bank in the principal sum of $67,531.71 plus interest. As against the guarantors, the bank sought payment in the amount of $55,000 plus interest from the date of demand. In addition, it sought payment from Issam Awad and Wadih Khoury in the amount of $5,000 plus interest from the date of demand.

[8] The company and the guarantors defended the action on the basis that the bank acted improvidently in the sale of the secured assets. According to the joint statement of defence and counterclaim, as of April 27, 1999, the assets for which the bank received $16,250 had a net book value after depreciation of $128,927. The company and the guarantors, therefore, maintained that the debt owed by the company would have been eliminated or substantially reduced had the bank taken reasonable steps to obtain a fair price for the secured assets.

[9] Following the exchange of pleadings, the bank moved for summary judgment against the company and the guarantors. For the purposes of the motion, the bank conceded the allegation of improvident sale. The motion against the company was, accordingly, dismissed in view of Part V of the Personal Property Security Act, R.S.O. 1990, c. P.10 ("PPSA"), which required the bank, as against the principal debtor, to dispose of the secured assets in a commercially reasonable manner.

[10] With respect to the guarantors, the bank took the position that the defence of improvident sale was not open to them because of a clause in the guarantee agreements which permitted the bank to deal with the securities as it saw fit. According to the bank, by agreeing to that clause, the guarantors relieved the bank of its common law duty to obtain a fair and reasonable price for the secured assets. In support of its position, the bank relied upon the following three authorities: Bank of Montreal v. Bauer, 1980 CanLII 12 (SCC), [1980] 2 S.C.R. 102, 110 D.L.R. (3d) 424; Bank of Montreal v. Soja, [1982] O.J. No. 85 (C.A.) and Bank of Nova Scotia v. Buckingham, [1983] O.J. No. 1347 (H.C.J.).

[11] In a brief written endorsement, the motions judge agreed with the bank's submission. Based on the authorities cited by the bank, which he considered binding, he held ". . . that the individual guarantors . . . contracted out of the common law right to complain about an improvident sale of the assets by the bank when they agreed that the bank 'may otherwise . . . deal with . . . the securities . . .' as it sees fit". [See Note 1 at end of document] Accordingly, he granted the bank's motion for summary judgment against the guarantors.

Analysis

[12] As indicated, the sole issue on appeal is whether the motions judge erred in holding that the guarantors were precluded, as a matter of law, from relying upon the defence of improvident sale because of the clause in the guarantee agreements which permitted the bank to deal with the securities as it saw fit.

[13] In order to resolve this issue, we find it unnecessary to engage in an analysis of the authorities upon which the motions judge relied. Suffice it to say that in our view, those authorities must be read in light of the more recent decision of the Supreme Court of Canada in Manulife Bank of Canada v. Conlin, 1996 CanLII 182 (SCC), [1996] 3 S.C.R. 415, 139 D.L.R. (4th) 426.

[14] In Manulife, Cory J., for the majority, reiterated the well-settled principle, affirmed in Bauer v. Bank of Montreal, supra, that parties to a contract may make their own arrangements and guarantors may, accordingly, contract out of the protections provided to them by the common law or equity. At the same time, bearing in mind that guarantee agreements are traditionally drawn by the lender on standard forms, with little or no input from the guarantors, Cory J. cautioned that clauses which purport to eliminate the rights of guarantors should be clearly worded. In this regard, he quoted with approval at p. 424 the following passage from K.P. McGuinness, The Law of Guarantee, 2nd ed. (1996), at p. 547:

Since the courts have tended to give a narrow construction to provisions in standard form guarantees which authorize such changes, it would be most unwise for a creditor to agree to changes without first obtaining the consent of the surety, except where there is clear authorization for him to act solely upon his own initiative. Where the creditor seeks to show that the guarantee agreement provides a blanket authorization to make material alterations to the principal contract, the wording must be very clear that such a right was intended.

(Emphasis added by Cory J.)

[15] Although this passage from McGuinness refers to clauses that enable lenders to make material changes to the principal contract without first obtaining the consent of the guarantors, in our view, the "clear wording" test applies with equal force to all clauses which purport to eliminate the rights of guarantors. Clauses of this nature must be clearly worded. If they are instead framed in broad, sweeping language that is reasonably capable of more than one interpretation, then, as Cory J. observed at p. 425 in Manulife, supra, the contra proferentem rule of construction will apply:

In my view, it is eminently fair that if there is any ambiguity in the terms used in the guarantee, the words of the documents should be construed against the party which drew it, by applying the contra proferentem rule.

[16] Cory J. at pp. 425-26 went on to adopt the following instructive passage from McGuinness, op. cit., at pp. 612-13, in which the author explains the rationale for applying the contra proferentem rule of construction to broad provisions that purport to eliminate the rights of guarantors:

. . . the contra proferentem rule of construction (under which the provisions of an agreement that were inserted by a party for his own protection are subjected to a strict interpretation) provides one method through which the courts can restrict the scope of extremely broad provisions which purport to eliminate the rights of the surety. The justification for giving such provisions a narrow construction is clear: it is one thing to say that a party may, if he so chooses, agree to assume an excessive burden, and to waive the rights which the law generally recognizes as existing for his protection. It is quite another thing to assume that parties necessarily intend to enter into such obligations. The more natural assumption is the exact opposite. Where the guarantee was drafted by the creditor, and there is any ambiguity or imprecision in the terms of a provision which purports to limit the rights of a surety, it is only fair that the ambiguity be resolved against the party who prepared the document. If the creditor wishes to take away a right belonging to the surety, he should use clear language in the document.

(Emphasis added)

[17] Applying these principles to the clause in issue, it can scarcely be said that the language used by the bank meets the "very clear wording" test referred to by McGuinness and adopted by Cory J. Viewed objectively, it is not at all plain and obvious that by agreeing to permit the bank to deal with the secured assets "as [it] may see fit", the guarantors intended to relieve the bank of its common law duty to take reasonable steps to obtain a fair price for them.

[18] Admittedly, the language in question could be construed as authorizing the bank to wilfully, recklessly or negligently sell off the secured assets at bargain basement prices that bear no relation to their true market value. In theory, it could even be construed as authorizing the bank to give the securities away or destroy them. On the other hand, it can just as readily be interpreted as imposing a standard of reasonableness and good faith on the bank. Indeed, in our view, of the two possible interpretations, the latter accords with commercial reality and produces a much fairer result than the former. This is especially so when one considers that as against the company, the bank was required under the provisions of Part V of the PPSA to dispose of the secured assets in a commercially reasonable manner. [See Note 2 at end of document]

[19] Be that as it may, given our conclusion that the clause in issue is open to at least two reasonable interpretations, the guarantors were entitled to have it construed in a manner most favourable to them. Unfortunately, the motions judge did not approach the issue in this manner. Had he done so, we are satisfied that he would have dismissed the bank's motion.

[20] Accordingly, the order under appeal cannot stand. The appeal is allowed and the bank's motion is dismissed. The appellants are entitled to their costs of the appeal and the motion.

Order accordingly.

Notes

Note 1: The full provision in the guarantee agreement reads:

IT IS FURTHER AGREED that the Bank, without consent of the undersigned and without exonerating in whole or in part the undersigned, or any of them (if more than one), may grant time, renewals, extensions, indulgences, releases and discharges to, may take securities from and give the same and any or all existing securities up to, may abstain from taking securities from, or from perfecting securities of, any accept compositions from, and may otherwise change the terms of any of the debts and liabilities hereby guaranteed and otherwise deal with the Customer and all other persons (including the udnersigned, or any one of them, and any other guarantor) and securities, as the Bank may see fit, and that all dividends, compositions and moneys received by the Bank from the Customer from any other persons or estates capable of being applied by the Bank in reduction of the debts and liabilities hereby guaranteed, shall be regarded for all purposes as payments in gross, and the Bank shall be entitled to prove against the estate of the Customer upon any insolvency or winding-up in respect of the whole of said debts and liabilities, and the undersigned shall have no rights to be subrogated to the Bank in respect of any such proof until the Bank shall have received from such estate payment in full of its claim with interest.

(Emphasis added)

Note 2: For the purposes of this appeal, it is unnecessary to decide whether the provisions of Part V of the PPSA also apply to guarantors.