October 21st, 2014
The recent Ontario Court of Appeal (“ONCA”) split decision in Can-Win Leasing (Toronto) Limited v Moncayo, 2014 ONCA 689, barred Can-Win Leasing’s claim for equitable contribution against Mr. Moncayo. In doing so, the ONCA clarified when a surety, after voluntarily repaying a guarantee they shared with other parties, can demand contribution from a co-surety. Together, this case sends a message to sureties that share guarantees: work together.
The debtor in this case is Can-Win Truck (“Truck”). Truck was equally owned by Mr. Irwin and Mr. Moncayo. Together with Can-Win Leasing (“Leasing”), Irwin and Moncayo guaranteed the debt of Truck to the Royal Bank of Canada (“RBC”). Irwin was the sole shareholder of Leasing.
In March of 2008, after Irwin and Moncayo had a falling out, Irwin took unilateral control of Truck’s operations and “shut out” Moncayo (para 5). In August of the same year, Irwin began to pay down Truck’s outstanding debt through Leasing. In 2009, RBC assigned the remainder of the debt to Leasing. The payments, and assignment, occurred without notice to Moncayo.
Leasing subsequently claimed contribution against Moncayo for his share of the payments to RBC.
The trial judge made several factual findings that dictated his application of the law:
- “It [was] common ground that RBC made no formal demand for payment,” and that Truck was never in a state of default (para 14);
- The payment of the debt was made for Irwin’s own interest and not for the benefit of Truck (para 15);
- Neither the assignment nor the payments were necessary for Truck’s survival (paras 17 and 21);
- Truck was salvageable as a business (para 20).
Based on these facts, the trial judge held that Leasing could not enforce Moncayo’s guarantee (para 28). The absence of notice removed Moncayo’s ability to re-negotiate the debt, and the payments were not actually necessary since RBC had made no demand (paras 21-28). As a result, paying the debt changed the risk to Moncayo, and thus prejudiced his interests (para 27).
The ONCA agreed with the trial judge and, importantly, accepted the lower court’s factual findings.
At law, if a surety pays “more than its rateable share” of the guaranteed debt they have “an equitable right, independent of contract, to recover contribution from its co-sureties” (para 33). Quoting Kevin McGuinnes’ The Law of Guarantee, the ONCA held that a right to contribution exists if the surety claiming such relief was “legally obligated” to make the payment (para 33).
In general, there are two circumstances that give rise to such an obligation (para 39):
- The creditor demands payment from the surety; or
- The debtor guaranteed by the sureties faces imminent default.
In the face of a claim for contribution, a co-surety can argue that the payment was “impudent or unnecessary,” thereby avoiding liability since the payor was not actually obliged to make the payment (para 33).
Leasing paid more than its rateable portion of Truck’s debt. Thus, Moncayo would owe contribution if Leasing was under an obligation when it made the payments.
Was there a demand?
The ONCA accepted that RBC did not make any repayment request (para 39). Thus, there was no argument under this operation.
It is worth noting that while a “surety is entitled to pay as soon as his or her liability arises under the terms of the guarantee,” doing so without notice to the co-surety can still give rise to the “impudent or unnecessary” defense (para 33). This is because a payment without notice robs the co-surety of his right to participate in settlement negotiations (para 34).
Was Truck’s default imminent?
If a surety learns that “the primary obligor’s default is … imminent,” they are “entitled to take unilateral action” to settle the debt (para 39). The notion is that if default is in fact imminent, then “payment did not prejudice” the co-surety (para 46).
This argument was also barred by the trial judge’s findings. The determination that Truck was a salvageable business led to the conclusion “that the discharge of the loan by [Leasing] was premature and prejudicial to Mr. Moncayo” (para 51). In other words, the state of the business did not rationalize Irwin’s unilateral settling of the debt. As a result, Irwin “was not acting under legal obligation, [and] was simply a volunteer,” meaning that “no right to contribution arose” (para 52).
While the ONCA recognized that the “imminent default” exception is intended to permit a surety to take swift and decisive action, the Court noted that it can also be stretched to rationalize abusive behavior (para 53). This may be the main reason for the decision, since the ONCA felt that abuse had occurred in this instance (para 54).
The Court felt that Irwin decided to exit the business, and did so by taking control of it, excluding Moncayo, and paying Truck’s debt without notification (para 54). While this may seem harmless, these actions “[deprived] Moncayo of the opportunity to work the debt down in an orderly way or to liquidate the company so as to maximize its contribution to the debt. It also deprived Mr. Moncayo of the ability to look to [Truck] for the discharge of its primary obligation” (ibid). This “was clearly prejudicial” to Moncayo (ibid).
Further, there is good reason to require a “surety to give notice of his intentions to [his] co-sureties” (para 55). Such acts promote “the efficient winding up of the business and the equitable allocation of its outstanding liabilities” (ibid). The ONCA even went so far as to say that “[a]bsent evidence of an imminent default, courts should promote [such cooperation] and not the unilateral action that occurred here” (ibid).
As a result, the majority of the ONCA felt that Irwin’s conduct, and the absence of any obligation to pay, prohibited Leasing from enforcing Moncayo’s guarantee. No equitable contribution was ordered.
The significance of this case cannot be truly appreciated without reading Justice Lawuer’s dissent. While the dissent characterizes the facts quite differently, its discussion of the law is more pertinent.
Lawuer J.A. implies that a co-surety must satisfy a more stringent test than the one used by the majority. The dissent holds that “[i]n the absence of a formal demand from the creditor, it remains open to the co-surety to establish that there should be no right of contribution on the basis that the payment to the creditor was premature and was prejudicial to the co-surety’s interests” (para 82; emphasis added).
In this sense, more is required than evidence that the payment
[i]n question was “officious”. A surety seeking to avoid contribution must establish prejudice. If there is no prejudice, then the surety seeking to avoid contribution will have been enriched by the impugned payment, and the objective of contribution – being the prevention of unjust enrichment in the context of a common obligation – will be defeated (para 83).
In the opinion of Lawuer J.A., Moncayo “[had] not established that he suffered prejudice as a result of the payments made by [Leasing] to RBC, apart from the obligation to pay his share” (para 88). Instead, Irwin had every right to reduce Truck’s debt, since he was the primary financer and wanted out of the business: Irwin provided, either personally or through Leasing, more than $4.1 million in security for Truck’s loans while Moncayo had only guaranteed $900,000 (para 65). This caused Lawuer J.A. to concluded that once Irwin had decided to stop financing the company, “default was imminent and inevitable” (para 80). Absent his support, and in light of the fact that Moncayo was either incapable or unwilling to provide further financing, no other result was possible (paras 87-88 and 91). Irwin’s actions merely forced Moncayo to pay his share earlier rather than later.
Thus, according to Lawuer J.A., the trial judge erred in relieving Moncayo of his guarantee. Since the business was eventually doomed, there was no inequity in forcing Moncayo to honor his obligations.
Together, the majority and dissent show a different preference for Irwin’s behavior. The majority seemed to feel that it was the exclusion of Moncayo that created the prejudice that vitiated his obligations. Had Irwin included Moncayo, or at least given him notice, Leasing would probably have been less vulnerable to Moncayo’s argument. The dissent, on the other hand, felt that “[w]hile [Irwin's] approach may appear aggressive, in view of [Moncayo's] apparent impecuniosity, that is not a factor that is relevant to the appellant’s rightful remedy” (para 97). It is enlightening to realize that the prejudice the majority refers to is merely a loss of opportunity. The abstract nature of this prejudice is probably why the majority emphasized the legal obligation aspect of the contribution test, as opposed to the harder prejudice requirement relied upon by the dissent. Without such a focus, their decision would have been even more susceptible to the dissent’s critique.
That said, the majority’s decision is the law. Thus, a key lesson to take from this case is that Irwin’s larger stake does not justify his exclusion of Moncayo. Given this formulation of the contribution doctrine, it is advisable for sureties to cooperate throughout their relationship. Through the provision of notice, and the maintenance of an open dialogue, parties can decrease their vulnerability to the defense used by Moncayo. Notice gives all parties the ability to decide their course of action, and circumvents the notion of prejudice that the majority used in this decision.