“Ready Weapons for Undue Influence” and other reasons for ILA
Independent Legal Advice
One of the most frequent questions/irritants Borrowers raise/experience in a commercial transaction is the requirement for their spouse to obtain independent legal advice. Typically, the complaint is that the spouse knows that what they are signing is a guarantee and that it is an inconvenient and needless expense to have to obtain independent legal advice, especially if it is being repeated as part of a refinancing.
What the Borrower does not appreciate is that the purpose of independent legal advice is not just to educate a guarantor
that what they are signing is a guarantee – that is usually obvious all by itself. The function of independent legal advice is actually to overcome defences that the bank would not have been aware of and which would render the guarantee unenforceable.
Defences such as undue influence, duress and other “ready weapons” are available to guarantors who only later argue that they did not sign the guarantee voluntarily. This article reviews the more common defence of undue influence.
If one person, by virtue of the nature of their relationship, is able to take an undue advantage of another, whether by reason of pressure, or distress, or recklessness, or wildness, or want of care and the facts show that one person did take undue advantage of the other by those circumstances, a transaction based on such dealing will be set aside. Put into the context of banking, it is a general rule that where a guarantor is persuaded to enter into a guarantee by the undue influence of another, and the transaction is of no financial benefit to the guarantor, the bank will be unable to enforce the guarantee. Lending transactions often are of no value to some guarantors: a loan to a corporation owned by one spouse will be of no benefit to the other spouse, for example. The challenge for the bank is that they will not have any knowledge of the undue influence and yet, because of the wrongdoing of the borrower or a co-guarantor, the guarantee that they obtained can fail.
The Presumption of Undue Influence
Courts have traditionally decided that married women who guarantee their husband’s debts (or guarantee their husband’s corporation’s debts) form a specially protected class. In each of these situations, the loan is of no financial benefit to the wife. Although the husband/wife relationship is traditionally considered to contain the highest risk of undue influence, the risk of undue influence is present in any relationship where one person has placed confidence and trust in another to make their financial decisions. The “at risk” can include, for example: elderly parents, young adult children, employees of a corporate borrower, a co-habiting spouse and, of course, husbands who leave financial decision-making to their wives. This defence can be seen in a number of examples:
Lloyds Bank v. Bundy: Bundy was an elderly farmer who mortgaged his only asset, Yew Tree Farm, to the bank toguarantee his son’s business and later signed additional guarantees and mortgages to assist his son. Bundy had great faith in hisson and told the bank that he would help his son as far as he possibly could. The son’s business was not successful. The banksecurity against the father was set aside by a court.
Morrison v. Coast Finance: Two men, Lowe and Kitely, persuaded an elderly woman of 79, Morrison, to borrow
money and then lend the bank’s advance to them. When the bank manager, who was present when Morrison was signing the loan documents, heard Morrison say: “Frank, that is more than I agreed to lend you” and heard her ask: “Should I sign this?” the court concluded that the bank should have been aware that Morrison was entering into the loan transaction under undue influence. The bank’s security was set aside.
McKenzie v. Bank of Montreal: McKenzie signed a mortgage and guarantee of the debts of the man with whom she co-habited. The bank knew her partner was not creditworthy. The court held the bank transaction unconscionable because the bank was aware of her emotional relationship with her partner and the risk of his undue influence over her.
The Bank’s Constructive Notice
A transaction with a guarantor who places their trust and confidence in a co-guarantor or debtor and who receives no financial benefit from the transaction automatically creates a presumption of undue influence. Anytime the bank is aware of such a relationship, the bank is considered to be “on notice” of the risk of undue influence. The bank will not have been aware of any actual undue influence, but the bank’s prior notice of the risk of undue influence gives it constructive notice of any wrongdoing.
The onus then falls onto the bank to rebut the presumption of undue influence. If the presumption of undue influence cannot
be rebutted by the bank, such constructive notice will prevent the bank from enforcing its guarantee against such a guarantor.
Rebutting the Presumption of Undue Influence
Evidence that such a guarantor obtained, or was advised by the bank to obtain, independent legal advice is evidence that the guarantee was delivered freely and voluntarily and will rebut the presumption of undue influence. Proving that such a guarantee was the product of a free and independent mind in the absence of independent legal advice may still be possible; however, because the onus is on the bank and because the bank is not privy to all of the details of the relationship that permitted the undue influence or the actions that caused the undue influence, the bank will automatically be at a disadvantage.
Simmons da Silva & Sinton LLP are approved external
counsel to the Bank of Montreal and have been assisting
with mid-market and small-medium enterprise
transactions for more than 40 years. More recently,
Simmons da Silva & Sinton LLP have also been assisting
the Bank of Montreal with CSBFA transactions.
Bruce Duggan is a certified specialist in corporate and commercial law and a partner at Simmons, da Silva & Sinton LLP, a Brampton law firm. Nirav Bhatt an articling student at Simmons, da Silva & Sinton LLP assisted with research. This article by necessity is general in nature and is not legal advice.