THE LAW PRIOR TO 1997
The heart of this work concerns the duties which are incumbent upon a lender where they take a guarantee or other security from a third party for the debts of a business or person closely connected to that party.
The law of Scotland had been remarkably stable in this area for around 100 years until the Smith case came before the House of Lords in 1997. Indeed, for cases where what we shall refer to as “the Smith Principle” is not engaged, the position remains reasonably straightforward.
The law is helpfully encapsulated in the case of Young -v- Clydesdale Bank.1
Mr David Young, the pursuer in that action, was brother to a cattle salesman, Robert Young. Robert Young appears to have been in the habit of asking his brother to guarantee his debts to the bank, usually limited in amount to between £300 and £400. In due course, the pursuer was asked by his brother to sign (and did sign) a letter of guarantee which was unlimited in amount. He claimed that he was unaware of the unlimited nature of the guarantee and that he understood at the time of signing that the document amounted to a liability similar in amount to what he had given before – i.e. under £500.
Upon receiving a demand from the bank seeking payment of £5,000, the pursuer raised an action seeking reduction of the letter of guarantee. He brought three distinct arguments to bear:
He had signed the letter in the belief that his liability was to be limited in a similar way to his previous letters, and alleged that a bank official had told him, “fraudulently”, that the granting of the letter was a “mere matter of form”.
That there was a duty upon the bank at the time of signature to inform him that his brother’s account with the bank was overdrawn by £5,000, and that concealment of this fact from him amounted to fraud.
That he was under an essential error by reason of not being told that the overdraft stood at that amount and that the letter was unlimited in amount, and whether or not that error was induced by the bank, his signature had been applied under essential error as to the nature and effect of the document and he should be entitled to reduction of the document on that basis.
On the evidence, it appears that any misrepresentation as to the contents of the document originated with the guarantor’s brother and his staff and not with the bank. It was a matter of admission that the document was not read before signature, and that Mr Young had not asked to read it “because [he] was under the idea that I knew what I was going to sign for before I went to the bank”.2 The question was, therefore, the extent to which the bank required to explain the terms of the document which the guarantor was signing and the liabilities to which he was exposing himself.
Unsuccessful at first instance, Mr Young reclaimed to the Inner House. In their judgment, the Inner House had no doubt that Mr Young and his co-cautioner Mr Mathieson had signed the document without any knowledge of its contents. They were also satisfied that the bank had neither offered nor insisted in reading over the document and/or explaining its contents. It was accepted that had the pursuer been aware of the true nature of the document he would not have signed it, and that he had been deceived as to the contents of the document by his brother. However, the issue in question was not resolved by the establishment of those facts.
The ratio of the case is helpfully encapsulated in the following paragraph:
“If David Young, relying upon his brother’s statement, chose to sign the document without reading, or without looking at what he was signing in order to ascertain what was in it, the consequences must fall upon himself, the bank believing—as they were entitled to believe—that the cautioner knew perfectly well what he was signing. They gave their money on the faith of this document, and it appears to me that that being so, the bank was not and could not be affected by any fraud, or undue concealment in this matter, as far as I can see. Having given money on the faith of the document that had been signed by David Young, David Young must be responsible for the amount.”3
In relation to the duties incumbent upon the bank, and in particular whether the bank had a duty to disclose the extent of the principal debtor’s indebtedness to the guarantor, the court commented that:
“There can be no ground of complaint because of concealment by the bank-agent, for nothing is better settled than this, that a bank-agent is entitled to assume that the cautioner has informed himself upon the various matters material to the obligation he is about to undertake. The agent is not bound to volunteer any information or statement as to the accounts, although if information be asked he is bound to give it, and to give it truthfully.”4
Thus, the Young case sets out very clearly the duties of the bank in circumstances where a guarantor was contemplating giving a guarantee for a relative’s debts. Those duties can be summarised shortly:
The bank had no duty to read the document to the guarantor nor to insist that they read it themselves.
The bank had no duty to inform the guarantor of the state of the principal debtor’s indebtedness.
However, if asked a direct question in relation to the state of the debtor’s account, the bank must answer honestly.
Beyond these duties, the risk lay upon the guarantor to satisfy themselves as to the obligations that they were undertaking and the degree of exposure which they might have. The only exception to that rule might be if it were shown that the principal debtor who induced the signature through misrepresentation was acting as agent for the lender, which would require specific factual averments.5
The issue of whether the lender has answered a question honestly will be a matter of fact, but might require more than merely giving a direct, narrow answer to a direct question. The lender may be required to elaborate on circumstances known to them which might affect the guarantor’s decision to grant the guarantee. For example, a proposed guarantor asking if there was “any issue” with the debtor’s application might require more than an answer in the negative in circumstances where there had been previous applications for credit which had been declined.6
The force of the principle that a lender is not required to disclose the state of the principal debtor’s account was further demonstrated in Royal Bank of Scotland -v- Greenshields7 in which a customer of the bank with an overdraft of £300 and obligations under promissory notes of £1,100 requested a friend to grant a guarantee in his favour in the amount of £300. Believing the customer’s indebtedness to amount to only £300 the proposed guarantor told the bank he was willing to guarantee £300. The bank advised him that a guarantee of £300 may not assist the debtor as the entire amount would be taken up by the bank. The guarantor was therefore persuaded to grant a guarantee for £500. At no point did he ask as to the state of the debtor’s account, and nor was this information volunteered. The guarantor did ask whether the debtor’s financial position was sound, which was answered in the affirmative.
In due course the debtor defaulted and the guarantee was called upon. The guarantor defended the bank’s claim on the grounds that the bank ought to have corrected his misunderstanding of the true state of the debtor’s account by disclosing that his borrowing was £1,100 and not £300. It was held that the bank had no such duty:
“The only circumstances in which I can conceive that a duty of disclosure would emerge, and a failure to disclose would be fatal to the Bank’s case, would be where a customer put a question or made an observation in the presence and hearing of the bank-agent which necessarily and inevitably would lead anyone to the conclusion that the intending guarantor was labouring under a misapprehension with regard to the state of the customer’s indebtedness. Nothing short of that, in my opinion, would do.”8
This general principle that an error induced either unilaterally or by a third party (even in cases of fraudulent misrepresentation) has no effect on the enforceability of the contract remains the law of Scotland in most commercial matters. In Universal Import Export GmbH -v- Bank of Scotland9 for example the shoe was on the other foot, and it was the bank who sought to avoid payment of a bank draft which was said to have been issued pursuant to the fraudulent misrepresentation of the bank’s customer. The payee under the draft was not a party to the fraud and sued for payment of the draft. It was held both at first instance and on appeal that the bank could not avoid liability on the basis of fraud by a third party.
Another example can be found in Whiteaway Laidlaw Bank Ltd -v- Green10 where a company director who had signed a loan agreement containing a personal guarantee was not permitted to put a lender to proof on the question of whether one of his fellow directors (whom it was said misled him into signing the guarantee) had been an agent for the bank. The court cited Young as being conclusive on the point.
Where a lender makes honest representations to a cautioner but the facts change after signature of the guarantee, this may be excusable in certain circumstances. In Bank of Ireland -v- Morton11 the guarantor sought reduction of his guarantee claiming that he had entered the guarantee under the apprehension that a first-ranked security over company property was also being taken by the lender. It appears that the lenders were under the same misapprehension and had communicated this to the guarantor. In fact, the security when it was granted was not first-ranked, which might have affected the guarantor’s exposure. The Inner House of the Court of Session held that there was no duty upon the lender to inform the guarantor that a first-ranking had not been obtained. Moreover in the circumstances of this particular case the terms of the guarantee itself clearly excluded such a duty. Such cases of alleged misrepresentation by the lender will, of course, turn upon their own facts.12
More recently, in a case seeking the reduction of a disposition and minute of agreement granted by a mother to her daughter and son in law on grounds of undue influence, Young was cited as authority for the proposition that it is insufficient merely to plead that a party did not understand what she was signing.13 The point was conceded by counsel for the pursuer that parties are generally bound by what they sign, even if they have not troubled to read it.
Indeed, it appears to be the case that where the bank have made what might be considered a misrepresentation to the principal debtor, the guarantor cannot rely upon that misrepresentation in order to avoid liability under the guarantee. An example of that is found in Barr -v- Dunbar Assets plc,14 where the lender had issued a letter to the debtor stating that they would require a joint and several guarantee from the two members of the business. However, in fact an individual guarantee was signed by one of the members instead. Importantly, the letter explaining that a joint guarantee would be required was not addressed to the member. His attempt to reduce that guarantee on the ground of having been misled by the letter to the principal debtor was unsuccessful. On the other hand, where the lender makes a misrepresentation to the guarantor themselves that misrepresentation can found an action for reduction of the guarantee, even where the misrepresentation is innocent.15
It is clear, therefore, that Young remains good law and tends to operate in the lender’s favour in most cases. As we shall now see, however, influences from outside of Scotland began to form through the 1990’s which were to lead to a conscious change in the law of Scotland by the House of Lords in 1997. As a result, the principle in Young now has a very important caveat in circumstances where the guarantee in question is being granted by the principal debtor’s spouse or another person in a close personal relationship with them and there is a risk of undue influence being brought to bear.
1 (1889) 17 R 231
2 Ibid at p. 234
3 Ibid at p.243, per Lord Adam
4 Ibid, at p244, per Lord Shand
5 See the discussion in Royal Bank of Scotland -v- Shanks 1998 SLT 355
6 See Bank of Scotland -v- Forbes 2011 GWD 12-270
7 1914 SC 259
8 Ibid, at p.268 per The Lord President
9 1994 SCLR 944
10 1994 SLT (Sh Ct) 18
11 2003 SC 257
12 Cf: Royal Bank of Scotland plc -v- O’Donnell 2015 SC 258, where the misrepresentation was considered sufficient to found an action for reduction.
13 Wilson -v- Watkins  CSOH 44: “As a matter of generality it may not be very extraordinary for an adult of ordinary intelligence and competence to sign binding legal documents without having read them or, if having read them, not having fully understood them, but as [counsel] conceded, in such circumstances an adult of ordinary competence will usually be held bound by what she has chosen to add her signature to as an indication of agreement” (per Lord Brodie at para ).
14  CSOH 44
15 Royal Bank of Scotland plc -v- O’Donnell 2015 SC 258, although see also Bank of Ireland -v- Morton, discussed above.