A recent decision by the Supreme Court will worry lenders and holders of security seeking to rely on the strict terms of recourse clauses in facility letters. Co-borrowers named in a facility letter may not be liable after all if they were not central parties to the transaction requiring the loan. The decision is rare because usually the Court will not look outside the four walls of a contract to the intention of the contracting parties. Importantly the circumstances of the case are not so rare. The decision could therefore apply in many other cases involving recourse loans.
The terms ‘recourse’ and ‘non-recourse’ gained common understanding during the boom here. A loan is non-recourse if in the case of default the lender cannot make the borrower personally liable for the loan. The lender’s recourse is limited to the asset on which the loan is secured. Non-recourse loans are nothing new but they traditionally required an insurance policy to be taken out by the lender to cover the risk of the borrower defaulting. The policy would entitle the lender in circumstances of default, where the value of the security did not cover the value of the loan, to recover any loss.
Non-recourse loans became popular during the boom but the insurance policies traditionally associated with them were not usually taken out. As concerns grew among lenders non-recourse loans were replaced by full recourse loans. These entitled the lender to pursue the defaulting borrower for any shortfall between the value of the security and the value of the loan. Consequently there are now hundreds of cases before the Superior Courts in which lenders are seeking to rely on personal recourse clauses in facility letters to make borrowers personally liable for those shortfalls. Clearly then, this Supreme Court decision could have far-reaching implications.
The present decision was made in Philip Lynch’s recent unsuccessful Supreme Court action to overturn a previous High Court order to repay a loan of more than €26m to AIB. (Mr Lynch entered a joint venture to purchase of 86 acres at Kilbarry, Waterford in February 2007). But the intriguing element of the Supreme Court judgment is the decision to set aside the High Court judgment against Mr Lynch’s wife, Eileen and his four children. The High Court had found them all liable for the full amount of the loan on foot of a full recourse clause in the Facility Letter executed by them all. The Lynch family argued that they had understood the loan to be limited in recourse only to the land in Waterford that had secured the loan. It was their position that there was to be no recourse to them personally.
But the clear terms of the facility letter provided that the loan was full recourse jointly and severally against each member of the Lynch family. In the appeal, the Supreme Court departed from the strict norm to look outside the four walls of the contract to the actual intention of the parties.
AIB argued it was entitled to judgment orders against all of the Lynch family members and the other joint venture partner Gerard Conlon. Evidence was heard that Philip Lynch told his daughter Judith that he would not do the deal if AIB had recourse to him for the loan. Judith gave evidence that she believed that she signed documents on the basis that AIB would have recourse only to the property purchased.
The first drafts of the Facility Letter limited recourse to Mr Lynch and Mr Conlon. In an amended Facility Letter, signed by Judith this limiting clause was deleted. An Affidavit sworn by her states that the family`s solicitors advised that the Facility Letter was amended “to reflect the fact that the bank now only requires legal recourse against the property being their security for the loan – they no longer require any legal recourse as against Philip, Gerry or the Lynch children”.
The Supreme Court ruled that the terms of the Facility Letter certainly bound Mr Lynch and that, on its face, it provided for the joint and several liabilities of all of the Lynch family as co-borrowers. But importantly, the Court observed that whilst they were indeed expressed as parties to the Facility Letter, the other Lynch family names were only added to the final draft of the Facility Letter on the day before the deal concluded. The Bank had been advised by its lawyers to name them as borrowers because that would simplify any subsequent enforcement of the security.
The Court found that the bank had no interest in Mrs Lynch and the Lynch children and that their addition to the transaction neither created any additional risk for the bank, nor provided any additional security in terms of payment. The Court found that the correspondence from the time establishes from a commercial point of view that the bank was focussed only on the possibility of recovery from Mr Lynch and his original co-purchaser, Mr Conlon.
Therefore the Court concluded that in the very particular circumstances of the case it was questionable as to whether it would be equitable to permit the bank to enforce its legal claim against the wider members of the Lynch family, or at least to do so without having first pursued execution against the “principal borrowers”, being Mr Lynch and his original co-purchaser Mr Conlan.
This decision represents another in series of recent jurisprudence applying and developing equitable principles to the terms of lending contracts. Those principles are increasingly being used to effectively limit the ability of financial institutions and others holding security to make borrowers entirely responsible for very questionable lending decisions. The difficulty is that borrowers generally do not have the financial resources to match those of the financial institutions and so they usually capitulate early. It is only when borrowers can finance effective legal challenges that we see the cracks that exist in the enormous debt enforcement edifice.
This publication is for guidance purposes only. It does not constitute legal or professional advice. No liability is accepted by Leman Solicitors for any action taken or not taken in reliance on the information set out in this publication. Professional or legal advice should be obtained before taking or refraining from any action as a result of the contents of this publication. Any and all information is subject to change.