Upon exercising their statutory power of sale, a Chargee cannot seek recovery against a Guarantor

A controversial ruling by the High Court in the case of Home Afrika Limited v Ecobank Kenya Limited (Insolvency Cause No. E010 of 2021) (the Ecobank Case) (available here) has sent shockwaves across the banking sector in Kenya, wherein the court held that if a Lender is unable to recover the advanced sums upon exercising its statutory power of sale on security held, it may not thereafter go after the guarantors.

a.)   Brief facts of the case

The facts of this case are that Ecobank Kenya Limited (the Respondent) granted certain advances to Moru Ridge Limited (the Borrower) that were secured by property owned by the Borrower.

Home Afrika Limited (the Applicant/ Guarantor) (together with others) guaranteed the payments of the Borrower vide a Letter of Guarantee (the Guarantee) for the sum of Kenya Shillings Four Hundred and Eighty-Three Million, Five Hundred and Forty-Five Thousand Eight Hundred and Eighty-Five (KES.483,545,885.00) (the Guaranteed Amount).

When the Borrower defaulted on the loan, and the Respondent sought to enforce the Guarantee. The Respondent issued a demand letter seeking payment of the Guaranteed Amount.

The Applicant failed to settle the debt owed by the Borrower, resulting in the Respondent issuing the Statutory Demand in accordance with the provisions of the Insolvency Act (Number 18 of 2015 of the Laws of Kenya) (the Insolvency Act).

The Applicant then brought this Application to set aside the said Statutory Demand pursuant to the provisions of section 17 (3) of the Insolvency Act and Regulation 17 of the Insolvency Regulations 2016 (the Insolvency Regulations), which provide that the Court may set aside a statutory demand where, inter alia, it appears that the creditor holds some security in respect of the debt claimed by the demand, or the Court is satisfied that the value of the security equals or exceeds the full amount of the debt.

b.)   Arguments by the Parties

i.)             The Applicant’s case

The Applicant contended that the Respondent had on its own accord successfully instituted proceedings against the Borrower in Ecobank Kenya Limited v Moru Ridge Limited and Anor (Civil Suit No. 137 of 2018).

The Applicant argued that the Respondent had obtained leave to purchase the security it holds in respect of the financial advances made to the Borrower and had exercised its statutory power of sale thereby settling the debt owed in its entirety and effectively extinguishing the Guarantee.

The Applicant added that the claim thereof by the Respondent is unmerited and amounts to an extortionate scheme at unjust enrichment.

ii.)            The Respondent’s case

The Respondent contended that a creditor who holds an array of security is not duty bound to take one particular line first and this was stated by the Court of Appeal in Barclays Bank of Kenya Ltd v Kepha Nyabera & 191 others [2013] eKLR.

The Respondent also relied on the decision in Peter Munga v African Seed Investment Fund LLC [2017] eKLR, where the court held that a creditor has a free hand, when to act and on which security, without any direction by the debtor, sureties or the court, unless parties have expressly agreed to the contrary and the security documents themselves stipulate the agreement.

The Respondent added that the charged property has not yet been sold and that the forced sale value of the property as per the valuation report was Kenya Shillings Five Hundred and Twenty-Five Million (KES.525,000,000.00).

The Respondent stated that the debt has since escalated and outstripped the value of the property and stood at Kenya Shillings Nine Hundred and Thirty-Eight Million Five Hundred and Ninety-Two Thousand Two Hundred and Sixty-Seven and Forty-Four Cents (KES.938,592,267.44).

The Respondent also contended that the exercise of a chargee’s power of sale under the Land Act (Number 6 of 2012 of the Laws of Kenya) (the Land Act) does not discharge a guarantor of its obligations under a guarantee and indemnity as the duty of the guarantor is created by the guarantee document itself and not the terms of the underlying contract.

The Respondent’s assertion therefore was that the Guaranteed Amount is due and owing and is therefore lawfully entitled to recover from the Applicant as guarantor of the Borrower. The Guarantor is bound by the terms of the Guarantee, and it cannot ask this Court to discharge it from obligations that it agreed to be bound to.

The Respondent also argued that the provisions of section 17(3) of the Insolvency Act and Regulation 17 of the Insolvency Regulations which the Applicant sought to rely on are not applicable with regard to liquidation of Companies but only for bankruptcy proceedings in respect to natural persons, relying on the decision of the court in Oldonyo Nairasha Estates (Narok) Limited v OCP Kenya Limited [2021] eKLR.

c.)   Findings of the Court

The Court set aside the Statutory Demand opining that, since the Respondent holds security in respect of the debt, the requirements for setting aside a statutory demand under the Insolvency Regulations had been met.

The Court added that the Respondents are barred from going after the Guarantor pursuant to the provisions of section 97(1) and (5) of the Land Act – reproduced below:

“97. (1) A chargee who exercises a power to sell the charged land, including the exercise of the power to sell in pursuance of an order of a court, owes a duty of care to the chargor, any guarantor of the whole or any part of the sums advanced to the chargor, any chargee under a subsequent charge or under a lien to obtain the best price reasonably obtainable at the time of sale.

(5) A chargee shall not be entitled to any compensation or indemnity from the chargor, any former chargor or any guarantor in respect of any liability arising from a breach of the duty imposed by subsection (1)”

The Court opined that its understanding of the above provisions is that the Respondent is not entitled to any compensation in the event that it is not in a position to recover the sums advanced during an exercise to sell the charged property and in this case the Respondent was granted leave to purchase the charged property. The Respondent cannot therefore purchase the said property and still go after the guarantors to recover the sum owed.

Our Commentary

In our view, this ruling does not however represent the correct position with respect to guarantees.

It is not an implied condition of a guarantor’s liability that the creditor proceed first against the principal debtor before suing the guarantor or that the creditor exercises simultaneous recourse against other guarantors.[1]

This arises from the fact that it is the duty of a guarantor to see that the principal pays the principal debt or performs the principal obligation, so that the guarantor is liable to the full extent of the guarantee’s secondary obligation upon the principal’s default.[2] It also follows that the creditor is under no duty to realise securities provided by the principal for the enforcement of the guaranteed obligation before proceeding against the guarantor.[3]

The Court also did not pay heed to any of the arguments raised by the Respondent in respect of the applicability of section 17(3) of the Insolvency Act and regulation 17 of the Insolvency Regulations. As the Respondent correctly pointed out, the said provisions apply only in respect of bankrupt natural persons and are not applicable with regard to liquidation of companies.

The Court stated in its judgment that its understanding of section 97(1) and (5) of the Land Act is that the Respondent is not entitled to any compensation in the event that it is not in a position to recover the sums advanced during an exercise to sell the charged property.

Section 97(5) however provides that a chargee shall not be entitled to any compensation or indemnity from the chargor, any former chargor or any guarantor in respect of any liability arising from a breach of the duty imposed by subsection (1).

The chargee is therefore estopped in seeking compensation or indemnity if it breaches its duty under section 97(1) of the Land Act. This duty is the duty of care owed by the chargee to the charger or guarantor to obtain the best price reasonably obtainable at the time of sale when it exercises its statutory power of sale.

The Court in the Ecobank Case did not show how or even if the Respondent breached this duty of care to obtain the best price reasonably obtainable for them to be stopped from seeking compensation or indemnity from the Guarantor.

It is for the reasons discussed herein that we consider that the High Court decision in the Ecobank Case does not represent the correct position in law. If the ruling is not successfully challenged on appeal, then lenders need to be wary as to the nature of securities that they accept before providing any commercial facilities to its borrowers.

[1] Dr James O’Donovan and Dr John Phillips, The Modern Contract of Guarantee (2nd English Edition, Sweet & Maxwell 2010), pg 609.

[2] Dr James O’Donovan and Dr John Phillips, The Modern Contract of Guarantee (2nd English Edition, Sweet & Maxwell 2010), pg 609.

[3] Dr James O’Donovan and Dr John Phillips, The Modern Contract of Guarantee (2nd English Edition, Sweet & Maxwell 2010), pg 610.

March 2023.

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