Understanding the significance of oral clauses in surety agreements

The case of European Bank for Reconstruction and Development v Teodori [2023] 2 WLUK 674 explores what the effect is upon guarantors agreeing to vary the underlying loan agreement and how this is impacted if the parties have agreed a ‘no oral modification’ clause.

Background facts

The claimant bank (the Bank) had lent €6m to the first defendant, an Albanian company (the Principal) to fund the design and construction of a hydropower project in Albania.

The second to fifth defendants were guarantors of the Principal’s obligations under the loan agreement and the sixth defendant had provided a performance security bond for a limited amount of the Principal’s liabilities.

The issues

The Bank applied for summary judgment in respect of its unpaid loan plus loss and expenses incurred in recovering the money due from the Principal.

The Principal’s defence was that the parties had verbally agreed to vary the loan agreement so that the Principal’s revenues would first be used to cover its operational costs on the project and any surplus would be put towards repayment of the loan. That verbal agreement the Principal submitted amounted to a contractual variation of the Bank’s rights, alternatively, the Principal had relied on the oral agreement and the Bank was estopped from making the repayment demands.

In response, the Bank relied on a clause in the loan agreement which stated that no oral modifications would be binding unless they were in writing and signed by the parties.

The decision

It was decided that the Court should give effect to a contractual provision agreed between the parties which required specified formalities to be observed for a variation.

The parties had agreed that no oral modification would be binding upon them unless it was signed and in writing and those formalities had not been complied with.

The Bank was granted summary judgment against: (i) the Principal in respect of the loan; (ii) the second to fifth defendants in respect of the claims under the guarantee and interest totalling €8.7m; and (iii) the sixth defendant in respect of the claim under the performance bond in the sum of €464,051.

Implications

This was not a full trial or hearing of all the issues in the case, but rather a summary judgment application. In effect, the Bank was saying that the defendant Principal and guarantors had no reasonable prospect of successfully defending the case and the Judge agreed with that.

The case is a useful reminder of ‘no oral variation’ clauses. They are often seen in commercial agreements such as indemnities. This case demonstrates that these clauses are important and will be upheld.

Interestingly, the personal guarantees appear to have been on-demand obligations. The judgment does not set out the terms of the sixth defendant’s bond, so we do not know whether it was a conditional guarantee or on demand obligation. The rule in Holme v Brunskill – to the effect that a guarantor will be discharged by a variation to the underlying contract which is neither advantageous to the surety nor inconsequential – will have no application to independent, on-demand type obligations, however, the Court did not need to consider that issue because the Principal did not get past this initial hurdle.

Other interesting questions arise such as the ability of the Bank to recover ‘loss and expenses incurred in recovering the money due’ from the Principal. Presumably, the terms of the guarantees expressly provided for the Bank to recover those sums, but this is not dealt with in detail in the judgment.