Q3. Explain the function of a cautionary in Scots law and detail the rights of the cautioner as well as the extent of their liability?
It may give lenders comfort. It is a personal obligation given by a third party in respect of an obligation of a principal debtor. It is therefore an accessory obligation. May be debt or may be obligation ad factum praestandum. May be gratuitous. Parent guaranteeing child’s obligations. May be onerous. Bank guaranteeing developes obligations under building contract.No special form
Writing – Generally, cautionary obligations do not require to be committed to writing in order to be validly constituted, but there are important exceptions to that rule. S1 (2) (a) (ii) of the Requirements of Writing (scot) Act 1995 stipulates that writing is required for the proper constitution of a cautionary obligation where it is a gratuitous unilateral obligation not undertaken in the course of business.
Where a cautionary obligation amounts to a security or guarantee for a regulated agreement under the Consumer credit act 1974 s105 states it MUST be in writing and executed by the cautioner.
Accessory obligation – A cautionary obligation is accessory in nature. Therefore, it is not an independent principle which stands on its own and it cannot exist without linkage to an independent principle obligation between a debtor and creditor
The Rights of the cautioners
Right to Relief –
- Cautioners have rights to demand that the principle debtor relieve him of all liability incurred to the creditor, even if debt isn’t due.
- Where cautioner pays then:
- He has a right of relief against the debtor
- He has a right to an assignation of any securities held by the creditor
- He has a right of relief against co-cautioners if he has paid more than his pro rata share
- Where there is more than one cautioner, unless each is bound only for a specific part of the debt, any who has paid more than his share may seek relief to that extent from the other cautioners
Buchanan v Main 1900
2 out of 5 co cautioners were insolvent, when two other cautioners aid the principle debt, they were entitled to require the 5th cautioner to contribute 1/3 of the debt. This presupposes that the cautioners are bound equally.
Assignation – where the cautioner has paid the principle debt in full, he can demand from the creditor an assignation of the debt, as well as any security for it, or diligence done on it. Such security must have been granted by the debtor.
- The right does not extend to securities granted to the creditor by 3rd If the creditor holds the security over two debts, then he is entitled to retain it despite the cautioner paying the principle debt if the other debt is unpaid, unless the second debt is incurred subsequent to the cautioner paying the principle debt
Sharing in securities – All cautioners are entitled to share any security granted by the debtor to a co cautioner even if that security is granted after the cautionary obligations have been undertaken, unless they have agreed that they should not have the benefit of the security.
The principle does not apply to securities granted by a third party. there is also authority for the view that the principle may not apply when co cautioners have limited the amount for which they are liable, but this seems to depend on them being regarded as having guaranteed separate specific sums – a relatively unusual construction,
Ranking in bankruptcy – Where the principle debtor becomes bankrupt the cautioner and the cautioner pays the creditor in full, the cautioner will rank in the insolvency of the debtor as an ordinary creditor. Difficulties arise where the extent of the cautioner’s liability extends to part only of the principle debt or where a limitation has been placed on the amount for which it is to be liable, and a larger debt has been incurred.
The Cautioners Liability – Aitkens Trustees v Bank of Scotland 1945 – provides that a cautionary obligation will be construed in favour of the cautioner and against the creditor. Where a cautioner enters into a cautionary obligation, Jackson v McIver 1875 – demonstrates that the extent of his liability can never be greater than that of the debtor. However, pursuant Struthers v Dykes 1874, the cautioner may be liable for the costs and expenses of the creditor in taking steps against the debtor to enforce the debt. The cautioner will not be liable for sums advanced by the creditor to the debtor after the date on which that financial limit is met.
Cautionary obligation may be extinguished by the actions of the Creditor, Cautioner or by Operation of law
Creditor – “ Giving time” – the creditor binds himself to GT to the principle without the consent of the cautioner. The creditor will be deemed to have given the debtor time where the creditor agrees to postpone the time at which payment by the principle debtor is due.
C & A Johnston v Duthie 1892
Operation of law – “ Prescription” s6 of the Prescription and Limitation (s) Act 173 where if 5 yrs have elapsed since it became enforeceable and no relevant claim or acknowledgment of obligation was made.
Cautioner – “Novation” – Occurs when the principle debt is terminated by a new debt.
Misrepresentation – Likelihood of debtor misrepresenting position is high thus inducing the cautioner to enter into the contract. That does not allow the cautioner to escape the contract.
North of Scotland Bank v Mackenzie (1925)
- Debtor told by bank loan would be called up unless he found a cautioner
- He found M (father and son) and misled them
- Argued Bank constituted him as agent and therefore the misrepresentation was effectively by creditor
- Argument rejected by court and cautioners were liable