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I have a question about subrogation and I would be grateful for anyone's thoughts.

The question is about the ability of a guarantor of a secured debt to have the benefit of the creditor's securities, once the guarantor pays the creditor. This ability is secure in all civilian systems (eg Civil Code of Quebec art. 1656(3); BGB s. 774). It was made part of the law of England by the Mercantile Law Amendment Act 1856, s. 5, after common law decisions suggested it was not. Most common law jurisdictions have cognate legislation.

To me, this seems to make perfect sense. The reason for my question is that the weight of commentary suggests the contrary. Burrows questions it (at 83), and Charles Mitchell in The Law of Subrogation says that it is "unjustifiable" (at 59). Goff & Jones doubt whether the rule should apply to securities of which the surety was unaware, or those taken after the guarantee was executed (at 604).

The reason for questioning the surety's ability to take over security rights is (i) there is no genuine intention built into the agreement between surety and creditor, that the surety will have the benefit of any securities (Burrows); and (ii) the surety cannot claim to have an undestroyed proprietary base, nor can he claim that he never took the risk of the debtor's insolvency (Mitchell). Therefore it is said there is no justification for the surety's acquiring the securities.

It seems to me that these arguments miss the point. The point is that the surety is guaranteeing a particular risk. He is guaranteeing to the creditor that the debt will be paid. He is not guaranteeing any other risk or any larger risk. If the creditor has real security for the debt, then the creditor's risk is reduced. So then should be the surety's. The only way to ensure that the surety's risk is no greater than the risk taken by the creditor is to provide that the surety shall have the benefit of any security, once he has paid the creditor.

This reasoning extends even to securities taken after the guarantee is signed. The reason is that the surety's risk must be exactly the risk of non-payment by the debtor to the creditor, in an ambulatory sense. After all, if the risk of default by the debtor goes up (eg because of a business failure), then so goes up the risk which the surety is insuring. Thus if the risk of default goes down (where the debtor gives a new security), so should go down the risk which the surety is insuring. It also extends to securities of which the surety is unaware. It is inherent in the guarantee that it covers the exact risk to which the creditor is exposed, whatever that may be.

I suppose another way to look at is analogous to marshalling. The creditor could, if he wished, realize on the security (extinguishing it) and then go after the surety for any deficiency. If he chooses to go after the surety first, why should this enure to the benefit of others (unsecured creditors of the debtor)?

Finally, this reasoning is supported by the rule that the guarantee is unenforceable (at least to the extent that the surety is harmed) if the surety does not protect the security (cf CCQ art. 2365; BGB s. 776). Recent authority holds that this rule is so fierce that it can operate even in the face of an express term in the guarantee which purported to exclude it (First City Capital Ltd. v. Hall (1993), 99 DLR (4th) 435 (Ont CA)). Similarly, if the creditor materially changes the contract with the debtor (eg giving more time to pay), the surety is discharged (at least to the extent that the surety is harmed). These rules only makes sense on the basis that the surety is guaranteeing a particular risk, and so is excused if the risk is enlarged by the creditor.

Any thoughts??

Lionel Smith
Faculty of Law
University of Alberta
403 492 2599; Fax 403 492 4924