Smith v Governor and Company of the Bank of Scotland

A creditor negotiating a cautionary obligation must act in good faith. A duty to advise arises where the circumstances would lead a reasonable person to believe that, because of the personal relationship between debtor and cautioner, the cautioner's consent might be neither fully informed nor freely given.

The creditor need not investigate possible wrongdoing. It is ordinarily sufficient to warn the cautioner of the consequences and advise the cautioner to obtain independent advice. Existing duties of full and honest disclosure remain. Failure to take the required steps may prevent enforcement of the security.

A wife sought reduction of a standard security granted jointly with her husband over their matrimonial home. The security supported borrowing for the husband's partnership, in which the wife had no interest. She alleged that her husband misrepresented the transaction and that neither the bank nor its solicitors warned her of its consequences or advised independent legal advice.

The Lord Ordinary dismissed the action, and the First Division refused the wife's reclaiming motion. The First Division applied the existing law of Scotland and declined to adopt Barclays Bank Plc v O'Brien [1994] 1 AC 180.

The central issue was whether Scots law should impose a corresponding duty upon a creditor where a close personal relationship creates a risk that a cautioner's consent is not informed and free.

Appeal allowed unanimously; case permitted to proceed to proof before answer. Lord Clyde delivered the leading speech. Lord Goff of Chieveley, Lord Lloyd of Berwick and Lord Hoffmann agreed with his reasons. Lord Jauncey concurred in the result, while expressing reservations about extending constructive knowledge to misrepresentation.

1. Per Lord Clyde, a voluntary obligation is not ordinarily challengeable merely because a third party induced it by misrepresentation. Established exceptions include agency, participation by the contracting party, and cases where coercion excludes true consent. A cautioner is also generally expected to protect his or her own interests, and a creditor has no general duty to disclose the debtor's financial position.

2. Those rules are qualified by the good faith required in constituting a cautionary obligation. A creditor must not mislead the cautioner by words or silence. Full and fair disclosure is required where the creditor speaks, where an unusual fact material to the risk is unlikely to be known, or where the cautioner's statement reveals a fundamental misunderstanding. Suspected fraud may also require inquiry.

3. Per Lord Clyde, the development in Barclays Bank Plc v O'Brien [1994] 1 AC 180 should be extended to Scotland, but its proper Scottish basis is contractual good faith rather than the English equitable doctrine of notice. Comparable transactions and policy considerations operated in both jurisdictions, and no sufficient feature of Scots undue-influence law justified a different result.

4. The creditor's advisory duty arises where the circumstances would lead a reasonable person to believe that, because of the personal relationship between debtor and proposed cautioner, the cautioner's consent might not be fully informed or freely given. No fixed classification of qualifying relationships is appropriate. The rule creates no evidential presumption that consent was defective.

5. The creditor need not investigate whether the debtor has engaged, or may engage, in conduct vitiating consent. Ordinarily the creditor remains in good faith by warning the cautioner of the consequences and advising independent advice. Any occasion for full and honest disclosure remains governed by the existing law.

6. Lord Jauncey would have dismissed the appeal on established Scots principles alone, particularly because he considered misrepresentation an uncertain basis for constructive knowledge. He nevertheless joined in allowing it. He cautioned against extending the rule beyond cautionary obligations and considered that a creditor unaware of cohabitation need not investigate whether it exists.

1. House of Lords: Allowed the appeal unanimously and held that the action should proceed to proof before answer.
2. First Division of the Court of Session: Refused the pursuer's reclaiming motion. It applied the existing law of Scotland and declined to follow Barclays Bank Plc v O'Brien [1994] 1 AC 180.
3. Lord Ordinary: Lord Johnston dismissed the action.