ARTICLE

Securing third party obligations

Case law is becoming uniform regarding the requirements to grant a valid guarantee in order to secure third parties’ obligations. In this context the Commercial Court of Appeals did not admit –in a reorganization proceedings case- a mortgage credit alleging that the creation of the mortgage by the company as a guarantee for obligations of a third party exceeded its corporate purpose.

October 6, 2009

On June 3, 2009, the Commercial Court of Appeals dismissed the appeal filed by the Argentine branch of Citibank, N.A. (the “Bank”) seeking to admit its credit in the reorganization proceedings (concurso preventivo) of Sabavisa S.A., alleging that the creation of a mortgage by Sabavisa S.A. as a guarantee for obligations of a third party exceeded Sabavisa S.A.’s corporate purpose.

1. The Facts

Sabavisa S.A. (the “Guarantor”) created a mortgage over real estate of its property in favor of the Bank and in security for obligations undertaken by a third party with the Bank.

Later, within the Guarantor’s reorganization proceedings, the bankruptcy trustee rejected the credit alleging, among other things, that the Guarantor’s by-laws did not allow the Guarantor to constitute guarantees, and that the mortgage did not guarantee a transaction in which the Guarantor was involved.

Consequently, the Bank appealed the decision based on the following grounds:

a) The Guarantor’s by-laws allowed the granting of the guarantee as it sets forth that the Guarantor may “enter into any necessary financial operations allowed by law”.

b) The Guarantor’s Board of Directors and Shareholders approved the granting of the guarantee.

c) The transaction benefited the Guarantor as a member of an economic group.

2. The Ruling

In connection with the first grounds argued by the Bank, the Court stated that it was not applicable when the obligations being guaranteed were obligations assumed by third parties.
The Court sustained that when the guaranteed obligations are assumed by third parties, such guarantees must fulfill certain requirements in order to fall within the Guarantor’s corporate purpose as follows: a) the Guarantor must obtained a direct or indirect benefit from granting such guaranty; b) the guarantor must have a financial purpose and must obtain a financial benefit for such guarantee. In this regard, it is important to highlight that even if a company has a financial purpose, a guarantee granted free of charge shall be qualified as exceeding its corporate purpose (ultra vires), as the granting of such guaranty would not bring any benefit to the guarantor.

The Court stated that the Guarantor neither had a financial purpose nor it received any benefit from granting the guaranty.

Regarding the second argument raised by the Bank, the Court stated that the approvals by the Board of Directors and the Shareholders were not sufficient as the corporate by-laws should have also been amended and such amendment should have been published in the Official Gazette in order to give publicity to such amendment.
Finally, regarding the third and last ground raised by the Bank, the Court stated that, in light of the two previous arguments, the third question became abstract.

Likewise, it is important to highlight that, although in some cases it is reasonable for the Guarantor to obtain a benefit from granting a guarantee for obligations of a third party by virtue of being part of an economic group (i.e. a parent company that grants a guarantee to a subsidiary); it is not clear in other cases (i.e. a subsidiary granting a guarantee to its parent company). However, given the Court’s silence in relation to this matter, further decisions on up-stream guarantees will be needed to bring more clarity to this issue.

Considering the above mentioned, the Court decided that the granting of a guarantee by Sabavisa S.A. in favor of the Bank was an ultra vires transaction that exceeded its corporate purpose and, thus, rejected the appeal.

3. Conclusion

Case law is becoming more and more uniform regarding the requirements to grant a valid guarantee in order to secure third parties’ obligations.

Such requirements may be summarized as follows:

(i) the granting of such guarantees shall be expressly set forth in the guarantor’s by-laws; and

(ii) they must involve some kind of benefit or, in companies that have a financial purpose, some profit to the grantor.

This insight is a brief comment on legal news in Argentina; it does not purport to be an exhaustive analysis or to provide legal advice.