A developer was lent money by the bank secured by a mortgage, a fixed and floating charge, and a guarantee. The developer went into liquidation but before it did, the guarantor advanced funds to enable it to complete the development. The bank debt was laterrepaid. The guarantor argued that the surplus funds paid to the developer were held on constructive trust for its benefit. The guarantor argued that the trust arose because the guarantor was subrogated to the bank’s rights which required the bank to account to him for the surplus.
The court found no subrogation because the advance by the guarantor did not reduce the developer’s debt to the bank – the bank debt was completely unaffected by the advance, so there was no basis upon which the guarantor could be subrogated to the rights and remedies of the bank in relation to the developer’s debt to the bank.
The court said:
It is no answer to say that, if the bank had advanced more money, the balance of the guaranteed debt would have increased. A right to subrogation arises to the extent that a guarantor pays off the debt owed by the debtor to the secured creditor. It does not extend to funds which the guarantor advances to the debtor which never form any part of the debtor’s liability to the secured creditor.
As such, the bank had no obligation to account for the surplus funds to the guarantee. In any event, the court found that the bank did not receive the surplus funds.
A fiduciary obligation only arises on the part of the first mortgagee where a surety has made payments under a guarantee in reduction of the debt to the first mortgagee. If the surplus is misapplied, the first mortgagee is treated as a constructive trustee to the extent that it must account to the surety as a defaulting fiduciary.
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