By Jason Bettles

Subrogation is defined as "the substitution of one claim for another, especially the transfer of the right to receive to payment of a debt to someone other than the original creditor"

Almost all readers of this e-Update would know that when a guarantor pays out all of the debt of the lender that guarantor is entitled to stand in the shoes of the lender. After payment in full not only is the guarantor able to claim against the borrower but he or she is also entitled to whatever security the lender held. All of this happens by operation of law and needs no separate agreement to be effective.

But quite regularly we come across situations when a third party (that is a non guarantor) pays a debt on behalf of another, on the assumption that by doing so they will automatically qualify to claim against the original debtor. The true position is that in the absence of a suitable agreement the payment by a non guarantor third party gives no automatic right of subrogation.

Perhaps an example from a recent liquidation will help explain the position better. In that liquidation:

  1. The company owed $35,600 to a creditor and that claim had been guaranteed by the sole director.
  2. Before the liquidation the creditor was pressing hard for payment. In an effort to keep the company afloat the director asked his parents to pay the creditor, which they did.
  3. When the company was placed into liquidation the director's parents lodged a claim against the company, which we had to reject.

As noted above subrogation happens automatically when a guarantor pays out all of the debt of the lender. But the parents had not guaranteed the debt so they were not entitled to automatic subrogation.

The parents claim would have been allowed if either:

  1. At the time of paying the debt the parents had obtained a properly prepared and executed assignment of the claim from the creditor. Of course it is too late for this to happen after payment has been made, so they could not go back and ask for an assignment later.

  2. Or

  3. The parents had been able to convincingly argue that the payment was made at the request of the company and that the transaction amounted to a loan by the parents to the company. The information which the parents gave us unfortunately negated this conclusion.

The lesson is that subrogation should not be assumed if the debt is not paid as a guarantor.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.