When a creditor provides a party with credit – e.g. a loan or the provision of goods or services on credit - a sincere promise by the debtor to repay the loan is often not enough for the creditor. Such a promise will almost certainly leave the debt at least partially – and maybe wholly - unpaid if the debtor goes bankrupt, no matter how much the debtor wants to honour their obligations.
Therefore it is normal for a creditor to require some other source of repayment. One way of achieving this is a guarantee.
A guarantee is a binding promise by a third party, that they will be liable for the obligations of the debtor, if the debtor defaults on their obligations. Therefore, if the debtor cannot repay all or part of the debt they owe, the creditor can call upon the guarantor to make up the shortfall.
Usually a guarantee relates to the payment of a monetary debt but it can also relate the performance of a contractual obligation which doesn’t involve money.
Who can give a guarantee?
A guarantee can be given by anyone with capacity to enter into a contract, a company or other legal persons such as statutory bodies, associations or trustees. An enquiry should always be made to ensure the party providing the guarantee has power to do so – for example this might be an issue when dealing with a company or trust.
It would be unusual for a party to undertake the risk of being called on to fulfil another’s obligations if they have no connection to the debtor. Some of the most common instances of guarantee will be related companies guaranteeing each other’s obligations, a director guaranteeing the obligations of their company or family members acting as guarantors for each other. Some of the saddest cases we have handled as lawyers have involved family members who have guaranteed the business debts of a son, daughter, brother or sister.
How do I enter into a guarantee?
To be enforceable, a guarantee must be in writing and must be signed by the guarantor. Since it is a contract, it also needs to fulfil the requirements of consideration (value), but using a deed can sometimes get around problem is created by consideration. There may also be additional formal requirements under state laws relating to the provision of credit, including requirements in relation to disclosure.
When can a guarantee be enforced?
The law of guarantees is very technical. Large volumes have been written on it. Issues in the enforcement of guarantees can include:
- whether the guarantee is supported by value (consideration) or is in the form of a Deed
- whether it stipulates that the guarantor will be liable only if the debtor defaults, or contains an indemnity making the third party (guarantor) liable whether or not default has occurred
- whether the guarantee is over obligations that the debtor has already incurred (this gives rise to specific issues where new value - consideration – is not being provided)
- whether the guarantee is security for the performance of an obligation that the debtor is presently incurring, or might incur in the future (e.g. further advances of credit)
- whether there is a limit on the liability of the guarantor
- whether the guarantee is for the whole of the debt of the debtor
- whether it covers interest and costs of enforcement
- whether the guarantee stipulates that the guarantor remains liable even if the primary contract that gives rise to the debtor’s obligations is varied
- whether the guarantee remains enforceable even if the debtor is given "time or other indulgence or consideration"
- what rights do co-guarantors have against each other
- what happens if a co-guarantor is released
- what happens if a security provided by the debtor (for example a mortgage) is released by the creditor
- what happens if a debtor goes bankrupt
- what should be disclosed to a guarantor about the debtor
- what rights does the guarantor have to stand in the shoes of the lender to seek recompense from the debtor once the creditor has enforced the guarantee (rights of subrogation).
Many other issues can arise.
People are often asked by loved ones, business associates or colleagues to guarantee loans for personal or business use. No matter how much you want to trust someone, entering into a guarantee should never be taken lightly or regarded as a mere formality. It is a serious undertaking that could leave you answerable to significant debts that are not of your own making – and being held accountable for the debt of someone else can damage or destroy the most important personal relationships.
If you are contemplating becoming a guarantor, it is important to understand the risk that you face.
There is no one form of guarantee. A competent lawyer can tailor the guarantee so that the guarantor is exposed only to the liability they are prepared to assume. However a creditor might decide not to advance credit to the debtor unless the liability of the guarantor is unlimited.
It usually comes down to the bargain – the negotiating power of the parties - and the quality of legal representation can also play an important role.
This article is correct as of October 2014. If you require any assistance in relation to guarantees please contact us.