What is a Guarantee? What happens if you sign on that dotted line on behalf of your family or friends?

A guarantee is a contract whereby one person agrees with another to pay some debt or perform some act or duty owed by a third person. This third person remains however primarily liable for such payment or performance and the person giving the guarantee will only become liable on the default of the third party.

The parties to a guarantee contract are:

• The Creditor: The person receiving the benefit of the guarantee is called the creditor. This is usually the bank, finance company, supplier or lender.

• The Principal Debtor: The person who is borrowing the money or obtaining the benefit of the contract.

• The Surety or Guarantor: The person who provides the guarantee is called the surety or the guarantor.

In order for a contract of guarantee to be enforceable, it must be in writing and signed by all the parties. For eg. If you are providing a loan to a friend "A", it is not sufficient for "B" the person who is going to guarantee the loan to say that he will guarantee the loan. It must be in writing.

What are your liabilities when you sign a contract of guarantee?

The extent and nature of the liabilities of a surety or guarantor will depend on the words of the contract of guarantee. Some guarantees are limited for a fixed amount. Some guarantees are for an unlimited amount. Whatever is alleged as being guaranteed, the court will interpret the contract of guarantee strictly and a surety will not be liable beyond the precise terms of his or her commitment.

An example : A surety's guarantee to find a replacement tenant for a shop at a specified rental and for a term of three years was satisfied by the surety finding a person who was willing to become a tenant on the prescribed terms. The surety is not held to guarantee the solvency of the replacement tenant or the conduct or performance of the replacement tenant.

Sometimes there may be two or more persons who enter into a contract of guarantee. The liabilities of the sureties or guarantors are in most cases joint and several. This mean that when there is a default by the principal debtor, the creditor is free to take action either against one or both of the sureties.

An example : B, C & D guarantee to pay Z a sum of $100,000 in case X cannot pay Z. X defaults. Z sues B only because B has assets sufficient to meet the debt.

 

B cannot say that it is unfair and demand that Z sue all the guarantors as they should be jointly liable.

 

However after B has paid the sum of $100,000 to Z, B has the right to claim contributions from C & D in what ever proportions they have agreed upon.

What are your rights as a guarantor?

After the guaranteed debt has become due but before the surety or guarantor has been asked to pay for it, the surety or guarantor may require the creditor to call upon the principal debtor to pay off the debt.

At any time after the debt is due, the surety or guarantor may apply to the creditor and pay him off. Upon being provided with proper indemnity for costs, he may sue the principal debtor in the creditor's name or in his own name if he has obtained an assignment of the guaranteed debt.

As soon as the surety or guarantor has paid to the creditor what is due to the creditor under the contract of guarantee, he is entitled to "step into the shoes" of the creditor and avail himself to all the rights possessed by the creditor in respect of the debt, default or miscarriages to which the guarantee relates.

Thus upon payment, the surety or guarantor has a right to the benefit of all the securities which the creditor has received from the principal debtor.

For example: Where the guaranteed debt is secured by a mortgage executed by the principal debtor, the surety or guarantor is, on payment of the debt in full, entitled to a transfer of the mortgage.

The surety or guarantor has also rights, either express or implied against the principal debtor or his estate for indemnification. The right includes the ability to recoup the amount which the surety or guarantor has actually paid for the principal debtor together with interest. Should the surety or guarantor suffer damage beyond the principal and interest which he is compelled to pay under the contract of guarantee, he is also entitled to recover that damage as well.

Discharge of the Guarantee

Payment made by the principal debtor of the guaranteed debt will normally discharge the surety or guarantor.

Before signing a contract of guarantee

It is of utmost importance that you understand the legal consequences of acting as a guarantor. Before signing on the dotted line, it is advisable to consult a lawyer so that he can explain to you your rights and liabilities.

Common instances of the need to provide guarantee

(a) An incorporated proprietary limited company seeking a business overdraft facility or loan. The Bank providing the overdraft facility or loan will call upon the directors of the company to stand as sureties or guarantors.

 

(b) An incorporated proprietary limited company leasing office premises. The landlord will require the directors to stand as guarantors for the due performance of the terms of the lease.

 

(c) When a family member wishes to buy a property and has insufficient income. A person with an alternative source of income and who has assets may be requested to stand as a guarantor.

What to Do

Very often, you may receive a request to stand as a guarantor. The 1st thing to ask yourself is whether you really should do it. The answer depends on assessing the risk involved and the person you are going to guarantee. If in doubt, the best course is to decline to be a guarantor. In the event that you cannot decline, then the next best thing is to try to limit the guarantee. Whatever it is, you should seek legal advice. Tan and Tan Lawyers will be pleased to advise you if the need arises.

To Cut A Long Story Short

We were asked by the son of a client to witness a guarantee to the bank for a loan for the son to purchase a property. The banks usually require a solicitor to provide independent legal advice before they will allow the loan to be drawn. The son had failed to fully inform his father that as part of the guarantee, the bank also wanted the father to include the father's property as security. Upon being fully informed as to the contents of the guarantee, the father of course declined to stand as guarantor

Moral of the story: Make sure you know what you are signing. Those fine print between the lines are fine print which need to be carefully considered.

On the lighter side

Moses, Jesus and an old man are playing a round of golf at the local course. On the third hole, a difficult par 3 which has a river guarding the front of the green, they hit their tee shots. Moses' ball runs into the river but the waters part and it rolls onto the green a foot from the cup. Jesus' ball heads towards the river as well, but skims across the surface of the water and stops three inches from the hole. The old man tees off and his ball hits a turtle in the river, bounces up and is caught by a passing bird, which drops the ball in the hole. "Nice shot, Dad," says Jesus.