A guarantee is an undertaking given by one party (the guarantor) to another party, to pay the principal obligor’s debts, or to perform their obligations set out in the underlying contract or deed.
Guarantees and personal guarantees are important commercial documents – they impose liability on a third party to a primary transaction (such as business loans), when the person meant to perform the obligation doesn’t.
Guarantees are not limited to providing backing for loans of money or financing and can also be used to provide backing to perform of a legal obligation of another person.
They are often given personally by individuals. The liability is personal to those guarantors, meaning that all of their personal assets are on the line. If more than one guarantor is granting the guarantee, the guarantors will usually be jointly and severally liable. This means that the lender can make a claim against any or all of the guarantors for the full amount. It would then be up to the guarantors to seek contributions amongst themselves.
The guarantee may also give the lender the ability to apply credit balances held with it (whether funds held in personal current accounts, savings accounts or longer term deposits) towards paying off sums owing under the guarantee.
The guarantee will usually provide a mechanism by which the guarantor can fix their future liability. This may be relevant in the context of working capital facilities or multiple drawing facilities. It usually involves a number of written months’ (usually 3) notice being given to the lender with the guarantor tending to remain liable for obligations incurred during the notice period. While it can seem an attractive option, the likelihood is the lender will seek alternative security from the borrower or the lender will consider whether the withdrawal of the guarantee constitutes an event of default under the borrower’s finance documents.
Please also note the key difference between a guarantee and an indemnity. An indemnity is an express contractual obligation to compensate for any loss suffered, independent of what the liability of the party in breach might otherwise be to a third party to the contract.
If done properly, as a rule, when you sign a guarantee it’ difficult to get out of it. In the worst case, they only become unenforceable after the maximum period of time allowed by the law to commence legal proceedings for breach of the contract of guarantee, subject to what is said in the contract.
The general law rules are:
- for normal contracts, 6 years from the date that the breach of contract took place
- for deeds, 12 years from the date of the breach.
Some of the more common ways guarantors look to try and get out of a personal guarantee include:
- The creditor breached the contract of guarantee in such a way that this can be accepted by the guarantor
- The creditor has failed to tell the guarantor something that affects the relationship between the debtor and creditor
- The guarantee was undermined by negligent misrepresentation, undue influence, or fraud because the guarantor was substantially misled before it was signed
- A variation is made between creditor and debtor in a way which the guarantor would not have expected or was not built into the guarantee (e.g. an extension on the time to pay etc)
- A condition precedent to the guarantee was agreed and never satisfied.
The key takeaway from the above is that just because the guarantor has forgotten about the guarantee, it doesn’t mean the lender will. The guarantor should seek a written release of the guarantee from the lender where they are no longer a director of a guaranteed company or other entity plus also where the borrower’s debt has been repaid.
Otherwise before signing, guarantors should always explore to see if the guarantee can be negotiated or agreed to be:
- limited in time
- capped to a specific amount
- limited to part of the obligations of the entity being guaranteed
- subject to a specific method of notice
- made subject to any other limitation
- any other condition which may be agreed
Please drop us an e mail or call if you need any further details or assistance and stay safe and well.
Roger
