Adult children often ask their parents to give a lender a guarantee, and possibly security, so they can buy a car or overcome a shortfall in a deposit to buy their first home. A borrower who operates a company may be required to guarantee a loan for the company to rent premises, to lease equipment, to create an overdraft, or to establish credit accounts with suppliers.

Usually when someone is asked to provide their guarantee, they are also asked to provide an indemnity.

What is a guarantee?

A guarantee is a contractual promise by the guarantor, to another party (e.g. lender, supplier, landlord) to fulfil the obligations by a third party (e.g. borrower, the company, tenant), in case that third party fails to fulfil their obligation.

The same principles apply whether a guarantee is given to a lender for the debt of a borrower, to a supplier for a customer, or to a landlord for a tenant. This article is restricted to a situation where a guarantee is given to a lender for a borrower’s debt.

The borrower has the primary liability for the obligations guaranteed by the guarantor. The guarantor has a secondary liability which is triggered when the borrower fails to perform the obligations that have been guaranteed. Despite a guarantor’s liability being secondary in nature, the lender is not required to first pursue the borrower, or enforce any other security, before claiming against the guarantor.

The guarantor’s liability cannot be more than the borrower’s liability.

What should you know before giving a guarantee?

If you are to give your guarantee, you should, ascertain:-

1. the financial capacity of the borrower to meet their obligations;
2. whether the guarantee applies only to a particular transaction, or if it is a continuing in respect to a series of transactions to be entered into between the borrower and the lender;
3. whether the guarantee is limited to a specific amount, or is unlimited so as to catch all possible amounts which may the borrower may owe the lender;
4. whether the guarantee is secured or unsecured. If it is secured (e.g. by a mortgage over a property you own), if you fail to pay in response to the Lender’s demand, this creates a default of the security over your property which entitles the Lender to sell it. If your guarantee is unsecured, if you fail to make payment, the lender will need to sue you in court to recover payment.

What rights does the guarantor have if s/he makes payment?

If, following the borrower’s default, and after demand to pay from the lender, the guarantor pays the lender:-

1. The lender gives the guarantor making payment all of its remedies against the borrower. This includes any security the lender held over the borrower’s assets or, if the borrower becomes insolvent or bankrupt, the lender’s entitlement to any dividend or distribution from the liquidation or bankruptcy.
2. the guarantor has the right to recover the payment from the borrower. Whilst this is not likely to be worthwhile at the time the guarantor pays the lender, the guarantor has a period of 6 years in which to commence recovery proceedings;
3. If other persons are co-guarantors, the guarantor making payment can claim contribution from the co-guarantors.

When is the guarantee discharged?

A guarantee is usually discharged or released only when the lender has received full payment of the guaranteed obligations or gives the guarantor a specific release. If you die, your estate usually remains bound by your guarantee. However, your guarantee may be unenforceable or discharged in circumstances including:-

1. If the lender gives the borrower more time to meet its obligations, thereby removing the guarantor’s ability to crystallise the contingent obligation under the guarantee, and make a claim against the borrower;
2. If a variation to the underlying contract is made which is not for the guarantor’s benefit;
3. If the borrower is released from the primary obligations;
4. If the guarantee is joint or joint and several with co-guarantors, and a co-guarantor is released;
5. If the lender releases or impairs any security it holds for the debt that is guaranteed;
6. If the obligations of the borrower become void, the guarantee falls away; or
7. If the guarantee was provided as a result of undue influence from someone, or there has been non-disclosure or misrepresentation by the Lender to persuade you to give the guarantee.

Indemnity

Because a guarantee may become enforceable, it is usual for the lender when taking your guarantee to also require your indemnity. An indemnity is an obligation on your part to make good the lender’s loss. An indemnity is a primary liability: it is not dependent of the existence of the underlying debt or the borrower’s default. The Lender can rely on the indemnity if the guarantee or the guaranteed obligation become unenforceable.

Takeaway

Giving a guarantee and/or indemnity is a serious thing to do. Ensure that you understand your rights and obligations before your give your guarantee and indemnity.

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