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Guaranteeing the Obligations of a Third Party

Guaranteeing the Obligations of the Third Party

When a lender agrees to advance funds to a borrower, a landlord agrees to let commercial premises to a tenant, or a supplier agrees to provide goods on credit, the lender/landlord/supplier (the creditor) might ask for the obligations under the relevant contract to be guaranteed by a third party (the guarantor) as a condition of entering into the contract.  The guarantor might be prepared to grant such a guarantee in consideration of the creditor’s agreement to advance, let, or supply to the borrower, tenant, or customer (the debtor), as the case may be. 

In practice, many loans, leases, and supply contracts are simply not possible without third party guarantees. This is because creditors will often not be prepared to take the risk of entering into a contract with a debtor in circumstances where the debtor’s obligations are unsecured or insufficiently secured, where the debtor is a new or undercapitalised limited liability company, or where the debtor otherwise has insufficient assets to cover a default scenario.  Guarantees make an additional party liable for the default of the debtor, thereby providing extra protection for a creditor.      

We use the term “protection” here because, despite the term “security” often being used to describe guarantees, a personal guarantee is in no way a security interest or other form of security for the creditor.  It is merely a secondary contract to which the creditor can resort if there is a default under the primary contract (i.e. the loan, lease, or supply contract). The obligations under that secondary contract – like the obligations under any contract – can be secured by a mortgage or other security interest in real or personal property.  But the guarantee itself is not security. 

A personal guarantee involves a serious commitment and should be approached with caution.  While there is the practical reality that certain commercial contracts will not occur without a personal guarantee, and so are effectively “take it or leave it” deals, the risks and consequences of guaranteeing a debtor’s obligations to a creditor must be carefully considered.   

If a debtor defaults in the performance of their obligations to the creditor, the creditor will be able to take steps to enforce the obligations under the guarantee.  The enforcement process is usually started by the creditor issuing a letter of demand against the guarantor.  This is because many (if not most) guarantees are on-demand guarantees, which require written demand to be made on the guarantor before they incur liability. 

In terms of formalities, a guarantee must be in writing and signed by the guarantor.  An oral guarantee is not enforceable. 

A guarantee can be unlimited, which means it applies to all obligations of the debtor, in any capacity.  Alternatively, a guarantee can be limited, either to a certain sum or to a particular set of obligations.  Whether a guarantee is unlimited or limited must be stated on the guarantee document. 

Most guarantees will provide that the creditor can go straight after the guarantor, without first enforcing the principal contract against the debtor.  Commercial guarantees will also usually contain a range of express clauses and terms in the contract, many of which are specifically designed to defeat and exclude the protections on which guarantors could otherwise rely on at common law.   

More often than not, the express terms of a guarantee will make the guarantor liable as if they were the debtor, and not merely as a surety, with such liability continuing until the creditor provides a formal written discharge.  This is usually the only basis on which the guarantor’s liability can be discharged.  Not even death will alleviate the guarantor’s liability, which will transfer to their estate. 

Because of the seriousness of guarantees and their potential consequences, solicitors are often asked to provide independent advice about their content and effects (or, failing that, obtain a waiver of such advice).  The requirement for a solicitor to properly explain a guarantee to a guarantor before execution is particularly important where the potential for undue influence between parties to a relationship exists.   

The example of undue influence usually given is a husband putting undue pressure on his wife to guarantee his company’s obligations – a transaction in which the wife has no obvious financial benefit.  Such influence can render a guarantee unenforceable.  To avoid that possibility, the solicitor must take extra steps to guard against undue influence when the potential for it arises, including having a separate meeting with each guarantor, if required. 

If you have been asked to provide a guarantee, or have questions about one, get in touch with our expert property and commercial lawyers here.