Legal Implications Of Being A Guarantor
Introduction
Many times, people sign agreements to stand as guarantors for others without understanding the legal implications of signing a guarantor’s form or holding themselves out as Guarantors for others. These types of scenarios are more popular with obtaining financial facilities from banks and other bodies.
Before obtaining a loan facility, one of the many requirements include getting a Guarantor to facilitate obtaining the loan. It may often come off as a mere formality until there is a default or complicated situations or other unintended events occur. This presentation will help to better understand the legal position of Guarantors and what to expect from standing in as a Guarantor for family, friends or colleagues.
When there is the existence of such a facility involving the Creditor, Debtor and a third party Guarantor, it can be said that there exists a contract of guarantee.
Understanding a Contract of Guarantee
A proper definition of Guarantee is an undertaking to answer for the payment or performance of another person’s debt or obligation, in the event of default by the person primarily responsible for it.
A contract of guarantee can be described as an assurance to a creditor that if the principal debtor fails to pay, the guarantor or surety would repay the debt.
Under a contract of guarantee, one person enters into a contract with another to pay some debt or perform some act or duty owed by a third person who remains primarily liable for such payment or performance, i.e. the person giving the guarantee becomes liable only on default of the third person. Thus, without a principal obligation, there can be no accessory of guarantee.
Who is a Guarantor?
A guarantor is someone who agrees to be legally responsible for a specified loan or agreement, should the person who has taken out the loan fail to make repayments. Guarantors can be a party to many types of agreements such as rental/tenancy agreements, personal loans and finance contracts.
What is a Guarantor Responsible for?
A guarantor’s legal liability will depend on the wording of the guarantee itself. Therefore, it is imperative that before becoming a guarantor that you read and understand the document you are signing. It may not be as simple as guaranteeing the principal loan. Guarantees can also create liabilities for administration charges, interest and costs of recovery in the event of default. A guarantor can also still be held liable even if the guarantor has lost their job, fallen ill or has been made bankrupt.
Types of Guarantee
There are generally two types of guarantee; secured and unsecured guarantee. The major difference between the two is the existence of some form of security from the guarantor.
A secured guarantee is when the creditor requires the guarantor to take out a mortgage or collateral over some part of the guarantor’s personal property in order to make their guarantee more enforceable. Unsecured guarantees simply omit the mortgage and collateral requirement and go without the added security it provides.
What to request before Signing as a Guarantor
So far we have explained the rudiments of every contract of guarantee. After getting a proper understanding of these, the next question will be how to better protect yourself before going into any such contract.
Before signing a guarantee, parties intending to act as a guarantor should obtain the following documents from the creditor:
A copy of the loan agreement that the person receiving the credit intends to sign. (This should also be done after all parties have signed to ensure there were no alterations or amendments to the terms)
A thorough outline of what is expected of the guarantor as part of the agreement.
Protection of a Guarantor
After obtaining these documents, it is also very important that the guarantor understands the transaction to which they have agreed to maintain responsibility. Several things are especially important for potential guarantors to be mindful of, including:
A guarantor has the responsibility to conduct a background check or carry out a feasibility study of the borrower’s projection with respect to the projects or business to which the borrower intends to apply for the loan, so as to determine how the borrower intends to liquidate the loan.
A guarantor should always try to reduce as much as possible the amount guaranteed in the contract of guarantee, so as to have a limit to the guarantee. This would ensure that the guarantor accepts liabilities within his means.
The Guarantor has a responsibility to assess or value the borrower’s assets available to indemnify him where the borrower defaults in the loan and the guarantor is obliged to repay the creditor’s loan. Furthermore, the guarantor must take proper steps to ensure that the borrower’s assets available to indemnify him are not the subject of any legal action or dispute.
The guarantor aside from pledging his immovable assets for the fulfilment of his obligation under the loan arrangement must be able to ascertain that he has the financial capacity to undertake the borrower’s debt if the borrower defaults without losing his immovable assets in the discharge of his guarantee obligation.
The guarantor must diligently identify the assets which he intends to nominate as security/collateral for the borrower’s loan. The assets so identified must be such that can adequately discharge his obligation as the guarantor under the loan agreement.
Liability of a Guarantor to the Creditor
The guarantor to a facility automatically becomes liable to the creditor upon the default by the borrower, and it is well established that the failure of the borrower to repay the facility as agreed gives the creditor the right to enforce the repayment against the third person guarantor.
Upon the execution of a contract of guarantee, there exists a separate contract between the creditor and the guarantor, which can be enforced by the creditor when there is a breach without recourse to the borrower, who is the principal debtor. Thus, the Creditor can go straight to a Guarantor without first going after the Debtor where there is a default.
Rights available to a Guarantor to reduce liability
There are certain rights available to a guarantor notwithstanding that the debt or obligation has crystallised and these rights can curb excessive liability. They include:
The right to discharge of the guarantee, thus, a guarantor’s obligation to liquidate the debt of the primary debtor co-exists with the existence of the debt. Hence where the principal debtor has completely liquidated his debt or where the guarantor steps into the shoes of the principal debtor to liquidate the debt, he is discharged from the Guarantee or he can immediately liquidate the debt before interest accrues and the Debtor eventually escalates the debt.
A guarantor has the right to liquidate the principal debtor’s indebtedness only to the extent of his undertaking. Where a guarantor’s undertaking is limited to a certain sum of money, he is under a legal obligation to discharge the guarantee only to the extent of his undertaking. Hence the creditor cannot recover from the guarantor any sum beyond the guarantor’s undertaking. You cannot pay for more than what you signed up for.
A guarantor has the inherent right to a set-off where there is a corresponding or mutual responsibility between the guarantor and the creditor. Therefore, where the creditor is also indebted to the guarantor, the guarantor can exercise his right to set off his liability against the creditor’s liability to him.
In the event that the guarantor’s asset is disposed of in the repayment of the principal debtor’s obligation, the guarantor has the right to demand a detailed account of the proceeds of the sale so as to ensure that the assets were sold at the best market price. Consequently, he has a right to request a refund where the asset sold is more than sufficient to completely liquidate the principal debtor’s indebtedness.
The guarantor also reserves the right to proceed against the principal debtor upon the discharge of the indebtedness to the creditor. There is a need for a guarantor to guarantee a loan granted to a person with close proximity to the guarantor.
Is a Guarantee Always Enforceable?
There are situations in which a guarantee might not be enforceable. These can include but are not limited to:
Where the guarantee was the product of fraud, negligent misrepresentation or undue influence.
Where the primary agreement is varied without the knowledge of the guarantor.
The guarantor was not made aware of material factors that might affect the relationship between the creditor and the borrower.
Can a Guarantor Recover Money or Their Loss From The Borrower?
If a guarantor is forced to settle a borrower’s debt, they might seek to recover their loss, directly from the borrower. A guarantor can do this by ‘subrogation’, which means “stepping into the shoes” of the lender and taking direct action.
The requirements for subrogation are:
The guarantor has paid under the guarantee.
The parties have not by agreement excluded the right of subrogation.
If a guarantor wanted to seek the benefit of any security granted by the borrower, under the principal agreement, it must be established that the security is for that specific liability. The benefit cannot be claimed if the security covers any additional credit held by either another creditor or the same creditor.
Conclusion
Guarantors are bound by an enforceable contract that requires them to meet the debtor’s credit obligations in the event that they are unable to do so themselves, which means that the decision to act as a guarantor should not be taken lightly. In the event that the debtor fails to meet their obligations, the guarantor is often required to pay the amount owed right away, or they are likely to face litigation in an attempt by the creditor to secure the funds owed.
Before going ahead to sign any document or stand as a guarantor for any person no matter how close they may be, the possibility of default should always be taken into consideration, hence, necessary steps must be taken to ensure the protection of your rights as a guarantor.