What is a guarantee?
A guarantee is a contract where the promisee undertakes to be liable for the debt or obligation of another.
A guarantee is a collateral contract – there must first be a primary contract where the debt or the obligation being guaranteed exists or is contemplated.
Does a guarantee need to be in writing?
A guarantee must be in writing (see Section 126 of the Instruments Act 1958). As with any other contract there must be consideration for the guarantee or it must be by deed under seal (which obviates the need for consideration).
Is a guarantee confined to one transaction only?
A guarantee may be confined to one single transaction or it may extend to a series of transactions (in which case it is called a “continuing guarantee”). A guarantee may be limited or unlimited in amount.
Strictly, the liability of a guarantor is secondary – it does not arise until the principal debtor, whose liability is primary has made a default.
However, most guarantees will:
– provide that the guarantor’s liability is to be a primary liability; and
– will also operate as an indemnity where it is not necessary to establish the primary liability of the principal debtor before the guarantor becomes liable.
It is not necessary that notice of the principal debtor’s default be given to the guarantor. Nor is it necessary for the creditor (the person in whose favour the guarantee is given), before proceeding against the guarantor to request the principal debtor to pay, or to sue him.
What is the duration of a guarantee?
The duration of a guarantee depends on its terms. A guarantee for a single transaction extends to only that transaction. A guarantee for a series of transactions extends until the transactions contemplated by the guarantee have been exhausted. The release of the principal debtor will normally automatically release the guarantor. In the case of a continuing guarantee the guarantor can normally obtain a release only by arranging payment to the creditor of the amount then owing (even although the payment might necessarily be made by the guarantor). If a guarantor is released from a continuing guarantee that may affect the principal debtors ability to obtain finance and thus to continue in business e.g. If the guarantee is of a bank overdraft then the release of the guarantee will extinguish the bank overdraft because the bank will not allow the overdraft to continue without the guarantee.
Is there a difference between a guarantee and an indemnity?
A guarantee document is normally framed as both a guarantee and an indemnity. An indemnity is a contract under which the promisor undertakes an original and independent obligation to indemnify the creditor – it is not a collateral contract (as is a guarantee) and the liability of the promisor/guarantor does not depend on the principal debtor being liable (as in a guarantee). Indeed many guarantees and indemnities make the guarantor liable under the indemnity even if the principal debtor is not liable.
Are there circumstances in which a guarantee can be extinguished or diminished?
There are many circumstances where a guarantor’s liability would be extinguished were it not for contrary provisions in the guarantee document.
Thus it is common for a guarantee and indemnity to provide that the liability of guarantor will not be extinguished or diminished by:
– the fact that one of a number of guarantors does not sign the guarantee or is not liable under it;
– the fact that a guarantor may cease to be a director of or shareholder in a company whose debt has been guaranteed;
– the fact that a guarantor becomes separated or divorced from his or her spouse where the spouse is principal debtor;
– the creditor releasing one of a number of guarantors;
– the fact that any security taken by the creditor is void;
– the death of the principal debtor;
– The principal debtor or any guarantor becoming incapacitated;
In general terms if a guarantee is given to a commercial institution there are unlikely to be any circumstances where the guarantor will not be liable while the principal debtor’s debt or liability still exists.
If there is more than one guarantor, each guarantor will be individually liable to the creditor for the full indebtness e.g. if there are two guarantors each is 100% Iiable rather than 50% liable. One guarantor, may, however be entitled to contribution from a co guarantor.
Where a guarantor makes payment to a creditor pursuant to a guarantee the guarantor is entitled to obtain recoupment from the principal debtor. But this right is likely to be worthless if the principal debtor has no funds.
While the purpose of this newsletter is to generally discuss guarantees it should be noted that many guarantees contain explicit warnings about the risks assumed by a guarantor. Unless the guarantee is essential, our recommendation is that guarantees should not be given – there is very little upside and there is very grave risk of a substantial downside.
The information in this newsletter is general. It must not be relied on without first obtaining specific advice from Henderson & Ball.
For Information about Henderson & Ball visit www.hendersonball.com.au