What is a Guarantee?
As guarantor, you agree with the bank that if the borrower defaults you will repay the borrower’s lending. By obtaining a guarantor’s promise the bank obtains additional security for a loan. There are other situations where guarantees arise, for example landlords will also often ask for a guarantee. However this article will focus on bank guarantees.
The best advice is that you should never give a guarantee. The commercial reality however, is that a bank may decline to make a loan available to a borrower unless a guarantee is given. In particular, if a small private company is borrowing funds, the bank will always ask for the directors or shareholders to give personal guarantees or in the case of a trust borrowing, then the trustees will be asked for a personal guarantee.
What are the Risks?
The risk is that if the borrower defaults on their repayment obligations and if the bank calls upon you as guarantor then you must pay. You are a principal debtor and the bank does not have to call upon the borrower to pay first or to realise any securities given by the borrower to the bank. This could mean selling any assets you have provided as security to the bank to meet the obligations.
The guarantee, once given, continues to bind you until the borrower’s obligations to the bank are completely repaid. You cannot get out of the guarantee without the bank’s consent.
Generally, the guarantee covers all of the obligations of the borrower to the bank on an ongoing basis. If, for example, the borrower has guaranteed the liability of someone else or has a joint loan from the bank with someone else, then you as guarantor will also guarantee those other entities and loans.
The guarantee will entitle the bank to use any securities it holds from you to recover money owed by the borrower. If the bank holds a mortgage over your home, the bank would be entitled to exercise rights of sale over your home for defaults of the borrower.
Bank guarantee documents also include an indemnity so not only do you agree to pay on default, you also agree that the loan is made on the basis you will ensure payment of the debt.
How can I minimise my risk?
Be fully informed
If you have been asked to give a guarantee of the obligations of a borrower you need to ensure that you are fully informed of the financial circumstances of the borrower at the time of the guarantee and on an ongoing basis.
If the borrower has sufficient assets to meet their liabilities to the bank then your risk is minimised. If your assets as guarantor are needed to meet the bank’s basic lending requirements then you are more likely to be called upon to satisfy the lenders obligations should default occur. You should ensure the borrower gives the lender security of some kind so if are asked to make payment as guarantor and subrogation rights are awarded, you will get the ongoing benefit of that security.
By keeping informed throughout the loan period, you will be alerted to issues as they arise and may be able to address defaults or cashflow problems at the onset and not when matters have gone too far.
You may, as guarantor, want to put in place repayment obligations on the borrower to ensure that the loan is in fact decreasing.
Take an ongoing interest
If you are completely independent of the borrower and have no control or input into the decision making of the borrower then you are more at risk of that borrower’s whims and behaviour. The bank’s guarantee is often put in place to encourage good management of a company or trust by the decision makers and you as guarantor will want to encourage this also.
You need to take an active role in the decision making of the borrower and be aware of major management and financial decisions. If you are a director or shareholder then take your job seriously (this is of course a legal responsibility also).
Limit the amount you are liable for
A guarantee can be unlimited, limited, fixed or continuing.
If you cannot avoid giving a guarantee, then you should always ask for a limitation to a fixed amount on the extent of your liability under the guarantee. Otherwise, under an unlimited guarantee you are liable for all debts of the borrower.
Generally, most guarantees are continuing so they extend to ongoing transactions and are not limited to the single initial loan. You can however limit the guarantee to one particular transaction (such as an overdraft).
Get legal advice
You should always discuss the terms of a guarantee and the relationship you have with the borrower with your solicitor so that you are aware of the risk you are taking. If you are feeling pressure to provide a guarantee don’t do it if you are not comfortable with it. Your solicitor may suggest putting in place arrangements with the borrower to minimize your risk such as you obtaining security from the borrower.
This article is current as at the date of publication and is only intended to provide general comments about the law. Harkness Henry accepts no responsibility for reliance by any person or organisation on the content of the article. Please contact the author of the article if you require specific advice about how the law applies to you.