Securing your guarantee
Lenders frequently seek a guarantee as part of the security package before making a loan or facility available to its client. Given that there are several situations in which a guarantee may be unenforceable or may be discharged, the following are essential areas for lenders to consider when putting in place a guarantee.
Due diligence
Whether the guarantor is an individual or a company, lenders need to assess whether the guarantor has the financial ability to pay the amounts due in the event of a default by its client. Lenders need to pay particular attention to the debts of the guarantor; whether the guarantor’s assets are being held as security for any other indebtedness; and whether the guarantor has any outstanding judgments or pending litigation. The lender will need to ascertain whether any of the creditors of the guarantor would have priority over them in the event of insolvency.
Where the guarantor is a company, a full company search should be conducted so as to ensure that there are no provisions in the articles of incorporation, by-laws or any unanimous shareholders agreement which limit the power of the company to provide the guarantee. Lenders should make themselves aware of all corporate requirements to be complied with in order for the company to give a valid guarantee and should obtain directors and, if necessary, shareholder resolutions approving the issue of the guarantee. In the guarantee, the guarantor should be made to represent and warrant that all corporate requirements have been satisfied and that it is issuing a legally valid and binding guarantee. In some situations, it may be appropriate to request an opinion from an attorney acting on behalf of the guarantor to confirm that all corporate requirements have been satisfied.
Certain actions that a lender may take in the ordinary management of the account of a client may have the effect of discharging a guarantee.
Protecting the lender
It may come as a surprise to lenders that certain actions that they may take in the ordinary management of the account with their client may have the effect of discharging a guarantee. If a lender agrees to vary the terms of a facility with its client without the consent of the guarantor, such an amendment may have the effect of discharging the guarantee. Similarly, where a lender agrees to grant its client additional time to repay a facility or releases security for the facility other than the guarantee, these actions may also have the effect of discharging the guarantee.
Best practice for lenders would be to notify and if possible obtain the consent of the guarantor prior to making any changes to the facility that it secures. Additionally, the guarantee should be drafted to specifically provide that it is not discharged by these and similar common actions of lenders which at law would have the effect of discharging the guarantee. Finally, an indemnity may be included in the guarantee so that the guarantor has a primary obligation to repay the sums due to the lender. A guarantee by itself is a secondary obligation in that it is contingent upon the obligation of the lender’s client to make payment. As such, if the primary obligation of the client is for some reason void, the guarantee would not be enforceable but the lender would be able to enforce payment under the indemnity as it is a primary obligation and is not dependent on the obligation of the client.
Undue Influence
Lenders tend to be well aware of the fact that a mortgage may be set aside if there has been undue influence. This is often an issue with respect to a facility secured by a mortgage over a matrimonial home. Lenders therefore routinely require the spouse providing the security to obtain independent legal advice. The principle of undue influence however also extends to guarantees and it is not only applicable to spouses. Best practice for lenders would be to require that the guarantor provide written confirmation from their attorney that independent legal advice was obtained.
How much is secured
In drafting a guarantee the amount that is being secured must be made clear. The document should specify whether it is a specified sum due to the lenders by its client that is being secured or whether the guarantee is a continuing security which covers several transactions on an account. Where the guarantee was meant to be continuing, additional protection can be drafted into the guarantee to allow the lender to credit all payments received by the client into a new account so as not to reduce the indebtedness secured by the guarantee on the original account.
