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Guarantees - What is a Guarantee, Legally?

We have all, at some point in our lives, agreed to "guarantee" something for someone. So what exactly is a guarantee legally and what are its implications?

Guarantees Generally

Essentially, a guarantee is an assurance in writing, signed by the guarantor, that certain obligations will be met. A typical scenario is where someone agrees to act as a guarantor for someone who has borrowed money from a lender. In this case the guarantor agrees to meet the obligations of the borrower (i.e. repayment of money) if the borrower fails to do so. It is important to note that the lender is entitled to pursue the guarantor before pursuing the borrower.

Types of Guarantees

Guarantee clauses are common in leases, hire purchase agreements, and in general dealings with a bank. There are many different types of guarantees, varying from a specific guarantee to cover a particular transaction, a continuing guarantee limited to a fixed amount, through to a continuing guarantee where the guarantor agrees to meet all obligations of the other party. Many guarantee documents include both a guarantee and an indemnity, which means that not only is the guarantor guaranteeing the obligations will be met, but they also agree to protect the receiver of the guarantee from any harm or loss.

In most contracts where there is more than one guarantor, they are treated as being "jointly and severally liable". This means the creditor is entitled to choose which guarantor to pursue, to recover the debt. Even if you are only one guarantor amongst many, you may find yourself held liable for all of the debt. In this case you may have a right to compensation from co-guarantors, but enforcing this right can be a lengthy and costly process.

Rights and Obligations of the Guarantor

As a guarantor who has been called upon by a creditor to pay a debt, you have a right to require repayment by the original debtor. Of course in practice, this right may not amount to much protection as often the creditor is enforcing the guarantee due to the inability of the debtor to make a payment. A guarantor can however use the securities available to the original creditor. In other words, if a debt secured by a mortgage is paid in full by a guarantor, the guarantor is entitled to take over that mortgage security.

Independent Legal Advice

Creditors rely on a guarantor making an informed decision. To ensure their guarantee is enforceable creditors should disclose to the guarantor information about the obligations they are guaranteeing and be satisfied that the guarantor fully appreciates the risk they are assuming. The Code of Banking Practice goes further, by requiring that prospective guarantors be advised to seek independent legal advice. The party providing legal advice is then required to confirm the guarantor understood the obligation they were assuming at the time they entered the guarantee.

Diligence Required

Whenever you decide to act as a guarantor for someone, including close friends and family, you should always familiarise yourself with their financial position, carefully read the contract and obtain legal advice to determine what your liability might be. As a guarantor you have no direct control over the debtor’s repayments and therefore it is advised that, where possible, you always seek to limit the amount that you guarantee.

Everyone is naturally optimistic when it comes to their family and friends, but it is vital to be aware of the risk you are assuming and make an informed decision.

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