Be Careful What You Guarantee

My first exposure to the term “personal guarantee” did not come from a law office or law school class. It occurred immediately outside of Bayswater Underground Station in London, where I made the unfortunate decision to purchase a video cassette (Stephen Segal) from a mobile street vendor who had set up there for the day. As the purchase did not involve the provision of a receipt I queried the quality of the video. One of the regular vendors, apparently recognising my suspicion that the seller was nomadic, assured me “if you are not happy with the quality I personally guarantee you will get back your money”.

Needless to say the video was unwatchable, and I returned the next morning in pursuit of a refund. Sadly the video salesman had long since departed, so I approached the guarantor and reminded him of his promise of a refund. The response I received, in the most smug East London cockney, was: – “Oral contract mate, not worth de paper tis written on”.

Guarantees are contracts of suretyship under which one person undertakes to be responsible for the debt or default of another person. While there are other contracts of suretyship such as indemnities, which have some technical differences to contracts of guarantee, this discussion focuses on the practical difficulties encountered by parties who find themselves in a situation where they have either agreed to guarantee the obligations of another, or are seeking to rely on a guarantee that was given to them to secure the obligations of others.

A guarantee relationship involves 3 separate parties. One person (the Guarantor) agrees to answer for some existing or future liability of another (the Principal) to a third person (usually a Lender), under which the liability of the Guarantor is in addition to the liability of the Principal. The important point to note is that the liability of the Guarantor only arises when the Principal has not done what he promised, so it is somewhat of a secondary obligation. Taking a simple debt or loan situation, a Guarantor will agree to pay a Lender where the Borrower fails to do so.

It is this concept of secondary obligation that makes disputes involving Guarantors particularly contentious. In most contractual arrangements the parties have usually agreed to the provision of some goods or services in exchange for money or some other form of payment. Even if one party does not entirely live up to his end of the bargain, some value will have passed which may be quantifiable so as to allow resolution. Most people who have given personal guarantees do not actually expect to be called upon to meet someone else’s liability, as they invariably expected such person to honour their obligations (otherwise they would probably have refused to give the guarantee). Furthermore, claims on Guarantors usually arise a considerable time after the guarantee was signed, where the Guarantor has either forgotten or no longer appreciates the extent of his exposure. As a consequence, disputes involving Guarantors are frequently acrimonious and necessitate the intervention of the Courts.

What is the approach of the Court to disputes between Guarantors and those seeking to enforce guarantees (i.e. usually Lenders)? On the one hand the Court will seek to uphold the intentions of the parties who signed up to a contract of their own free will. On the other hand the Court recognises that the Guarantor has not gotten full “value” for his promise, so perhaps needs added protection. The effect of these dynamics is the general accepted premise that Courts will interpret uncertainties in contract of guarantees in favour of the Guarantor, on the basis that a person who is getting very little for his promise should only be held liable for such exposure as is clearly and distinctively covered by the terms of the contract.

It is this same line of reasoning which explains the long standing rule that contracts of guarantee which are made orally are unenforceable. Where there is an oral promise to answer eventually for the legal default of another, the precise wording of that oral promise will often be difficult to ascertain, and even if the actual words used can be ascertained with certainty, it will be difficult for the Court to contextualise the use of the words so as to establish the intention of the parties. On reflection it would seem that my vendor friend outside Bayswater station knew what he was talking about when he scoffed at my request to honour the oral guarantee he had given.

Against the background need for certainty with contracts of guarantee, particular care needs to be taken in the preparation of documentation. It is not sufficient for a Guarantor to merely enquire as to the amount he is being asked to guarantee. It is likely the guarantee will include additional exposure in the form of interest and liabilities which arise when the Borrower does not make payments on time. It is also common for a substantially higher rate of interest to be payable where the Borrower is in default. Unlike situations where a person may feel it safe to sign on to a standard form of contract, it is very risky to give any type of guarantee without a comprehensive understanding of the applicable terms and implications.

The importance for certainty applies at least equally to the recipient of guarantees. Since uncertainty with contractual documentation will generally be interpreted in favour of the Guarantor, the use of lengthy commercial precedents by financial institutions (or others taking guarantees) without due consideration can end up more prejudicial than beneficial. Any inconsistencies in documentation may open the doors for Guarantors to escape a liability which they had knowingly taken on at the outset. Any organisation which regularly relies on guarantee documentation should ensure that this documentation is appropriately tailored to meet each situation, rather than assuming that the same terms and conditions will always apply.

Unfortunately the use of clear and concise documentation will not always remove the acrimony felt by Guarantors who are called upon to meet the obligations of others. This dissatisfaction stems from the perception of being forced to give something for nothing, and probably cannot be avoided. However certainty may force parties to more readily accept the consequences of their actions, and in any event will reduce the chances of an unfair outcome. In the meantime, if you are a fan of action movies, I have just the video cassette for you. The quality is superb – “I personally guarantee it”.

This article is for general information purposes only and does not constitute legal advice.

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