Where are the loopholes in Guarantees?

Guarantees and personal guarantees are important - and serious - commercial documents.

When you sign one it's difficult to get out of it, when they're properly done.

But then there are things that can happen outside the contract that allow can make the guarantees and personal guarantees unenforceable.

It can be a matter of knowing the sort of thing that you're looking for.

 

What is a Guarantee?

Guarantees and personal guarantees are important - and serious - commercial documents.

They impose liability on a third party to a primary transaction (such as business loans), when the person meant to perform the obligation doesn't.

Practically any contract obligation can be guaranteed by another person, not just business loans.

Guarantees can be:

• limited to part of the obligations of the debtor
• capped to a specific amount
• limited in time
• subject to specific methods of notice
• made subject to any other limitation
• any other condition which may be agreed

 

“See to it” Guarantees

Guarantees are not limited to providing backing for loans of money or financing.

Guarantees can provide backing to perform of a legal obligation of another person.

It could be for the delivery of goods, services or any other contract obligation.

This is usually referred to as a “see to it” guarantee.

So a guarantee is a promise made by a one person to another to honour that the person primarily responsible for performing a contractual obligation.

 

What is a Personal Guarantee?

A personal guarantee is a guarantee given by an individual rather than a company.

The liability to honour the guarantee is personal to you. There's no protection from a company. This means that all of your personal assets are on the line.

Personal guarantees are attractive to creditors when the guarantor has assets to cover the exposure of the creditor.

 

Guarantees: Security for Performance

Guarantees are a form of security of performance of a contract.

The guarantor accepts liability to answer for the debt or obligation of another person.

The guarantor may not sign up to pay damages for the breach of performance. But guarantors are nevertheless liable to the creditor for the failure of the first person to perform.

 

Legal Requirements for a Guarantee

Many documents are called guarantees when they’re not.

The factors that courts take into account are:

1. Proper interpretation: contracts of guarantee are interpreted “as a whole”. It is the particular words used in the relevant clauses that count. Not what it's called
2. Title of document: the title of the document is not decisive
3. Substance over form: Just because the word “guarantee” is used in the contract somewhere, does not make it a guarantee

Guarantee have a number of formal requirements to be a guarantee to put it beyond doubt that it is a guarantee.

• Form of guarantees: It must be evidenced in writing. The writing is may be formal contract or agreement, note, memorandum or promissory note
• Signed: The guarantor should sign it, or have their authorised agent sign it. The name may be written or printed, so long as it is intended to operate as a signature
• Secondary Liability: Establish that the guarantor has secondary liability to perform the guaranteed obligation. The principal debtor has the primary liability to perform the contract
• Consideration: The document should satisfy the requirements of any other contract.
  That means, offer and acceptance, consideration, an intention to be legally bound and capacity to make the contract

 

What makes Guarantees so special?

The parties to a contract make promises that they will do the things set out in contracts. The party to the contract is responsible for performance of promise. 

Guarantees are different. Guarantees are a promise by a person not responsible for performance of the contract.

Guarantors receive no benefit from the contract.

They expose themselves to liability of the contract for no return.

Guarantors promise that they will make good to a creditor failure by the primary contracting party to perform the contractual obligations.

So guarantees create a secondary obligation to perform the contract on the guarantor, where the primary obligor (often a debtor) fails to deliver on their contractual obligations.

For these reasons, the law imports special considerations for guarantees to be valid: the guarantor is not primarily responsible for the performance of the contract. It is outside their control. Someone else is primarily responsible.

We come to the main differences between indemnities and guarantees in a moment.

 

How long is a personal guarantee enforceable?

A guarantor’s liability is “coextensive” with the debtor.

Whatever the debtor is liable for to the creditor, is the liability of the guarantor. If the debtor’s liability is released, so is the liability of the guarantor.

Guarantors have all the defences to payment and/or performance available to them as the debtor.

This means two things:

1. where the debtor remains liable to the creditor, so does the guarantor.
   If the debtor is able to show that their own liability is extinguished or reduced, the guarantor gets the benefit of that reduction.
2. There may be terms in the contract of guarantee which caps the liability of the guarantor or even limits the time in which the credit can call upon in the guarantor to make good the default.

 

Unenforceable personal guarantees

When do guarantees become unenforceable?

In the worst case, they only become unenforceable after the relevant limitation period expires.

A limitation period is the maximum period of time allowed by the law to commence legal proceedings for breach of the contract of guarantee. But then the contract may contain time bars, which restrict the period of time within which the creditor may claim. It depends on what is said in the contract.

The general law rules are:

• for normal contracts, 6 years from the date that the breach of contract took place
• for deeds, 12 years from the date of the breach.

It's not likely that a creditor will allow this to happen.

Also, things might have happened before or after the guarantee was signed which make it unenforceable.

That's next.

 

Defences: How to get out of a personal guarantee

Some guarantees will have loopholes, others won't. But it's not just the terms of the guarantee that decide these things. The creditor may behave themselves in a way that prevents them from relying on the guarantee.

Some of the more common ways guarantors get out of a personal guarantee include:

• The guarantee was undermined by civil fraud, negligent misrepresentation or undue influence, because the guarantor was substantially misled before it was signed
• The creditor repudiated the contract of guarantee, and the guarantor accepts the repudiation
• The creditor has failed to tell the guarantor something that affects the relationship between the debtor and creditor
• A variation is made between creditor and debtor in a way which the guarantor would not have expected. Possibilities include:
  • extension on the time to pay
  • increase in the sum of the debt of the debtor
• A condition precedent to the guarantee was agreed and never satisfied.

 

Examples:

• The guarantor may have agreed to be co-guarantor. The other intended guarantor never signed the guarantee as guarantor.
  The guarantee was intended to be signed as one document part of a larger transaction, and those other contracts were never signed.
  In each case, the contract would not come into existence in the first instance because the condition had not been satisfied.

• The guarantee was to be secured over specific property, and
  1. that asset does not exist, and
  2. no other form of security can be identified as a substitute
• Each of the parties have operated under a common mistake
• The guarantor has acted under economic duress.
  The practical effect of the pressure is that there is compulsion on or a lack of practical choice for the guarantor. 
  The pressure must be illegitimate, as opposed to "the rough and tumble of the pressures of normal commercial bargaining.". It's a high standard to satisfy.
• The Unfair Contract Terms Act 1977 applies to relieve the guarantor of onerous terms of the guarantee
• The contract of guarantee is illegal on some basis

As you can imagine, creditors take guarantees seriously. We've never known a creditor to forget that they have received a personal guarantee for debt, whether by a company director or anyone else.  They will prepare the guarantee document to make sure their interests are protected. Usually.

Reduction of amounts owed

The liability of guarantors can be reduced to the extent that:

1. The debtor discharges the financial liability to the creditor
2. A damages claim for misrepresentation caused the guarantor to enter into the agreement, was albeit not fraudulent, but negligent
3. Breach of an implied term of the contract to take reasonable care to ensure that the price at which property is sold is the best price that can be reasonably obtained for the security given under the guarantee

 

Proper Interpretation of Guarantees

Liability under the guarantee is determined by what is known as a "proper interpretation" of the contract of guarantee.

Legal obligations of guarantors are interpreted from the standpoint of a commercial perspective of a reasonable person, knowing what the parties to the guarantee knew as at the date of the contract. Here's a guide to reading contracts.

It has to be said that it's tough to avoid liability under a properly drafted guarantee. It narrows your options.

Whether you can get out of a personal guarantee often depends on what happened before the guarantee was agreed and what has happened since it was signed.  

In hard cases, this means that you can't tell whether you can get out of a guarantee without:

1. reading the contract of guarantee and the terms of the guarantee; and
2. knowing what actually happened before and after the contract of guarantee was agreed: ie all of the relevant facts of the case.

Whether or not a guarantee is enforceable is highly fact specific – a slight change of the facts can mean the difference between success and failure.

Limited Opportunities to get out

If you do get an opening to get out of a guarantee, that window of opportunity can be short before it closes on you.

 

Interpreting Guarantees: Loopholes

Frequently, contracts contain obvious ambiguity.

When the facts of the case have come to pass (by the time courts come to consider them), they often contain latent ambiguities.

That is, the contract can be interpreted in more than one way.

Differences in interpretation - or “the construction of the contract” – may mean the difference between success and failure of the guarantor avoiding liability.

It’s important stuff if you’re a guarantor who believes that it would be wrong for you to be liable.

Owing in part of the special nature of the contracts of guarantee, courts take a “strict” approach to interpretation. The means that clear words – in the legal sense - must be used in the guarantee.

If there is ambiguity, it is likely to work against the creditor.

The reasons for doing so include:

1. side-stepping attempts to exclude the application of general law requires clear and unambiguous language
2. the creditor drafts the contract. It presents it to the proposed guarantor to sign.

As a consequence, the contra proferentem rule of interpretation applies so that ambiguities will be interpreted against the creditor. 

The Court considers all the surrounding circumstances of the case, particularly as at the date the contract was signed.

The state of affairs and knowledge of the parties as at the date of the contact play an important part in the outcome. This is because the Court uses the information to clarify the scope and extent of the guarantee., and therefore the obligations of the guarantee.

In Liberty Mutual Insurance Co (UK) Ltd v HSBC Bank plc [2002], it was said in respect of interpretation of contracts:

…. against the background of admissible matrix of facts known to or at least reasonably available to the parties, the meaning sought is that of the language in question would convey to the reasonable man.

In that context, the language used is to be given its natural and ordinary meaning, unless a reasonable man would conclude that something has gone wrong in expressing the parties’ intentions.

What this means is that courts have the power to:

1. consider evidence outside the contract to ascertain who was to receive the benefit of a guarantee
2. interpret a contract so as to correct a mistake in its preparation
3. see past allegations which are not supported by documentary evidence, but merely oral evidence
4. ignore words which attempt to exclude or limit the application of the general law, which would be to the advantage of the guarantor

 

Example Guarantee Clause

In an appropriate case, a guarantee clause might be worded as follows:

The Guarantors hereby guarantee to [creditor] the due and punctual performance of all present and future obligations of [the debtor] to pay the monies payable to [creditor].

Guarantees in contracts are rarely this straightforward or simple.

Personal guarantee wording

The wording of a personal guarantee could be the same as the simple example above. The guarantors would be individuals, not companies.

 

What is a personal guarantee on a business loan?

Suppose a friend wants to take out a business loan with a bank to start a business.

The bank insists it receives a guarantee for the repayments of the loan, before it gives the loan to your friend. You offer to be the guarantor.

If your friend then defaults on the repayments of the loan, the bank can call upon you to pay the outstanding sums on the loan.

This is one of the simplest forms of guarantee. Because you have guaranteed the loan in your own name (and say, not through a company), it is a personal guarantee. That means all of your personal assets are available to the bank to recover against, if your friend defaults on the loan.

Being a Guarantor for a Loan

Personal guarantees attract so much risk - if things don't go as they are expected - that directors of businesses and other giving them in a business environment take out personal guarantee insurance.

 

Directors' Personal Guarantees

Directors of companies are often requested by banks to provide personal guarantees for sums lent to companies which they control: ie director's guarantees.

This situation is quite similar to the example above. When the director gives the guarantee, if the company can’t service the loan, the director is called upon for the sums owed on the loan. They're personally liable under the director's guarantee.

So:

• A director of a company might personally guarantee to the bankers of the company or loan provider that all the loans given to the company will be paid by the company.
• If the company defaults on payments or becomes insolvent, the bank or loan provider can look to the director to repay the loans given to the company, on the strength of the director's guarantee.
• A company director might give a performance guarantee to a service provider to the company that some state of affairs will exist throughout a contract between the service provider and the company. This is a “see to it” guarantee.

Director's Liability for Company Debts

Directors personal liability for company debts is not relieved or avoided when the company enters liquidation or administrative receivership, and can no longer service the loan. In fact, these are precisely the cases where lenders call on guarantors and their personal assets to reply the loan(s) given to the company.

Recovery proceedings by lenders for company debts isn't piercing the corporate veil. The guarantee and/or indemnity is a freestanding contractual commitment with privity of contract between the lender the guarantor to pay the debt, and probably the expenses incurred by the lender to chase the debt.

Recovery by Creditor from Guarantor

When a creditor recovers money from the guarantor because the debtor has defaulted on (say) a loan, the debtor (say a company) is then liable to the guarantor for sums that the guarantor has paid the creditor.

The liability of the guarantor is said to be “secondary”.  This is because liability arises in the guarantor at the request of the creditor. The guarantor assumes liability when the debtor fails to perform and the guarantor is called upon to honour the guarantee.

 

What is an Unlimited Personal Guarantee?

It's a guarantee that has no upper limit or cap on the amount that the creditor can recover under the guarantee from the guarantor.

Upper limits on recovery under a guarantee can be imposed by stating them in the contract. These sorts of clauses are known as limitations of liability, limitation clauses or exclusion clauses. 

 

Is it a Guarantee? Guarantees vs Indemnities

There are significant differences between a guarantee and an indemnity.

In a well drafted guarantee, it will usually include a guarantee and an indemnity.

Indemnity

A person who indemnifies another party to a contract promises to compensate them if a particular state of affairs does not come to pass, and the contracting party suffers loss as a result. They are directly contractually required compensate the other party for their loss – they are “primarily liable”. Contract indemnity clauses are easy to spot - they usually use the word "indemnify" and/or "hold harmless". They, like guarantees may give rise to joint and several liability with the debtor company.

So an indemnity is an express contractual obligation to compensate for any loss suffered, independent of what the liability of the party in breach might otherwise be to a third party to the contract.

Guarantees and Secondary Liability

In contracts of guarantee, the guarantor assumes secondary liability. The guarantor answers for obligations for which the debtor, who remains primarily liable.

This means a guarantor is liable for (say) the debt regardless of the position of the debtor, and whether a demand has been made upon the original debtor or not.

A guarantor only becomes liable when the debtor has failed to perform its primary obligations; the liability arises when the rights against the original debtor have been exhausted.

Just because a party is named as a debtor, does not mean that they cannot be found to be a guarantor as well. It depends upon the intention of the debtors, and whether they intended one to be a guarantor for the other.

 

Differences between Guarantees and Indemnities

 

Requirement	Guarantee	Indemnity
Amount of liability	Same as the debtor, usually	Independent of any guarantee
Liability arises	When debtor is in breach of contract	When indemnifier is in breach of contract
Given in writing?	Yes	Not necessarily
Signed by the guarantor	Yes	Not necessarily
Consideration	Yes	Yes
Compensate the loss of another person	Yes	Yes
Parties to Contract	Creditor, principal debtor and guarantor	Indemnified and indemnifier
Past consideration good consideration	No	No
Variation to guarantee agreed between creditor and debtor	Guarantee void under general law	Indemnity continues

 

Challenging Personal Guarantees

Standards of behaviour by creditors can vary from guarantee to guarantee. Believe it or not, there's solid legal authority that says that no one guarantee will be interpreted in the same way for different contracting parties.

They're drafted in the main party with a view to be being challenged by a debtor in the fullness of time.

But there's only so such a draftsperson of a guarantee can do when drafting the guarantee document.

Important factors which affect enforceability of guarantees happen in the real world, not in the contract of guarantee itself.

Enforceability of  a guarantee can depend as much on the behaviour of the creditor as the terms of the contract.

Still, there's no question that the contract should be reviewed before it's signed. When the advice doesn't say what it should say, there may be a claim against the advisor.

 

Legal Advice on Contracts of Guarantee

We've never met a person who has a guarantee from a guarantor, and has forgotten they have it.

Guarantees in business are serious documents. Assets are at stake.

If it's a personal guarantee, they're personal assets and not just those of a company.

Is it a waste of money to ask a solicitor to look at your situation?

It depends on your objectives.

Suppose a creditor claims say £20,000 under a personal guarantee. Suppose then the legal costs for the legal advice on the guarantee for ways to challenge it are £1,700.

If the lawyer comes and says that you have no hope of defending the claim on the guarantee, it’s a waste of money, right?

Not necessarily.

What if the guarantee isn’t as watertight as you are being told it is?

What if you’re not in such a bad position as you think you are?

What if you can set yourself up with a better negotiating position to?

What if as a result of the advice, you’re able to negotiate a lower settlement than the £20,000, like £6,000?

Is that a win? 

Despite what you might have heard, the open and shut case is rare - very rare - in the law. Things tend to happen on the ground, outside the legal documents - events that happen in the real world - which affect the enforceability of guarantees, and weaken the position of creditors.

The people working for the creditor may not know what they do when signing guarantors up or how they treat guarantor after it is signed may hurt the the creditors' legal position. 

That may be the case with yours.

If you’ve got a budget to defend a guarantee, and the creditor is hassling you for payment before they move to enforce it, you have a limited opportunity to do something about it.

When creditors start legal proceedings, things moves forward. Fast.

That’s not the ideal time for you to size up your options.

The earlier you address the issue, the less sunk costs the lender has in chasing unpaid money, the less effort and expense has been incurred chasing it. Emotions can run high by the time it comes to starting legal action. The lender might be far less willing to compromise at a later stage.

If you don’t take advice early - or at all - you’re no better off and won’t find out if there’s a way to crack the guarantee and:

• improve your position
• negotiate a better deal in time or money
• buy time to preserve your assets

Drop us an email on contact@hallellis.co.uk with a copy of your guarantee, loan documentation a summary of the backstory for a cost estimate for legal advice on your guarantee.  We're business dispute lawyers that advise businesses.