Discharge of a guarantee
Guarantees are complex instruments. Lawyers go to great efforts to ensure that the terms of a guarantee are watertight. Despite this, there are a number of circumstances which can result in the discharge of a guarantee. One particular minefield is dealings between the lender and the borrower during the life of the loan. There are a number of actions of the lender which can inadvertently result in the discharge of a guarantee.
Variation of the principal contract
A material variation of the principal contract (e.g. the facilities agreement) by the lender and the borrower may discharge the guarantee. If it is clear that the variation is insubstantial or that it is beneficial to the guarantor, it will not constitute a material variation. However, the court will only reach this conclusion if it is obviously so; the court will not otherwise inquire as to the effect of an alteration. This test is strict and works in favour of the guarantor. The mere possibility of detriment to the guarantor is sufficient to result in the discharge of the guarantee. For this reason, as a rule of thumb, all variations to the principal contract should be regarded as material.
A guarantor may be discharged if the lender and the borrower enter into a binding agreement to extend the time for performance by the borrower of its obligations under the principal contract.
Release of the borrower
An absolute release of the borrower by the lender will release the guarantor. An absolute release may be by written contract, but it may also be a result of certain arrangements between the lender and the borrower. For example, the novation of the principal contract (and acceptance of a new debtor in place of the old) or the composition with the debtor may result in the guarantee being inadvertently released.
There are means by which the lender can ensure the guarantor remains on the hook. The most effective, and the easiest, is for the lender to obtain the consent of the guarantor.
Most guarantees do in fact contain a clause which aims to secure the guarantor’s prior consent to such dealings between the lender and the borrower. So long as the wording of these clauses covers the exact dealings which occur, the guarantee will remain valid. But, in practice, lenders err on the side of caution and obtain the guarantor’s express consent at the time of the particular arrangement. This is to avoid any subsequent dispute over the validity of the guarantee.
Two years ago Bank A entered into a facilities agreement with Borrower B. Borrower B’s obligations under the facilities agreement were guaranteed by Guarantor C. The guarantee contains a clause that states that the guarantee will not be affected by any variation to the facilities agreement or the granting of time to Borrower B. Bank A and Borrower B have agreed to amend the facilities agreement. The amendments include an increase to the margin and an extension of the final maturity date.
The amendments appear to be covered by the clause in the guarantee and as a result Guarantor C will be deemed to have given its prior consent to the amendments. Nevertheless, Bank A would be advised to obtain the express consent of Guarantor C to these amendments to reduce the risk of future litigation concerning the effectiveness of the guarantee.