Do you want to know how to put a guarantee in place without incurring unnecessary time and expense? If your answer is yes, help is at hand below. By stopping to think through the following five steps before drafting and negotiation gets under way, the time and cost of producing a guarantee document should be kept to a minimum.
1. Ask - which obligations need to be guaranteed?
Working out which obligations are to be covered by a guarantee is crucial to ensure that protection and liability under it do not exceed the parties' expectations. Guarantees can cover both payment obligations and/or other performance obligations, and distinguishing between these obligations will help to ensure that liability is not greater than expected.
It should also focus minds on whether the obligations are of a type that the guarantor is likely to be able to meet in the first place. Always consider whether the obligations to be guaranteed will arise under one, or a series of, agreements and in each case, whether or not an agreement is likely to be amended in the future.
2. Ask - in what circumstances do you want to be able to call on the guarantee?
Always establish when a breach under an agreement will trigger liability under the guarantee. Should any breach under the agreement trigger guarantee liability, or should it be limited to specific major breaches? Additionally, should time be allowed for a breach to be remedied before liability arises under the guarantee?
Failing to consider these points may result in liability under the guarantee being triggered when the commercial reality is that a breach is minor or could be easily fixed to the satisfaction of all concerned.
3. Ask - will the guarantee have a liability cap?
Guarantees can either be unlimited or contain a liability cap, but this needs to be clear from the outset. If the guarantee should only cover specific contracts, specific obligations or a specific amount, then the guarantee drafting must cater for that. It is also worth considering whether or not a payment under the underlying contract will reduce or terminate liability under the guarantee. Considering these points first will help to avoid a re-drafting exercise and additional legal cost further up the line.
4. Ask - will the guarantee have a long stop date?
In addition to liability caps, always consider whether the guarantee should automatically terminate after a specific date and/or whether the guarantee should terminate once certain milestones have been reached in the underlying contract. These points can sometimes be overlooked in commercial negotiation, but if the intention of the parties is for the guarantee to fall away at a certain date or time, then provision needs to be made for that in the guarantee.
5. Ask - when can a demand be made under the guarantee and what evidence will be required to make that demand?
The parties should consider when demand can be made under the guarantee, to ensure that it isn't inconsistent with the underlying contract. If grace periods to remedy breaches are provided in the underlying contract, then it is usually considered fair that this position is replicated in the underlying guarantee.
Additionally, the parties should consider what evidence is required before a guarantee claim can be made. Common provisions include the requirement to provide a copy of any demand made on the original defaulting party, so that the guarantor has clear evidence that a claim has been made.
By considering these areas before drafting guarantees, the time spent on agreeing them should be reduced. Always remember, if the guarantee or any of the parties to the guarantee are in different jurisdictions, or the guarantee is governed by non-English law, then the parties should always consider whether or not they should take foreign law advice.
Coming soon: Look out for our parent company guarantee checklists, providing a list of key areas to consider when acting for either a guarantor or a guarantee beneficiary.