Lenders regularly seek security from third parties by way of a contract of guarantee. Guarantees are technical documents and should be carefully drafted to ensure that the lender is protected from the wide range of circumstances in which a guarantor may be discharged from liability under a guarantee. In this briefing we consider the essential requirements of guarantees, highlight potential dangers for lenders and identify ways to protect a guarantee from successful challenge.
A guarantee is a promise to be liable for the debt or some other legal obligation of another. The disadvantage of a guarantee, from the point of view of the lender, is that it is a secondary obligation dependent on the existence of the borrower's liability to the lender. As a result guarantees will often provide that the guarantor indemnifies the lender for all losses in relation to the borrower's debt as a primary obligation, in addition to guaranteeing repayment of the debt to the lender.
Essential Requirements of a Guarantee
Under section 2 of the Statute of Frauds (Ireland) 1695, a guarantee must be in writing and must be signed by the guarantor or his authorised agent. A guarantee must comply with the common law rules relating to contracts, an essential requirement of which is the presence of consideration unless the guarantee is executed as a deed. Lenders should be aware that a guarantee which is entered into after the borrower's obligation has been created may be void for past consideration and should avoid any potential danger of this sort by having the guarantee executed as a deed. A corporate guarantor must have the corporate authority and power to give the guarantee and the giving of the guarantee should be for the commercial benefit of the company.
In terms of regulatory compliance lenders should note that prescribed warnings must be included in guarantees to which the Central Bank's Consumer Protection Code 2012 and the SME Regulations1 apply. The SME Regulations, where applicable, impose certain obligations on lenders in their dealings with guarantors including the provision of information and explanations.
Grounds for Challenge
The law takes a protective approach to guarantors on the basis that a guarantee sees the guarantor taking on the liability of another. This is evidenced by the wide range of circumstances in which a guarantor's liability under the guarantee may be discharged. For example, a guarantee can be discharged by a material variation of the principal agreement, by a misrepresentation of the borrower or by the lender giving time to the borrower to repay the guaranteed debt. A guarantee induced by duress or undue influence may be set aside and this is one of the main reasons why lenders will generally require a guarantor to obtain independent legal advice.
A guarantee may also be vitiated on statutory grounds. A failure by the lender to comply with the strict requirements of Part III of the Consumer Credit Act 1995, where applicable, may render the guarantee unenforceable. Furthermore, where the guarantor is a consumer, the European Communities (Unfair Terms in Consumer Contracts) Regulations 1995 may limit the ability of the lender to rely on certain terms in the guarantee. The Companies Act 2014 imposes significant restrictions on the ability of a company to guarantee the obligations of its directors or a connected person and restricts the ability of a company to provide financial assistance (including in the form of a guarantee) for the acquisition of shares in such company.
A continuing or "all sums" guarantee, as distinct from a specific guarantee, covers all of the debts of the borrower to the lender including future indebtedness. Such a guarantee is typically required where the borrower has a revolving credit facility with the lender. The continuing nature of the guarantee will depend on its construction and the circumstances surrounding it. The Irish courts have held that a guarantee that is stated to be continuing will be ineffective as such if the intention of the parties was that it was to guarantee a particular transaction2.
In practice lenders should ensure that a guarantee which is to take effect as a continuing guarantee is clearly drafted as such. In these circumstances a party seeking to challenge the continuing nature of the guarantee will bear the onus of proof in establishing that, despite the express terms of the guarantee, it was given for a specific transaction.
Where a lender requires more than one guarantor, the guarantee should set out the nature and extent of the liability of each co-guarantor. Where the guarantors are expressed to be acting severally (rather than jointly), each guarantor makes a separate promise to the lender for the amount of the debt guaranteed and separate proceedings are required to be instituted by the lender against each guarantor.
Where the guarantors jointly promise to answer for the debts of another, then the lender will be entitled to make one demand, and have one right of action, against all the guarantors. A guarantor acting jointly and severally is liable in respect of a promise made by him jointly and a promise made by him separately. Lenders should proceed with caution when dealing with joint and several guarantors as the treatment of one guarantor may affect the liability of the others. For example, the release of one joint and several guarantor will release the other guarantors unless the guarantee provides otherwise.
There are many factors which may affect a lender's ability to recover under a guarantee. A guarantee should be carefully drafted to ensure that the guarantor does not have the ability to avoid or reduce any liability. Lenders must also consider potential statutory grounds for vitiation which may cut across an otherwise robust guarantee.