Guarantees: Relevant case law and potential issues

Emma Bufton: Hello, my name is Emma Bufton and I am a Senior Associate at Gowling WLG. I also co-chair Thinkhouse Foundations which is a network for in-house lawyers at the start of their careers where we provide tailored training, development and resources exclusively for paralegals, trainees and lawyers of up to five years PQE. At our most recent Thinkhouse Foundations event, Senior Associate, Matt Owen, from our Banking and Finance Team spoke about guarantees giving a brief recap on the relevant case law and highlighted potential issues for beneficiaries and the reasons why certain provisions are typically included in guarantee documents. So commercial parties often talk about guarantees and indemnities interchangeably, is there any real difference?

Matt Owen: Yes absolutely there is a big difference from the lender's perspective in relation to guarantees and indemnities.

A guarantee is a contract between two parties where the guarantor promises to perform someone else's obligations to the beneficiary if they are not performed by that other person. So, for example, a guarantor could provide a guarantee in respect of a borrower's obligations to a lender under a loan agreement. This means that a guarantee is a secondary obligation: it is an obligation for the guarantor to perform the primary obligation if the borrower fails to do so. If the primary obligation fails for some reason then the guarantee fails too because the secondary obligation is dependent on the primary obligation existing and being valid and enforceable.

An indemnity is different because it is a free standing agreement, a promise from the guarantor to the beneficiary: it is a primary obligation rather than a secondary one, lenders should and do insist on having an indemnity as well as a guarantee in what they call a guarantee document, so that they will still have recourse of the guarantor even in the event that there is something problematic with the primary obligation, and that might be because something has not been done properly when entering into the loan agreement for example, or perhaps because the nature of the loan agreement itself renders this unenforceable. So for example if the loan agreement needs to be in a particular format for the purposes of the Consumer Credit Act and is not, it will not be enforceable without a court order and, in the absence of a Court order, the unenforceability of the loan agreement would mean that any guarantee in respect of it would also not be worth having.

Emma: OK thanks Matt. So are there any legal issues that relate to guarantees in particular?

Matt: Yes, the courts over the years have been very protective of guarantors and have generally been sympathetic to their plight when a guarantor has been asked to pay under a guarantee.

As a result various rights and protections have been developed and these can cause difficulties for lenders who obviously want certainty that when they need to call upon the guarantee the guarantor will be required to pay.

For example, a guarantor has a right to be indemnified by the borrower following a claim by the lender under the guarantee. That might cause difficulties if at the same time the lender is also trying to claim amounts due from the borrower.

In addition, guarantors may have a right of subrogation which means that they can step into the shoes of the lender as against the borrower under the loan agreement following payment and obligation under the guarantee.

In both cases the lender will want to ensure that the guarantor is not able to exercise those rights at a time when the lender may be pursuing the customer or the borrower for outstanding amounts under the loan agreement and that is why guarantees will almost always contain a provision which says that the guarantor will postpone taking any such action until all amounts due to the lender have been fully repaid. In addition guarantees can be discharged sometimes where the underlying agreement is amended.

Emma: So can you talk to us about the amendments in a little more detail?

Matt: Yes certainly. The issue here is that for specific guarantees, so that is guarantees where the guaranteed obligations are limited to a particular loan agreement for example, the general rule is that variations to that loan agreement will discharge the guarantor from its obligations under the guarantee unless the guarantor has consented or the variation is very minor in nature and will not adversely affect the interest of the guarantor.

There have been attempts to displace this general rule by getting consent from guarantors in advance and this is why most guarantee documents will contain a provision which says something like "I the guarantor guarantee these obligations notwithstanding any variation to the loan agreement from time to time". However these clauses have been held to be ineffective in circumstances where the variation was not within the purview of the original guarantee.

There is some uncertainty as to exactly where the line is drawn and so most lenders will adopt the approach that any variation to the underlying document requires guarantor consent and this is certainly the more prudent approach.

Also the circumstances of the variation together with the text of the guarantee and the underlying document need to be considered carefully. This is because just obtaining consent to the variation from the guarantor will not be sufficient if the change results in a new obligation or a change in the obligations under the underlying document which will take the obligations which need to be guaranteed outside the scope of what is defined as the guaranteed obligations under the guarantee.

So overall wherever the lender is contemplating allowing a variation to the underlying loan agreement, it is very important that careful consideration is given to all the circumstances and any consent or amendment to the guarantee and the guaranteed obligations that may be required.

Emma: So if you had to pick a few take away points for our avid listeners, what would they be?

Matt: I think the main one is that drafting is key. The courts are generally reluctant to imply terms into documents and even more so in the case of a guarantee where the implied term would be in favour of the lender. That means it is important to make very clear on the face of the guarantee exactly what is covered and whether the guarantee is a guarantee or whether it also includes an indemnity and making it clear means including the words indemnity or indemnify, and also referring to the document as a whole as a guarantee and indemnity on the front sheet.

The second point is to think about variations very carefully, whether you are varying, amending or doing anything to the underlying document which is guaranteed then consider whether the scope of the guaranteed obligations needs to be amended and consider obtaining consent from the guarantor which is something that we would usually recommend.

The final point is that guarantees will typically contain a large number of provisions which are intended to protect the lender and are considered what might be called boiler plate provisions. Guarantors should bear in mind that these provisions will have been included for a reason and that lenders are generally reluctant to amend or remove these provisions and so guarantors ought to focus their efforts in negotiating guarantee documents on the clauses which establish the scope of the guarantees or rather the guarantor's obligations under the guarantee so, for example, the scope of the guarantee obligations and perhaps whether the amount which can be claimed against the guarantor is capped or subject to a longstop date.

Emma: Thanks Matt for those helpful and useful insights. If you do need any further guidance on anything raised in this Podcast then you can contact Matt at matt.owen@gowlingwlg.com. Thanks for listening.