In Short
- A guarantee and indemnity makes you legally responsible for repaying a loan if the borrower cannot. This can include not just the loan amount but also interest, fees, and other costs.
- Being a guarantor can impact your credit and financial future. Lenders may consider your guarantee when assessing your borrowing capacity.
- Understand the risks before signing. Review the loan and guarantee terms carefully, assess your financial ability to cover the debt, and seek legal and financial advice if unsure.
Tips for Businesses
Before agreeing to guarantee a loan, evaluate the borrower’s financial position, check whether your liability is capped, and confirm how and when you can be released from the guarantee. Ensure you have enough assets to cover the debt if required, and always seek legal advice to fully understand your obligations.
Table of Contents
Many lenders will require an independent third party, known as a guarantor, to guarantee a borrower’s obligations under a loan agreement. This is typically documented through a ‘guarantee and indemnity’ provided by the guarantor in favour of the lender. This may also be incorporated into the lending agreement itself. The guarantee and indemnity state that if the borrower fails to fulfil their obligations under the loan, the lender can demand that the guarantor perform these obligations on the borrower’s behalf by seeking repayment of the loan from the guarantor. A guarantee and indemnity is generally necessary when the borrower is considered a high credit risk. The lender will seek a guarantee and indemnity from a guarantor with a low credit risk. This minimises the likelihood of not being repaid under the loan agreement.
This article will outline the key considerations, risks, and legal implications of providing a guarantee and indemnity.
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What to Ask Before Guaranteeing a Loan
If you are asked to provide a guarantee and indemnity to a lender, there are several things you must consider as follows.
Who Is the Borrower?
You need to consider whether the borrower represents a high credit risk. For example, are they likely to default on the loan agreement, meaning you will have to pay the lender on their behalf? To establish this, you can ask the borrower to provide financial information (such as their current assets and cash, whether those assets are secured, and their income and expenses). You might also want to investigate whether they have been declared bankrupt.
What Exactly Are You Guaranteeing?
You need to clarify precisely what you are agreeing to guarantee. It is unlikely that this will be a fixed amount, nor is it likely to be limited to the principal sum of the loan. You are probably guaranteeing all amounts payable under the loan agreement, which may include the following:
- principal;
- interest;
- fees;
- costs;
- expenses (including legal fees); and
- indemnity payments.
Furthermore, you may also be ensuring the borrower meets their obligations under the loan agreement. This implies that if the borrower defaults on a non-payment obligation (such as supplying information to the lender), the guarantor must provide that information instead. You may guarantee the borrower’s commitments under the security documents if the loan agreement includes collateral. To understand your guarantee, it is essential to consider the following:
- review the guarantee and indemnity that you are signing; and
- review the loan agreement and any other underlying documents to see what obligations the borrower has under those documents.
Do You Have Enough Money to Repay the Lender if the Borrower Defaults?
Once you have worked out the amount of money you are guaranteeing, you need to determine whether you can repay that amount if necessary. You must also ensure you can repay those amounts until the guarantee and indemnity are discharged.
Consider whether you would like to engage with a financial advisor to ensure you have enough assets to cover the borrower should they default on their repayment obligations. The relative amount of the loan and the value of any assets you own are likely to influence your risk appetite when considering becoming a guarantor.
What Are the Risks of Signing a Guarantee and Indemnity?
There are several risks associated with signing a guarantee and indemnity.
For loans you guarantee, ensure you notify your credit card provider whenever you apply for credit. Your credit card provider will consider how much you have already repaid when deciding whether to lend you money. They will assess your capacity to repay. They may refuse to lend if the person whose loan you are guaranteeing is not in default but still poses a sufficient risk.
Failure to repay a guaranteed loan can have disastrous consequences. For example, it may result in you and the borrower receiving poor credit ratings. Your credit report will mark the loan as a default or non-payment. This will make it difficult for you to borrow money for several years.
If the borrower defaults on the loan agreement, you must cover that default. This could involve a substantial payment. If you do not have enough cash, you may need to secure a mortgage on your property. Even worse, you may have to sell your property and use the proceeds to repay the lender. If this still doesn’t provide enough funds to settle the debt entirely, you may have to declare bankruptcy.
Key Takeaways
Consider your options carefully before agreeing to guarantee a loan. Significant personal risks are involved, and you could lose a considerable amount. It’s wise to seek financial and legal advice before guaranteeing a loan to ensure you feel confident and that there is minimal risk of the borrower being unable to repay.
If you have been asked to provide a guarantee and would like advice on the risks involved, our experienced leasing lawyers can assist you as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers who can answer your questions and draft and review your documents. Call us today at 1300 544 755 or visit our membership page.
Continue reading this article below the formFrequently Asked Questions
A guarantee and indemnity is a legal commitment where a guarantor agrees to repay a loan if the borrower defaults. This can be a standalone document or part of the loan agreement.
Lenders require a guarantor when the borrower is considered a high credit risk. A guarantor with a strong financial standing helps reduce the lender’s risk of non-repayment.
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