Many lenders will require an independent third party (referred to as a guarantor) to guarantee a borrower’s obligations under a loan agreement. This is usually documented by the guarantor providing a document called a ‘guarantee and indemnity’ in favour of the lender. The guarantee and indemnity will provide that, in the event the borrower fails to perform its obligations under the loan, the lender can ask the guarantor to carry out the obligations on the borrower’s behalf. A guarantee and indemnity is generally required where the borrower is a high credit risk. The lender will want a guarantee and indemnity from a guarantor who is low credit risk to minimise the chance of not being repaid under the loan agreement.
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 is a high credit risk (i.e. are they likely to default under 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 how much money and assets they have, whether their assets are secured, their income, and their expenses). You can also look into whether they have ever been declared bankrupt before.
What exactly are you guaranteeing?
You need to determine what exactly you agree to guarantee. It is unlikely to be a fixed amount and it is unlikely to be limited to the principal amount of the loan. You are likely to be guaranteeing all amounts payable under the loan agreement (such as the principal, interest, fees, costs and expenses (including legal fees) and indemnity payments). You may also be guaranteeing the performance of the borrower’s obligations under the loan agreement. This means that if the borrower fails to satisfy a non-payment obligation under the loan agreement (for example, providing information to the lender), then the guarantor will be responsible for providing that information on behalf of the borrower. If the loan agreement is a secured agreement, then you may also be guaranteeing the borrower’s obligations under the security documents. To determine what you are guaranteeing, you must do two things:
- 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 have to work out whether you would be able to repay that amount if necessary. You also need to make sure you can repay those amounts until the guarantee and indemnity are discharged.
What are the risks of signing a guarantee and indemnity?
There are various risks associated with signing a guarantee and indemnity as follows:
- For loans that you are guaranteeing, you need to make sure you have notified your credit card provider whenever you apply for credit. Your credit card provider can consider how much you have already repaid when deciding whether or not to loan you money. The provider will assess your capacity to repay and may refuse to lend you if there is a risk that the person whose loan you are guaranteeing is not in default but presents sufficient risk.
- Failure to repay a guaranteed loan can have disastrous impacts. For instance, it may result in you and the borrower both receiving bad credit ratings. The loan will be listed as a default or non-payment on your credit report, making it hard for you to borrow money for several years.
- If the borrower defaults under the loan agreement, then you will have to make good that default. This could mean the payment of a substantial sum of money. If you do not have sufficient money in cash, then you may have to get a mortgage on your property or, even worse, sell your property and use the sales proceeds to pay the lender. If this still doesn’t provide sufficient money to repay the lender in full, you may have to declare yourself bankrupt.
You should think carefully before you agree to guarantee a loan. There are enormous personal risks involved and you could end up losing a lot.
If you have been asked to provide a guarantee and would like some advice on the risks involved, please get in touch with one of our specialised lawyers who would be delighted to assist. Or, if you would like us to review a guarantee and any underlying documents to determine what precisely you are being asked to secure, get in touch today.