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 perform 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 credit-worthy in order to minimise the chance of not being repaid under the loan agreement.
What to look for in a guarantee
If you are asking for a guarantee and indemnity, there are several things you must consider:
- 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 that you may not get your money back?). In order to establish this, you can ask the borrower to provide financial information (such as how much money do they have; what assets do they have; are their assets secured; what is their income; what are their expenses). You can also look into whether they have ever been declared bankrupt before. If the borrower is a high credit risk then you should consider asking them to provide a guarantee from a credit-worthy individual or some form of security to minimise the risk of losing your money.
- Who is the guarantor? You want the guarantor to be credit-worthy so that, if the borrower is unable to repay you, the guarantor will be able to meet the payments. Again, you can ask the guarantor to provide you with financial information to determine whether they have sufficient funds to meet the payments. You might also consider asking for a guarantee from multiple guarantors. If there are multiple guarantors, you want them to be jointly and severally liable so that you can bring a claim against either all or just one of them for the full amount owing.
- What exactly is being guaranteed? You need to determine what exactly is being guaranteed by the guarantor. You want to make sure all amounts payable by the borrower under the loan agreement (such as the principal, interest, fees, costs and expenses (including legal fees) and indemnity payments) are guaranteed; not just the principal amount. You also want the guarantor to guarantee 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 you) 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 also want the borrower’s obligations under the security documents to be guaranteed. You need to read the guarantee carefully to ensure it is drafted broadly enough to cover all obligations owing to you by the borrower under the relevant documents.
- Is the guarantee a continuing guarantee? You want to make sure that the guarantee will remain in place until the borrower has discharged all of its obligations to you under the loan agreement. You also want to make sure that the guarantee will not be affected by anything (such as an amendment to the underlying loan agreement). Again, you need to review the guarantee carefully to ensure it contains provisions covering these matters.
- Does the guarantee contain an indemnity? A guarantee is a secondary obligation granted by the guarantor to the lender. It relates to primary obligations (being the obligations of the borrower to the lender under the loan agreement). If the primary obligations become unenforceable then the secondary obligation is unenforceable. This means that you cannot enforce the guarantee (as, basically, there is no enforceable obligation to guarantee). For this reason, a guarantee should always contain an indemnity. The indemnity is a primary obligation granted by the guarantor to the lender and is not dependent on the enforceability of the loan agreement. Accordingly, if you suffer a loss under the loan agreement, the guarantor must indemnify you under the indemnity.
- Does the guarantor make any representations and warranties under the guarantee? You want the guarantor to make certain basic representations and warranties under the guarantee. These are statements made by the guarantor which are designed to protect you. They include matters such as the guarantor’s capacity and ability to enter into the document; the fact it is not bankrupt; and the fact it has sought independent legal and financial advice before entering into the document. If one of the representations turns out to be untrue, you may bring a claim against the guarantor for misrepresentation.
- Is the guarantor an individual? If the guarantor is an individual you want to make sure you have some evidence from them that they have received independent legal advice (explaining the effects and risks of entering into the guarantee) before entering into the guarantee. This could be by way of a representation in the guarantee. However, most lenders go further and require a certificate from the lawyer who gave the advice stating that they have provided it. This prevents the guarantor announcing to the court down the track that they didn’t understand the effects of the guarantee and didn’t realise it could result in them having to pay such huge sums of money on behalf of the borrower.
- Is the guarantee executed as a deed? As the guarantor does not receive consideration for entering into the guarantee, it should be executed as a deed to ensure the guarantor is bound by its terms.
It is a good idea to ask for a guarantee when lending money to someone. This minimises the chance of the loan not being repaid. If you would like us to draft or review a guarantee for you, please do not hesitate to contact us. One of our specialised contract lawyers would be delighted to assist.