A guarantee must be in writing and will usually be executed as a deed. The guarantee document will usually provide that the consideration constitutes the bank making the facilities or accommodation available to the customer whose liabilities are guaranteed. Execution as a deed obviates issues around consideration such as past consideration etc.
In consumer cases, the Consumer Credit Act and the Consumer Protection Code require that specific prior information and warnings be provided. It is a question of interpretation of the legislation as to whether the failure to include the requisite warnings, affects the validity of the documents. Some Consumer Credit Act failures of compliance can affect enforceability. Others may be regulatory matters only, by which the lender may be subject to regulatory enforcement. They may be considered in the context of complaints to the Financial Ombudsman’s Office.
Indemnity and Primary Liability
A guarantee, in the strict sense, is an agreement to meet the obligations of another person. Where that other person’s liabilities do not, for some technical reason, arise or are legally invalid, then the guarantee (in the strict sense) will not apply, unless the guarantee document otherwise provides.
Some bank guarantee documents include an indemnity or otherwise make the “guarantor” co-liable on the guaranteed debt. An indemnity is an obligation to compensate the indemnified party, Euro for Euro, for any loss by reason of the failure of the guaranteed person to pay.
This undertaking of primary liability removes some of the possible frailties that may arise in a guarantee, where the underlying debt is invalidated or unintentionally released. The indemnity and/or primary obligation is onerous on the guarantor and does not always apply. It may be instead (or also) provided that the liability of the guarantor is not to be affected by certain acts and events, which might otherwise release the primary liability of the customer.
Covenant to Pay
There is generally an obligation to pay on demand when the guarantee is enforced or “called.” This issue is of importance in the context of the Statute of Limitations. In the case of a deceased obligor, a two-year time limit from the date of death applies to obligations that have arisen prior to death. Therefore, the two-year time limit will not apply where the guarantee has not been demanded, prior to the guarantor’s death.
The covenant to pay will set out the scope of the guarantee. It may be limited to a particular loan account or loan amount. It more commonly covers all obligations and liabilities, present or contingent either jointly or severally owed by the guaranteed party, whether as principal or surety on all facilities including acceptances, credits, bonds, guarantees, and indemnities.
It will also cover interest, before and after judgement. It will usually extend to commissions, fees and other expenses incurred in relation to the underlying loan. A certificate signed by an authorised officer of the bank is usually deemed conclusive evidence of the indebtedness of the customer to the bank.
There may be a separate covenant to pay interest from the date of demand until all monies are paid, at a specified rate. The rate will generally be a higher rate, reflecting the underlying default by the customer. Without this provision, the lender would have to rely on the Court’s discretion to allow interest.
Limitations on Guarantees
A cap on liability is commonly provided, by way of a maximum amount guaranteed. This limitation on the total amount recoverable is often inserted after the covenant to pay. This will not usually include interest, costs, and expenses which will apply over and above the maximum amount.
Sometimes the guarantor will be liable for the full amount, but recourse to a will be limited to a specified amount or specified asset. This may mean that if the guarantor pays the specified sum, he will not have the right of subrogation against the principal debtor because the amount outstanding is still technically due.
The limitation on the amount of the guarantee should ensure from the lender’s perspective that it does not enable the guarantor to exercise its rights to security or to compete with the lender until the lender has been paid all of its liabilities in full.
Continuing Guarantee and Appropriation
A guarantee may be in respect of a specific amount or it may be “continuing.” Most bank guarantees are “continuing” so that they apply in respect of the liabilities that are outstanding from time to time. From the lender’s perspective, the guarantee should be expressed as a continuing security for the ultimate balance owing to the lender by the borrower, notwithstanding any intermediate settlement of account, especially where the guarantee relates to a variable account.
In the absence of the above provision, the rule in Clayton’s case may cause the guarantee to be discharged or reduced in value. This rule presumes that monies paid firstly into an account discharged earlier debts. Most standard form guarantees prevent the rule from applying so that the guaranteed sum is not limited to the initial advance.
The lender is generally entitled to appropriate sums received from the borrower as it chooses. It may be for example appropriate sums to the unguaranteed element of an account, which leaves the guarantor to cover the guaranteed part of the account.
Liability on most guarantees arises, and they are enforceable “on demand.” The liability only arises once demanded by the guaranteed lender. This has the important consequence that the time limit of the Statute of Limitations runs from the date of the demand.
Guarantees may be joint and several. Each guarantor may be sued for the full liability. In this event, the guarantor against whom full recovery is obtained will have a right of contribution against the other co-guarantors. A guarantee by a number of parties might be limited to a specific proportion of the overall debt.
Clear wording is required to limit the liability in this way. It is not enough that the guarantors are “severally” liable; it must be clear that they are severally liable for are proportion on the debt…
Subrogation and Indemnity
The guarantor is not entitled to insist that the lender sues the borrower or indeed relies on other security, as a pre-condition to enforcement. If the guarantor pays the lender, he may be subrogated to the lender’s security rights. A right of indemnity applies, where the guarantee was given at the implied or actual request of the principal debtor.
Where the guaranteed sum has been paid, the guarantor may exercise the right of indemnity against the borrower. This is a right to recover the sum paid plus interest.
The equitable right of subrogation is designed to prevent unjust enrichment. The guarantor is entitled to every right that the creditor would have had against the debtor and the right to enforce every security and means of payment available. Effectively, the guarantor steps into the shoes of the creditor. The guarantor is entitled to expect that the securities are kept in place.
Where a part only of the debt has been guaranteed, the guarantor is entitled to a proportionate part of the security. This position is almost always reversed so that it only applies to the full payment of the debt.
A guarantee may apply for a particular period only, in the sense that if it is not invoked within that particular period, it ceases to apply. This type of provision would be unusual in the case of a bank guarantee. It is more common that if a time limitation applies, that it limits of crystallises the liability on the guaranteed debt as at the termination date.
Some guarantees provide for termination by notice. The notice must usually be in writing. Once notice has expired, liability is released for monies lent after this period. Standard terms usually provide that the guarantor is liable for the amount due at the end of the period of notice. If there is no contractual right of revocation, it is a question of interpretation, as to whether the guarantee is revoked. If the guarantee covers future advances, it is arguable that notice can be given in relation to advances after the time of the notice.
Notice of the death of the guarantor is generally equivalent to notice of termination. If a co- guarantor’s liability is determined, this does not necessarily discharge the other guarantor.
Negation of Default Guarantor Rights I
If a guarantor is prejudiced by the lender, the guarantee may be discharged at common law. This may occur if there is a material alteration in the terms of the underlying loan, if the creditor gives more time or if it releases its security. These actions interfere with the guarantor’s right against the principal debtor.
Where there are multiple guarantors, the guarantee may be expressed as valid, notwithstanding that it is not signed or is ultimately invalid and is discharged against other co-guarantors. The lender will wish to have the ability to pursue the guarantor, notwithstanding non-enforcement of its rights against the borrower.
A bank guarantee will usually seek to reverse the various common law, equitable and statutory protections which might otherwise discharge or release the guarantor or enable the guarantor to compete with the lender by taking security from or claiming in the insolvency of the borrower. The lender’s objective is to ensure that the guarantor unconditionally pays the loan monies if the borrower does not do so.
Negation of Default Guarantor Rights II
The guarantee will usually provide that the guarantor is liable, irrespective of whether the guaranteed borrower is bound or not. The guarantee will provide that the liability is not to be diminished if the bank releases or varies the security, grants time or enters any settlement with the principal borrower or fellow guarantor.
The invalidity of a security to which the guarantor might otherwise be entitled upon full payment, may release the guarantor at common law. It is therefore usually provided that the guarantor’s liability is not to be diminished if any security is unenforceable or is not perfected. The guarantor may be enforced, notwithstanding that no action is taken to enforce any security held by the bank.
The guarantor is usually prohibited from proving in the insolvency of the borrower in competition with the bank. A trust may be provided in favour of the bank in respect of any dividend received by the guarantor in the borrower’s winding up. The guarantor may warrant that he has not taken any security or that if he has, that it is to be held in trust for the bank.
The guarantee is not to be discharged or diminished by any act or omission which would have discharged or affected the liability of the guarantor, had he been principal debtor instead of the guarantor. Until the ultimate balance is paid in full, the guarantor waives rights of subrogation and indemnity against the principal debtor and all persons liable.
The bank may credit money received under the guarantor to a suspense account in order to preserve its rights against the debtor and co-guarantors. The guarantee may provide for a “hardening” period. If any payment received is set aside in insolvency as an unlawful preference, the lender will wish to reactivate and reclaim its rights under the guarantee. The guarantee is retained during this period.
The guarantee may provide a set off over accounts due by the lender to the guarantor, such as bank account balance. The guarantor may agree that the lender may at any time without notice after a default, combine or consolidate accounts of any other nature or in any other currency.
Until the ultimate balance owing by the customer to the bank has been paid or satisfied, the lender may have a lien on property and assets of the guarantor from time to time in its possession and a charge over shares, stocks and marketable securities.
As with other security and loan documentation, provision will be made as to what constitutes proper notice to the guarantor. This is important in the context of enforcing the guarantee. Certain acts will be deemed to constitute notice, without the necessity to prove actual notice to the guarantor. Service is usually deemed effective by personal delivery or post sent to the last known place of business or residence.
Communications delivered personally are deemed served at the time of delivery. Communications by letters are deemed served on the next or the following business day. There may be provision for service by fax, e-mail or equivalent means of communication. There may be provision for nomination of parties to accept the notice.
References and Sources
Breslin Banking law + Supplement 3rd Ed 2013
Mortgages Law & Practice Maddox 2nd Ed 2017
NAMA Act 2009: A Reference Guide Raghallaigh, Kennedy, Whelan
Money Laundering & Anti-Terrorist Financing Act 2010
Financial & Emergency Provision Legislation Annotated 2011
Shelley & McGrath National Asset Management Agency Act Annotated 2011
Dodd & Carroll Law Relating to NAMA 2012 0
Ashe & Reid Anti-Money Laundering: Risks, Governance & Compliance 2013
Johnston & Ors Arthur Cox Banking Law Handbook 2007
Dr Mary Donnelly The Law of Credit and Security, 2nd Ed, 2015
A Hudson The Law of Finance 2nd Ed (Sweet and Maxwell 2013)
Veil (Ed) European capital markets law (Hart Publishing 2013)
IG MacNeil An Introduction to the Law on Financial Investment 2nd Ed ( Hart Publishing 2012)
E Ferran Principles of Corporate Finance 2nd Ed ( OUP 2014)
Gullifer (ed) Goode and Gullifer on legal problems of credit and security (6th edn Sweet and Maxwell London 2017).
MA Clarke et al (eds) Commercial Law: Text, Cases and Materials (5th edn OUP Oxford 2017)
McKendrick (ed) Goode on commercial law (5th edn Penguin London 2017)
G McCormack Secured credit under English and American law (CUP Cambridge 2004)
L Gullifer and J Payne Corporate Finance (2nd edn Hart Oxford 2015)
D Sheehan The Principles of Personal Property Law (2nd edn Hart Oxford 2017)
Ross Cranston, Emilios Avgouleas, Kristin van Zwieten, Christopher Hare, and Theodor van Sante Principles of Banking Law 3rd Ed 2018
E.P. Ellinger, E. Lomnicka, and C. Hare Ellinger’s Modern Banking Law 5th Ed 2011
Andrew Haynes The Law Relating to International Banking Bloomsbury Professional 2009
Charles Proctor Mann on the Legal Aspect of Money 7th Ed 2012
Charles Proctor The Law and Practice of International Banking 2nd Ed 2015
Sheelagh McCracken The Banker’s Remedy of Set-Off 2010 Bloomsbury Professional
Louise Gullifer, Jennifer Payne Banking & Financial Law 2018
Hubert Picarda QC The Law Relating to Receivers, Managers and Administrators 4th Ed 2006 5th Ed 2019
Lightman & Moss on the Law of Administrators and Receivers of Companies 6th Ed Sweet & Maxwell 2017
Timothy N Parsons Lingard’s Bank Security Documents 6th Ed 2015