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GUARANTORS

GUARANTORS' RIGHTS AND OBLIGATIONS

WHO IS A GUARANTOR?

A guarantor is a party who agrees to be responsible for the payment of another party's debts.

WHAT IS A GUARANTEE?

A guarantee is a written promise by you (the guarantor) that the person who is obtaining credit (the debtor / borrower) will keep to all the terms and conditions of their contract (the credit contract / loan agreement).

THE GUARANTOR IS RESPONSIBLE

A guarantee is not just a formality to help a friend or relative obtain credit. On the contrary, being a guarantor is a big responsibility. It means that you are prepared to pay if the debtor / borrower does not. You may need to pay the credit provider all the money owing under the contract as soon as it is asked for. Often the lender will sue you without suing the debtor / borrower.

Many people believe that the friend or relative for whom you "go guarantor" would never do anything to make the credit provider enforce the guarantee. Unfortunately, your friend or relative may suddenly find that he or she cannot meet the terms and conditions of the credit contract because of unemployment, illness or any other reason.

To "go guarantor", you must be prepared to pay and you must understand your obligations as a guarantor.

GUARANTOR'S OBLIGATIONS

If the debtor / borrower defaults in payment or in other obligations to the lender, the guarantor would be liable to make good that default which could involve all amounts owed by the debtor / borrower to the lender and substantial arrears of interest.

CAN GUARANTORS ESCAPE THEIR OBLIGATIONS?

Over recent years there has been significant press about guarantors who escape their obligations under guarantees. This was generally on the basis that they were able to demonstrate to a court that they did not understand what they were doing when they gave the guarantee.

Lenders have learnt many lessons from those court cases and you should assume that any guarantee you sign will be enforceable and that any security given by a guarantor will be enforceable.

Lenders may require guarantors to get legal advice or financial advice or both. Lenders do this to reduce the risk of guarantors being able to escape their liabilities by claiming they did not understand the legal ramifications or the financial ramifications of giving the guarantee or giving any security in support of the guarantee.

Guarantors can also sue the debtor / borrower if the guarantor has been obliged to pay out under his or her guarantee.

WHAT INFORMATION SHOULD A GUARANTOR GET?

Before you sign the guarantee you should make sure that you receive from the lender:

  • a copy of the loan agreement that the debtor / borrower is to sign.
  • a document explaining the rights and obligations of a guarantor.

There are various new obligations of a Bank lender if the loan is to an individual or small business. These new obligations will apply from August 2003 when the new Code of Banking Practice takes effect. For example there must be a prominent notice on any guarantee of the fact that the guarantor should:

  1. seek independent legal and financial advice on the effect of the guarantee,
  2. the guarantor can refuse to enter into the guarantee, and
  3. there are financial risks involved with the giving of the guarantee and other matters.

The Bank lender is obliged to tell the guarantor about any notice of demand made by the Bank on the debtor and any excess overdrawing or dishonour in relation to any loan facility the debtor has or has had with the Bank.

UNDERSTAND THE NATURE OF THE DOCUMENTS

You should make sure that you have a clear understanding of what these documents do and what you are guaranteeing. Some of the things you should ascertain are:

  • Is the guarantee an all accounts guarantee or a guarantee limited to a specific transaction? An all accounts guarantee covers past and future, actual and contingent indebtedness of the debtor / borrower in his or her own right and as a guarantor.
  • Is the guarantee limited or unlimited in duration?
  • Is the liability of the guarantor limited to a certain amount, or is it unlimited?

UNDERSTAND THE TRANSACTION

Ensure that you are comfortable with the nature of the underlying transaction.

You should consider the overall desirability of the transaction, particularly if the guarantee is to be supported by a mortgage over your home or other assets. You should ascertain:

  1. the history of the debtor's / borrower's account with the lender;
  2. whether the debtor / borrower has been or is in default;
  3. the extent of any other securities held;
  4. the nature of the principal debtor's / borrower's business, how long it has been established and whether or not it is risky.

If you are concerned about these matters, you should have an accountant go through the books of the debtor / borrower.

UNDERSTAND THE CAPACITY IN WHICH YOU ARE SIGNING THE GUARANTEE.

Make sure that you understand the capacity in which you are signing the guarantee. If it is as director, is there a corporate benefit? Otherwise, there could be a breach of your duties as a director. If you are signing as a trustee of a trust, is the guarantee to be limited to the trust's assets? If not for the benefit of the trust, the trustee may lose its right of indemnity from the trust assets.

CAN YOU LIMIT YOUR GUARANTEE?

The short answer is yes.

You can specify to the lender that you will only go guarantor if you can limit your guarantee to a specified amount of money, and/or for a limited amount of time. However, bear in mind that the whole reason that the lender requires you as guarantor is because the debtor/borrower is not able to provide sufficient security for the loan on his or her own. If you limit your guarantee the lender may then refuse to loan the money to the debtor/borrower.

You should endeavour to limit your guarantee to the particular amount lent plus interest and recovery costs of that amount and exclude from your guarantee any further advances made later to the debtor/borrower.

WHAT IS AN "ALL ACCOUNTS" GUARANTEE?

An "all accounts" guarantee means that you guarantee all the money that is at any time owing by the debtor/borrower to the lender including money owing in relation to:

  • other loans;
  • guarantees that the debtor/borrower has given;
  • overdrafts;
  • credit cards;
  • chattel leases; and
  • any other monies owing.

Because it is a guarantee of money that may be owing at any time, an "all accounts" guarantee does include any further advances and loans made after the date that the guarantee was signed.

You should endeavour, where possible, to limit your guarantee to the particular amount that you have been asked to guarantee. Of course, the whole reason you are being asked to provide your guarantee may be because the lender feels that it is over-exposed to the debtor/borrower because of other loans. In that case, the lender may require an "all accounts" guarantee or refuse to loan the money to the debtor/borrower.

SECURED OR UNSECURED GUARANTEE?

The lender will tell you whether or not it requires your guarantee to be secured or unsecured.

An unsecured guarantee means that the lender does not require a mortgage over your property to make your guarantee more secure.

A secured guarantee means that the lender requires you to grant a mortgage over some of your property to secure your guarantee. This makes it easier for the lender in the event that the debtor/borrower defaults under the loan. The lender can sell up your property if you are unable to pay the debt.

Whether your guarantee will be secured or unsecured will depend on a number of factors such as:

  • whether the debtor/borrower is providing security for the loan
  • the credit risk of the debtor/borrower
  • your income/amount of assets.

If you provide an unsecured guarantee, your property is still at risk for payment of the debt. However, before the lender can use your property to recover the debt, the lender must get a court judgement against you.

WHAT HAPPENS IF THE DEBTOR / BORROWER DEFAULTS?

If the debtor / borrower fails to make any payment on time, the guarantor will be liable to remedy that failure, and that could involve the guarantor in payment to the lender of all amounts owed by the debtor / borrower to the lender including principal, interest, default interest and the lender's costs of rectifying the default. The lender can exercise its rights against the guarantor even if it has not pursued the debtor / borrower.

WHAT HAPPENS IF THE GUARANTOR FAILS TO REMEDY THE DEBTOR'S / BORROWER'S DEFAULT?

If the guarantor fails to remedy any failure by the debtor / borrower to comply with the terms and conditions of the loan in any way, including the obligation to pay principal, interest, default interest, or other charges, the lender can sue the guarantor personally, and can take possession of the guarantor's property secured to the lender and sell it to recover the amount owing together with interest and other costs, including solicitor's costs, the costs of selling the property and the costs of maintaining the property and, if the proceeds of sale of the guarantor's property are insufficient to satisfy the debt to the lender, the lender can sue the guarantor for the deficit.

SUING THE DEBTOR / BORROWER

If you pay out money for the debtor / borrower, you can try to sue the debtor / borrower to get your money back. But if the debtor / borrower could not repay the credit provider, he or she is unlikely to be able to repay you.

FURTHER INFORMATION

This Information Outline is provided courtesy of McKean & Park Lawyers & Consultants who are experienced in this area of law. They are located at 405 Little Bourke Street MELBOURNE VIC 3000 or call them on (03) 9670 8822 if you would like more information on the legal topic, or you wish to obtain formal advice regarding your situation.

McKean & Park was established in 1863 by James McKean and thrives today with 20 professionals specifically in all major areas of practice including Workplace Relations and Anti-Discrimination Law. The firm is proud of the fact that many of its Lawyers are accredited specialists approved by the Law Institute of Victoria. McKean & Park is committed to providing clients with comprehensive and innovative legal services delivered promptly in a professional and cost effective way.

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