Signing a guarantee agreement? Think twice - International Law Office

Introduction
Pitfalls
Minimizing risk
A word of warning

Introduction

Sometimes a person is asked by a family member or friend to act as guarantor on a mortgage or personal or business loan from a bank or other lender. In such cases, the guarantor will be asked to sign a guarantee agreement (which may also be called a surety agreement).

A guarantee agreement is not a statement declaring that a guarantor is honourable and capable of repaying a loan; rather, it is a legal document that can cause financial hardship to a guarantor.

A lender usually requires a guarantee because it is unsure whether a borrower will be capable of repaying a loan. In such circumstances, the lender will not advance the loan without the comfort of a guarantor, who should be alert to the reason that the loan requires a guarantee agreement.

A guarantee agreement should be in writing and signed by the guarantor, but the borrower need not be a party to it. If the guarantee agreement is not expressed to be a deed, normal contractual rules apply and the lender should give a consideration to the guarantor in exchange for the guarantor's signature.

Pitfalls

A guarantee agreement is usually worded so that the guarantor is liable to the lender in the same way that the borrower is liable. In the event of borrower default, the lender may take action against the guarantor without first taking action against the borrower. Moreover, the guarantee is often worded so that the guarantor also agrees to pay the lender for any loss that the lender suffers by reason of the borrower's default. This is known as an indemnity and means that, in addition to the loan, the guarantor may have to repay the lender for any costs that the lender incurs in trying to collect from the borrower. Such costs might include court and attorneys' fees and the costs payable to a collection agent. Interest is also usually payable on the loan, costs and charges until the guarantor pays the lender.

If there is more than one guarantor, the lender is not obliged to require payment from all equally; rather, the lender can require payment from only one guarantor, or even all except one. However, a co-guarantor can demand fair payment from the other guarantors.

Certain legal presumptions can assist a guarantor. However, lenders are wise to these presumption and the wording in guarantee agreements usually specifically excludes them.

Minimizing risk

Although the safest option may be not to sign a guarantee agreement (particularly if there is no benefit to the guarantor from the loan), a potential guarantor can take steps to minimize the risk by (i) asking the borrower to save up a deposit first, so that the lender has alternative security, and (ii) considering what additional information the borrower can provide to the lender, so that the lender can reassess the need for a guarantee.

If a guarantor decides to sign a guarantee agreement, he or she can limit liability by:

• limiting the sum of money for which the guarantor is liable to a specific amount, to include all lender's interest, costs and other sums, and ensuring that he or she can afford to lose this sum;
• limiting the guarantee to a specific period within which a claim can be brought by the lender against the guarantor, so that he or she knows when they are free of a potential claim;
• ensuring that the lender is not permitted to give the borrower any allowances or remissions in time, or reductions in amounts;
• asking the lender for the right to terminate the guarantee agreement after a certain notice period (which is often four weeks);
• requiring that any variation to the terms of the loan be first approved by the guarantor; and
• getting impartial legal advice.

Obtaining legal advice is the most important step, as an attorney may be able to persuade the lender to change the wording of the guarantee agreement to make it fairer to the guarantor. The attorney advising the guarantor should not also be advising either the borrower or the lender.

A word of warning

Only once the guarantor pays the lender the guaranteed sum is he or she entitled to demand reimbursement from the borrower. This is because there is usually a restriction written into the guarantee agreement limiting the guarantor's exposure. However, a borrower in default may be unable to repay the guarantor. A guarantor must be aware that in a worst-case scenario, he or she could end up facing financial hardship or even bankruptcy.

For further information on this topic please contact Neil Molyneux at Appleby by telephone (+1 441 298 3245), fax (+1 441 298 3444) or email (nmolyneux@applebyglobal.com).