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A guarantee is a promise to answer 'for the debt, default or miscarriage of another', if that person fails to meet the obligation: Statute of Frauds 1677, s.4. Primary liability for the debt is incurred by the principal debtor. The guarantor incurs secondary liability, that is, the guarantor becomes liable only if the principal debtor fails to pay. If the principal debtor's liability to the bank is void, the guarantor will not be liable: Associated Japanese Bank (International) Ltd v Crédit du Nord SA .
A guarantee must be evidenced by a written note or memorandum signed by the guarantors or their agent. Without such written evidence, a guarantee is unenforceable. Bank guarantees are, of course, always written contracts.
In these two respects, a guarantee differs from an indemnity. An indemnity imposes direct or primary liability to pay and need not be evidenced in writing: Mountstephen v Lakeman .
Bank guarantee forms are, in fact, dual purpose documents. They operate as guarantees where the borrowing is enforceable against the principal debtor - the guarantor by definition incurring secondary liability - but as indemnities where it is not.
An unsupported guarantee is a very simple security to take - no registration is involved and no complications concerning proof of title arise.
A guarantee can easily and immediately be enforced by court action.
As with any other security given by a third party (collateral security), it can be ignored when claiming against the principal debtor.
As several parties can guarantee a loan, it is useful security where the principal debtor is unable to provide security but offers a viable business loan proposition.
Unless supported by a cash deposit or other security, a guarantee is always of an uncertain value as a security. A guarantor's financial position can change very quickly. An unsupported guarantee should only be accepted after careful investigation into the proposed guarantor's financial circumstances.
Court action may be necessary to realise the security and a technicality may defeat the bank's claim. For example, special rules apply to guarantees taken from partnerships and companies. A defeat of the ban's claim on a legal technicality would almost certainly be the result of carelessness when taking the security.
Enforcing a guarantee may cause bad feeling, particularly if the guarantor is a valued customer.
Litigation may be necessary to enforce payment where the guarantee was not supported by other (realisable) security.
Specific guarantee: the guarantor's liability to a particular transaction between the debtor and the bank is limited to a specific sum.
Continuing guarantees of a limited amount: the guarantor guarantees the debtor's liability to the bank for a specified sum, thus limiting his own liability. If possible, banks usually obtain a continuing guarantee.
The basis of undue influence
Ensure that the guarantor is not unduly influenced by the bank or, more likely, by the principal debtor, to sign the guarantee. If undue influence is proved, the guarantee may be set aside by the court: Davies v London and Provincial Marine Insurance Co. ; Lloyds Bank Ltd v Bundy ; Bank of Credit and Commerce International SA v Aboody ; Woodstead Finance Ltd v Petrou ; Goldsworthy v Brickell .
Proof of domination alone is not sufficient. The guarantor must also have suffered a real detriment as a result of executing the guarantee: National Westminster Bank plc v Morgan . The guarantee will not be set aside on the grounds of undue influence unless it can be proved that the transaction is to the manifest disadvantage of the person subject to undue influence.
Undue influence exerted directly
by a bank is rare. More usually, the principal debtor exerts it
and is deemed to be acting as the bank's agent in the transaction.
Problems are most likely
to occur where a wife guarantees her husband's borrowing or an elderly
parent that of their child. Although no undue influence is presumed
to exist in such relationships, it can be proved on the facts, e.g. where
the wife has neither an interest in, nor gains a benefit from, the transaction:
National Westminster Bank plc v Morgan . However, provided
the bank does not have actual or constructive notice that under influence
has been exerted, the guarantee will not be set aside: Midland
Bank plc v Perry . In the majority of cases undue influence
arises where, at the time of the transaction, a particular relationship
of confidence existed between the parties, thus giving rise to a presumption
of under influence: Tate v Williamson .
It is not advisable to ask the principal debtor to obtain the guarantor's signature. Apart from the obvious risk of forged signature(s), the debtor would almost certainly be deemed to act as the ban's agent and the bank would be responsible for any misrepresentation or undue influence which might be exerted: Avon Finance Co. Ltd v Bridger ; Kingsnorth Trust Ltd v Bell ; Coldunell Ltd v Gallon ; Bank of Baroda v Shah ; Midland Bank plc v Perry ; Midland Bank plc v Shephard ; Lloyds Bank plc v Egremont .
The possibility of direct undue influence by a bank arises here. In Lloyds Bank Ltd v Bundy , for example, the guarantor relied on the bank for financial advice, and the bank failed to avoid the conflict of interest that arose where it took security from its customer to secure the borrowing of another customer, Bundy's son.
The likelihood of the principal debtor being deemed to be the bank's agent is possibly increased where both the principal debtor and guarantor are customers of the bank.
A bank may breach its contractual duty to its customer by failing to explain the guarantee and/or insisting that independent legal advice is received, particularly where:
Because of experiences of
certain cases in the past, lenders take a cautious approach when handling
a guarantee given by a woman, especially when she guarantees her husband's
liabilities: Barclays Bank plc v O'Brien . A
woman may claim undue influence and this will invalidate her guarantee.
If she is a company director or has her own business interests, it is
unlikely for her to succeed in such a claim.
The terms of the guarantee must not be misrepresented to the customer. At law, misrepresentation entitles the party misled to avoid the contract, whether the misrepresentation was innocent, negligent or fraudulent.
A apparent misapprehension about the guarantee must be clarified by the bank, as failure to do so may amount to a breach of its contractual duty (if the guarantor is a customer) or misrepresentation: Lloyds Bank plc v Waterhouse ; Royal Bank of Scotland v Greenshields . Insistence on independent legal advice should avoid such problems: Barclays Bank plc v O'Brien ; Davies v London & Provincial Marine Insurance Co. . A bank is not under a duty to explain the terms of a guarantee to a guarantor who is not a customer of the bank: O'Hara v Allied Irish Banks Ltd .
A bank owes no duty to volunteer information about its customer which might influence a prospective guarantor: Cooper v National provincial Bank Ltd ; National Provincial Bank of England Ltd V Glanusk . The guarantors must make their own enquiries about the principal debtor. A duty does exist, however, to correct any obvious mistaken belief the guarantor holds about the principal debtor. This poses a problem, because correcting the belief would almost certainly be a breach of the duty of confidentiality. The correct course of action is therefore to obtain the customer's consent before making the disclosure, or arrange a meeting where questions can be put to the principal debtor directly by the guarantor. If the principal debtor fails to co-operate, the guarantee can be declined.
Guarantors may subsequently claim that they mistook the nature of the document signed: Saunders v Anglia Building Society . However, to avoid a guarantee on this ground, the guarantors must show that they acted without negligence. Thus, provided the guarantors understand the nature of the guarantee, signing the guarantee without reading it will not warrant it being set aside: Howatson v Webb .
The following points should be kept in mind.
The guarantor must be legally able to enter into the transaction, e.g. they must be an adult and not an undischarged bankrupt. A bankruptcy search at the Land Charges Registry can be made in this latter respect using form K16. This will reveal any petitions or bankruptcy inhibitions against the guarantor. Added protection is provided by the standard 'indemnity clause' which ensures that the guarantee is directly enforceable against the guarantor even if the borrowing is not. Under the Minors' Contracts Act 1987, a guarantee of a loan to a minor is enforceable even though the loan itself is not.
The guarantor should have adequate personal means to honour the guarantee when called upon to do so. It is preferable to obtain a joint and several guarantee, as this puts the bank in a stronger position against each of the guarantors if it has to enforce the guarantee (see 3.8.5). This is standard banking practice.
Obtain a status enquiry for
the full amount of the guarantee if the prospective guarantor is not a
customer of the bank. Make it clear on the form whether it is an
individual guarantee or a joint and several co-guarantee. In the
case of co-guarantors, a status enquiry for the amount should be made
against each co-guarantor.
There must be a sufficient margin for the value of security taken in support of the guarantee.
Consumer Credit Act 1974
If the lending is regulated by the Consumer Credit Act 1974, the guarantee must be executed in accordance with the requirement of the Act.
Accuracy of details
Obtain the name and address of the solicitor. If necessary conduct a status enquiry.
Explanation of the guarantee
Explain the principal clauses
of the guarantee to the guarantor to avoid the guarantor being under any
misapprehension. Take care not to misrepresent the contents.
Misrepresentation may arise where the bank voluntarily asumes the role
of giving advice: Redmond v Allied Irish Banks plc .
It is good practice to make a file note of the interview noting that the
principal clauses were explained and facts clarified. This is particularly
important where an awareness/freewill clause is to be signed confirming
that the guarantor was advised to take independent legal advice but the
offer was declined and the bank was prepared to accept this.
Ensure that the names of the principal debtor and guarantor are correctly spelt. Mark in pencil who is to sign the independent legal advice or freewill clause. Complete one form for each guarantor if there are co-guarantors.
Instructions for execution
Send the forms direct to the bank or solicitor. Do not release the guarantee to the principal debtor or to the guarantor to obtain the latter's signature.
The bank or solicitor should be instructed to:
Attest the guarantor's signature and sign an attestation clause to the effect that they have explained the terms of the guarantee to the guarantor.
Obtain the guarantor's signature
to the freewill clause, where the guarantor does not wish to obtain independent
legal advice before executing the guarantee. (The clause states
that the guarantor was given the opportunity to obtain legal advice before
executing the guarantee, but chose not to do so, having fully understood
the nature of the liability incurred under it.)
Date the guarantee with the date of execution.
Give a copy of the executed guarantee to each guarantor. In the case of Consumer Credit Act guarantees, the copy need not be given at the time of execution but must be sent within seven days of its execution. The surety is entitled to a copy of not only a guarantee but also of the regulated agreement and a copy of a statement later on (if he requests): s.107 Consumer Credit Act.
Post the executed guarantee direct to the bank.
After the guarantee is returned, check that it is signed by all the guarantors, dated, that all insertions are initialled, and that it is properly witnessed and attested.
A co-guarantee must be signed by all co-guarantors to be valid: National Provincial Bank Ltd v Brackenbury . Similarly, a forgery of one of the signatures renders the guarantee void: James Graham & Co. (Timber) Ltd v Southgate Sands .
A partner has no implied authority to give a guarantee in the firm's name. Thus, express written authority from all partners is required. In respect of partnership borrowing, ensure that the guarantee is conducive to the operation of the business. Do not take a guarantee from a partner for the firm's account as he is liable in any event.
Carry out a company search
and a mortgage register search to ensure that the company still exists
and that there are no adverse charges or entries which would affect the
Also ensure that giving the guarantee is to the commercial benefit of the company: Charterbridge Corporation Ltd v Lloyds Bank Ltd . (Again, it is probably prudent not to rely on the abolition of the ultra vires rule.) Extra care must be taken in this respect where an inter-company guarantee is proposed. Please note that different banks adopt different practices in relation to company objects clauses.
In Ford and Carter Ltd v Midland Bank Ltd , the problems of a short cut, in respect of mutual guarantees entered into by the companies when a bank lends to a group, were highlighted.
If directors have a personal
interest in the guarantee (Victors Ltd v Lingard , e.g. the
loan guaranteed is to be used to repay loans to the company from directors,
the resolution authorising the guarantee should be passed by a quorum
of independent directors.
Follow these steps:
Give the surety the opportunity to obtain legal advice.
Explain the terms and clauses of the guarantee to the guarantor.
Have the guarantee signed on the bank's premises.
Give a copy of the guarantee to the guarantor after it is signed.
In respect of a loan, give a copy of the loan agreement, if already signed by the principal debtor, to the guarantor. If it has not been signed, send a copy (signed on the bank's premises) to the guarantor within seven days.
In respect of an overdraft,
give a copy of the facility letter to the guarantor at the time the guarantee
is signed, or within seven days of the principal debtor signing the facility
If a status enquiry on the
guarantor was made, keep a copy with the guarantee.
If the principal requests an increased facility, it is better to obtain a new guarantee for the whole of the increased facility than to take a new guarantee for the additional facility. Where an unlimited guarantee was taken, the usual 'all monies' clause renders this legally unnecessary.
When the new guarantee is executed, the original guarantee can be placed with the cancelled papers, but do not mark it 'cancelled' just in case the bank needs to rely on it in the future (see page 39).
Deterioration in debtors' position or unacceptable conduct
If the bank is aware that
the debtor's position is deteriorating, e.g. where the overdraft facility
is funding gambling, a bank may consider it owes an ethical (not legal)
duty to protect the guarantor. A tripartite meeting can be arranged
between the guarantor, debtor and the bank, where the situation can be
discussed without the risk of breaching the duty of confidentiality.
Continuation of the account
This clause protects a bank
if, after determination of the guarantee, it fails to break the guarantor's
account and open a new account to prevent the rule in Clayton's
case  operating to its detriment.
Bank guarantees always include a statement of the consideration given by the bank, although this is not strictly necessary: United Dominions Trust Ltd v Beech . A guarantee by deed does not require any consideration.
The consideration is not stated to be a fixed amount, because the guarantee would then be ineffective if the bank does not lend the stated, fixed amount: Burton v Gray . Unless the guarantor has an authority to give consideration, it will not be considered as valid: Deutsche Bank AG v Ibrahim and others .
A guarantee of a non-operative account poses a problem, because if no further funds are lent and the account is not operated normally, the bank cannot prove that it allowed, say, the debtor time to pay or provided continuing facilities. Technically the consideration would be 'past' and therefore, at law, no consideration.
In such cases the bank should either:
refuse the guarantee; or make a demand on the debtor to repay (in response, the proposed guarantor can request the bank to give time to the debtor against the security of the guarantee); or have the guarantee executed as a deed.
Repayable on demand
By this clause the guarantors undertake that, on a written demand being made to them, they will discharge all monies and liabilities owing by the principal debtor to the bank.
The effect is that the six-year limitation period (Limitation Act 1980) in which the guarantee can be enforced does not begin to run until a formal demand for repayment is made. In respect of a guarantee by deed, the limitation period is 12 years.
This clause ensures that the guarantee covers the outstanding balance at any time and not the specific sum advanced. It thereby avoids the operation of the rule in Clayton's case  to the bank's detriment. Without this clause, every payment in would reduce the amount secured by the guarantee, while very payment out would constitute a new debt that would not be covered by the guarantee. If supporting security is held, this clause offers no protection against a subsequent mortgagee who gives notice to the bank: Deeley v Lloyds Bank Ltd .
All monies/whole debt
This makes the guarantor liable for the total amount owing, including all interest and costs, irrespective of the amount demanded. It is usual, however, for this clause to include a limit on the guarantor's actual liability to pay.
This clause is included because:
It prevents the guarantors
claiming a contribution from any co-guarantors where the guarantors
The guarantor loses the right to prove in the debtor's insolvency in competition with the bank: Re Sass .
It prevents the guarantor
suing the principal debtor for the amount paid to the bank under the
The guarantor is unable to
exercise the right of subrogation against a proportionate share of any
securities deposited in support of the guarantee by the principal debtor
or a third party.
This ensures that if the sums due cannot be recovered from the principal debtor because of their contractual incapacity or other legal limitation, the bank can recover the monies advanced directly from the guarantor as principal debtor, i.e. the guarantor incurs primary liability in such a case. This clause is useful when lending to a club, society or church. (Guarantees of loans to minors are enforceable by virtue of s. 2, Minors' Contracts Act 1987, even though the loan to the minor is not enforceable.)
Variation of terms
This clause gives the bank
power, without further consent from the guarantor and without affecting
the guarantors' liability under the guarantee:
Power to open a new account with the debtor notwithstanding the determination of the guarantee
Although the validity of a clause allowing the bank to continue the debtor's account after notice of determination by the guarantor was recognised in Westminster Bank Ltd v Cond , the usual practice is to break the account and open a new account for all future transactions.
A demand in writing has to
be made to the debtor before action can be taken to enforce the guarantee.
Problems can be encountered in proving to the court that the demand was
made before action to enforce the guarantee was taken, where the guarantor
does not acknowledge receipt of the bank's letters.
The guarantee may include a clause which makes the guarantor liable for any advance made within the limits of the guarantee during the period of notice for determination prescribed by the guarantee.
If the clause is omitted, the guarantor could repay the outstanding liability and have the guarantee cancelled, thereby not incurring liability for further advances made to the principal debtor during the period of notice: Coulhart v Clementson .
By a clause in the bank guarantee
forms, a guarantor agrees in advance to variation so that the guarantee
shall not be discharged if: extra time
after the due date for payment is given to the borrower, or the borrower
obtains the release of securities lodged with the bank or enters into
an arrangement with the bank to vary the terms of the advance or
compound the debt; and
Although this type of clause is valid it must be appropriately worded: National Bank of Nigeria Ltd v Oba M.S. Awelesi .
Security from the principal debtor
This clause prevents the guarantor from competing with the bank in the principal debtor's insolvency, by proving for sums paid under the guarantee in the insolvency, by taking security from them, or by suing them: Re Sass .
The guarantee is stated to be in addition to, and not in substitution for, any other guarantees for the borrowing. It protects the bank should the guarantor argue that a subsequent guarantee was given in substitution for the original.
Where an additional guarantee is required, the original guarantee should be cancelled and a fresh guarantee obtained for the full amount.
This clause is included to avoid the guarantor disputing the extent of the principal debtor's liability.
Under it the guarantor agrees to accept a written statement from the bank of the amount owing to the bank by the principal debtor as conclusive evidence of the debt: Bache & Co. (London) Ltd v Banque Vernes et Commerciale de Paris SA .
Change in the constitution of the parties
This clause avoids any problem
caused by the principal debtor (or the bank) changing its name, constitution
or amalgamating with another person; or through the insolvency, death
or dissolution of the principal debtor.
Notice of death
This clause prevents the
guarantee being determined by receipt of notice of the guarantor's death
and the personal representatives remain liable.
If the guarantor's estate is insufficient to cover the liability, or the bank does not wish to increase the liability, determine the guarantee by giving notice to the principal debtor.
Choice of law
Under this clause the guarantor agrees that the guarantee of the principal debtor's UK debts is made under English law, but that the guarantor will submit to alternative jurisdiction if the bank so requires. A receiver or manager of a company appointed in one part of the United Kingdom may exercise his powers in relation to property situated in any other part of the United Kingdom provided their exercise is not inconsistent with the law applicable there: Ford and Carter Ltd v Midland Bank Ltd .
Action against the principal debtor
By this clause the guarantors agree that they will be liable for the ultimate balance due to the bank from the principal debtor, and that they will not take any legal action against the principal debtor until any balance owing after the guarantee has been honoured, is repaid to the bank: Davies v Humphreys .
Joint and several liability
This applies where there are two more co-guarantors and it prevents any dispute about the nature of the liability. It is also advisable to include a clause stating that the release of a joint and several guarantor does not release the other(s) from liability: Mercantile Bank of Sydney v Taylor . Where a joint and several guarantee is worded to stipulate that the guarantee will be a continuing security until three months' written notice of determination is given by each of the co-guarantors, written notice by one co-guarantor will not be effective.
A clause is included which entitles the bank to hold a guarantee uncancelled for at least 24 months after the borrowing guaranteed has been repaid.
This avoids loss should any payment to the bank made in discharge or reduction of the principal debt be subsequently avoided as a preference, i.e. have to be repaid to the liquidator or trustee. (Twenty-four months is the maximum period in which a preference can be set aside.)
The clause also affords protection where a floating charge is taken from a company in substitution for a guarantee of the company's borrowing and this charge is invalidated by the insolvency of the company within 12 months of giving the charge.
Thus, to preserve the guarantor's liability, it is vital that the guarantee is not released or cancelled until the end of the specified period.
Charges and costs
A clause is included providing that any charges and costs incurred by the bank in enforcing the security can be recovered from the guarantor if they cannot be recovered from the principal debtor.
By this clause, the guarantor agrees to be liable as a primary debtor.
This clause protects the bank in cases where the principal debtor is not liable because of incapacity, thus making a guarantee void. In these cases the guarantor has direct liability to indemnify the bank for any loss it may incur.
Guarantee to remain the bank's property
Even though the borrowing originally guaranteed is repaid, an 'all monies', 'continuing security' guarantee remains enforceable until it is determined by notice in accordance with its terms.
As guarantors rarely determine their guarantees after the original borrowing is repaid, it is clearly in the bank's interest to retain ownership of the guarantee form because, subject only to the statutory limitation period after a demand is made, it operates as an open-ended security for any future indebtedness of the principal debtor.
Where the guarantee liability is in a foreign currency, this clause gives the bank the right to convert such liability to sterling.
A guarantee that contains this clause gives the bank a (contractual) lien on any securities, property, any account credit balances and items held in safe custody. (This is not a true lien because a lien arises by operation of law, not by agreement as here.)
Separate suspense account
This clause enables a bank to open a separate suspense account and pay into it any sums received, recovered or realised under the guarantee, without any obligation to appropriate (apply) those sums in reduction of the sums due or owing by the debtor.
To facilitate obtaining judgment against the guarantor, a clause can be included which:
renders admissible as evidence
of the amount outstanding any award or judgment obtained by the bank
against the debtor: Bache & Co (London) Ltd v Banque Vernes
et Commerciale de Paris SA ; and
Consumer Credit Act guarantees
If the facility given to
the debtor falls within the Consumer Credit Act 1974, a 'Guarantee and
indemnity subject to the Consumer Credit Act 1974' form must be executed.
This contains most of the standard guarantee clauses.
Realisation of security ban bank
A clause in the guarantee sometimes provides that (e.g. in cases where the bank holds security from the principal debtor and the guarantor) the bank can realise securities in such manner as it may deem fit. The guarantor then cannot claim that the bank did not act properly in realising the security at the time of selling the property, thereby increasing his liability. A clause may also state that the guarantee obtained is 'in addition to' and not 'in substitution of' any other guarantees held.
Bank guarantee forms are complex legal documents: additions, deletions or amendments must not be made to them without reference to the bank's legal department. Ill-considered changes may result in the guarantee proving to be unenforceable: Westminster Bank Ltd v Sassoon .
When a guarantor asks for the outstanding balance under his liability, the following information can be given:
Balance is less than the amount of the guarantee
Here the bank can disclose the actual balance but the guarantor should be reminded that this is the current balance.
Balance is greater than the amount of the guarantee
Inform the guarantor that the guarantee is being fully relied on; do not disclose the actual balance outstanding.
A credit balance exists
Inform the guarantor that the guarantee is currently not being relied on; do not disclose the actual credit balance.
If, on the basis of this information, the guarantor asks the bank to cancel the liability, remind the guarantor of the notice period for determination - usually one to three months - and that he/she would be liable for the outstanding debit balance at the date the notice period expires. If necessary, arrange a meeting with the debtor and guarantor to discuss the account; additional security can be requested.
If the customer confirms that the overdraft facility will not be utilised and that the account will be maintained in credit in future, the bank can cancel the guarantee if it considers that it will not need to rely on it.
If, however, the customer confirms that the guarantee is being relied on, e.g. to fund future business, ask the guarantor to give written notice to determine the guarantee on the expiry date. Subsequently advise the guarantor of the liability if the borrowing has to be recovered from them.
In this latter case, stop the customer's account and open a new account which must be maintained in credit or appropriately secured.
Do not disclose information or action taken by the bank against co-guarantors.
Copies of cheques or account statements
Such requests must be refused because of the bank's duty of confidentiality: Tournier v National Provincial & Union Bank of England (1924). If possible, however, discover the reason for the enquiry.
Consumer Credit Act guarantees
The Consumer Credit Act 1974, s.107 gives the guarantor of a loan or overdraft regulated by the Act a statutory right (on payment of a small fee) to a statement of the principal debtor's account.
Demand by the bank
The following actions should be taken:
If the debtor's account as been conducted unsatisfactorily, first make a demand for repayment against the debtor. Stop the account to prevent the rule in Clayton's case (1816) operating to the bank's detriment.
If the debtor does not pay, make a demand against the guarantor.
If the guarantee is unlimited, the total amount outstanding at the date of the demand, including all costs and interest, can be demanded.
If the guarantee was a joint and several co-guarantee, demand the full amount from each co-guarantor.
The demand must be made in accordance with the terms of the guarantee to the guarantor's last known address.
Do not allow any debit transactions on the account(s) secured after a demand has been made.
If the guarantor makes a payment which is less than the total outstanding balance, credit the payment to a separate suspense account or securities realised account. Should the debtor prove to be insolvent, this action preserves the bank's right to claim the full amount outstanding in the insolvency.
If the guarantor makes full repayment, credit the debtor's account to adjust the debt.
Notice by the guarantor
The guarantor can determine his guarantee by giving notice in writing (usually three months). The following actions should be taken:
Acknowledge the notice in writing, draw the guarantor's attention to the notice period stated in the guarantee (one to three months) and advise the guarantor that he or she will be liable for the debt outstanding at the date the notice expires.
Arrange a meeting with the borrower and guarantor to discuss how the account will be conducted during the notice period.
Continue to rely on the guarantee up to the end of the notice period.
Make a diary note of the date of expiry of the notice so that the debtor's account can be stopped.
Decide whether further securities from the debtor should be requested or whether demand on the debtor should be made so that the guarantor's liability is fixed before the notice expires.
After the guarantor has given notice to determine the guarantee, the guarantor can ask the principal debtor to pay even if the bank has not made formal demand for repayment: Thomas v Nottingham Incorporated Football Club Ltd (1972). This is an example of equitable right of exoneration.
If the guarantor makes payments during the notice period, credit them to a separate suspense or securities realised account.
In the case of a limited guarantee, a full payment by the guarantor during the notice period should still be placed in a suspense account to preserve the bank's rights against the debtor. (If the guarantor pays the liabilities in full, all securities held by the bank for the account guaranteed (both direct and third party securities) can be transferred to the guarantor. However, if requested to do so, first refer to head office. Do not release the guarantee, but confirm in writing that there is no immediate liability on the account).
If during the notice period, the guarantor informs the bank that he or she is aware that the debtor is increasing the debt, with the guarantor's consent, make a demand on the debtor in order to fix the guarantor's liability. If the debtor fails to respond, make a demand against the guarantor.
At the end of the notice period, stop the account and open a new account if the bank has agreed to continue to lend without the security of the guarantee, although the bank will be protected if it fails to stop the account because of inclusion of a clause in the guarantee: Westminster Bank Ltd v Cond (1940).
Notice by one co-guarantor
The guarantee will allow
the bank to release one co-guarantor or depositor of security without
affecting its rights against the others. Thus, there is no need
to break the account.
Take a fresh joint and several guarantee from the remaining guarantors for the continuing account if they agree to apportion the debt. Take a fresh independent guarantee from the guarantor who has given notice for the amount for which they are liable. Upon the expiration of the notice, the guarantor giving notice can be held liable for the whole debt unless the other co-guarantors agree to apportion the debt.
If one or more co-guarantors give notice to determine a proportion of the liability, remind the guarantor(s) that the guarantee cannot be released until the whole liability is repaid.
Although the guarantee provides that it remains effective against remaining co-guarantors, it is advisable not to cancel the liability of a co-guarantor making part payment, because at common law cancellation of their liability would discharge the other co-guarantors.
Change in the constitution of a partnership
Unless expressly agreed otherwise, a guarantee from a partnership will be determined on its dissolution, or where partner retires or joins. A new partner will not be bound by the existing guarantee and a new guarantee must be executed. Partners remain personally liable, of course, for existing partnership borrowing. (Note: Bank guarantees provide that a change in the constitution of the bank or the debtor will not determine the guarantee.)
Notice of death
On the death of a sole guarantor, the deceased's personal representatives remain liable. The bank should either:
- Write to the personal representatives stating the guarantee liability and explaining the determination procedure and the notice period if it wants to continue to rely on the guarantee;
- Stop the debtor's account and call up the guarantee if the guarantor's estate is not substantial or where it wishes to protect the estate from further liability.
If the personal representatives give notice of determination, consider whether to ask for additional security from the debtor of whether to make a demand on the debtor to fix the guarantor's liability.
Co-guarantor with joint and several liability
Bank guarantees invariably impose joint and several liability on co-guarantors. Joint and several liability:
enables the bank to exercise
the right to combine a credit balance on a co-guarantor's individual account
with his/her liability under the guarantee; and
Neither would apply if the
guarantee imposed only joint liability. Depending on the terms of
the guarantee, it make not be necessary to break the account. It
is not necessary to do so where:
Egbert v National Crown Bank (1918).
If the guarantee does not contain such a clause:
break the debtor's account and pass all future transactions through a new account in order to preserve the liability of the deceased guarantor's estate;
contact the deceased guarantor's personal representatives so that the estate is not distributed.
Unless otherwise agreed, notice of the principal debtor's death determines the guarantee, because a guarantor does not promise to be liable for the debts incurred by the debtor's personal representatives.
Break the debtor's account and pass all further entries through a new account. This must be kept in credit or appropriately secured.
Notice of the guarantors' mental incapacity
Break the account and make demand on the principal debtor.
The other co-guarantors remain liable by virtue of the joint and several liability clause. Thus, there is no need to break the account. Do not make further advances.
Release of the debtor
Do not release the debtor from his or her obligation as this will discharge the guarantor's liability: Perry v National Provincial Bank of England Ltd (1910). The legal reasoning is a little complex. Merely agreeing not to sue the debtor does not discharge the guarantee as the debt still exists. If, however, the release is in return for 'value' (consideration), e.g. part repayment, this amounts to an 'accord and satisfaction' which discharges the debtor's debt and therefore means that there no longer is a debt to guarantee.
Death, mental incapacity or insolvency of the principal debtor
The following actions should be taken:
Stop the debtor's account on receipt of notice of any of the above events and open a new account.
Advise the guarantor and make demand on them.
Place any credits received from the guarantor to a separate securities realised account.
Bankruptcy of the guarantor
The following actions should be taken:
Stop the debtor's account and make demand on the debtor.
Prove in the guarantor's bankruptcy for the outstanding debt or for the amount of the guarantee, whichever is the smaller.
Place all payments received from the debtor's trustee in bankruptcy to a separate account in order to preserve the bank's right of proof against the debtor for the full amount of the outstanding debt.
Joint and several guarantors
The following actions should be taken:
Follow the steps above for a sole guarantor.
Obtain a new guarantee signed by the remaining solvent guarantors if no proof is made against the bankrupt guarantor.
Repayment by the Principal Debtor
A guarantee taken to secure specific lending, i.e. one which does not cover future facilities, can be cancelled upon repayment of the debt by the principal debtor.
If the guarantee is to cover regular borrowing and is expressed to be a continuing security for past and future liabilities, it must not be cancelled.
A letter may, however, be sent confirming that monies have been received but retaining the bank's rights under the guarantee.
Retention of the Guarantee and Subsequent Position
Retention of the guarantee
Do not hand over the guarantee or write 'cancelled' across it when a guarantor pays the full amount of the outstanding debt. This enables the bank to rely on the guarantee in the future should it have to. For example, if (unusual) payments into the debtor's account are made and the debtor subsequently becomes insolvent, these may be set aside as preferences. Retaining the guarantee enables the bank to claim under the guarantee for any sums which are held to be preferences, and which it therefore has to repay, as well as the outstanding balance.
A guarantor has the right
of subrogation and the right to assume the position of the bank against
the debtor, where the guarantor pays the total outstanding debt.
For example, the guarantor has the right to take over all securities lodged
by the debtor with the bank.
Obtain the written authority of the guarantor(s) making repayment for the release of security held.
A co-guarantor repaying the
debt in full has a right of contribution from the other co-guarantors
which can be exercised over any security deposited by them.
Realisation of debtor's securities
Ensure that the true market price is obtained. Failure to do so renders the bank liable to the guarantor to the extent of the guarantor's resulting additional liability: Standard Chartered Bank v Walker and Walker (1982).
Make a record when the guarantee is paid, discharged or the limit cancelled, and place the guarantee with the cancelled papers. Only mark the guarantee 'cancelled' if it is certain that the bank will not wish to rely on it in the future.
Enforcing a Guarantee
Once a bank has enforced its security, it does owe a duty both to the mortgagor and to guarantors of the mortgage debt to exercise reasonable care when it sells the property:
Standard Chartered Bank v Walker and Walker (1982); China and South Sea Bank Ltd v Tan Soon Gin (1990).
The guarantor who pays off all the liabilities of the borrower is entitled to the right of subrogation. A demand in writing should be made on the principal debtor first to repay his liabilities. If the debtor fails to pay, make demand in writing to the guarantor at the address for service given in the guarantee and at the last known address.
Where a fixed sum guarantee is held as a security comply as follows:
If the customer's liability (including interest) exceeds the amount of guarantee, make demand for the total amount of the guarantee plus interest.
If the customer's liability is less than the amount of the guarantee given as security, make a demand for the outstanding amount owed plus interest, quoting a daily rate of accrual of interest applicable until payment is made.
If the bank has received
a notice of determination of the guarantee, acknowledge the notice, advising
the guarantor that the bank will calculate his liability at the expiry
of the notice period.
If the guarantor Pays the
customer's entire indebtedness, it is advisable to place the payment received
to a suspense account, if a likely claim for preference is anticipated.
If the guarantors pay their proportions separately, place the payment in a suspense account to preserve the bank's claim against the borrower and against each guarantor.
Letters of Comfort
Letters of comfort are given
to a bank by a parent company in respect of a facility to its subsidiary
or associated company. While falling short of a guarantee, they
are intended to give some comfort to the lenders that the subsidiary or
associate will be kept in a reasonably good financial state so that they
can perform their obligations to the bank.
A comfort letter will be presumed to be legally binding if its wordings include a contractual promise or warranty (i.e. a confirmation as to the present and future), although the absence of promise or warranty as to the future does not rule out the possibility of the comfort letter being binding.
A comfort letter may be binding in part but not in whole.
If a bank wants to rely on a letter of comfort as legally binding, it must make sure that the wordings include a promise or warranty for the future conduct of the party giving it. A clear intention to bind would constitute a legally binding promise: Chemco Leasing S.p.A. v Rediffusion Ltd (1987).
NCs commented on the incorporation of the Standby Credit into the UCP 400 and its retention in UCP 500. It was agreed unanimously that the Standby Credit is not to be merged with the bank guarantee rules regulated by the ICC's Uniform Rules for Demand Guarantees (URDG), ICC Publications No. 458. While the Standby Credit is, from a legal viewpoint, equal to the demand guarantee, there are important differences between the two. The Standby Credit has developed into an all-purpose financial support instrument embracing a much wider range of uses than the normal demand guarantee. For this reason, and since the UCP is the most suitable and compatible set of rules with the basic character of the Standby Credit, the link between the Standby Credit and UCP was maintained.
NCs commented on the possibility of the identifying the individual Articles applicable to the Standby Credit. It was decided that this request could not be met. NCs must acknowledge that not all the Articles in the UCP apply to a Commercial Credit or to a Standby Credit and that the majority of the Articles do not apply to the Standby Credit. It is recognized that the parties to the Credit may wish to exclude certain Articles of the UCP from a specific type of Credit. If such is their desire, they should state this clearly in the terms and conditions of the Commercial Credit or the Standby Credit.
The documentary credit specialist should note the reference made to Uniform Rules for Demand Guarantees (URDG) ICC publication No. 458 and to the difference between the standby credit and the normal demand guarantee. Nevertheless it is not easy to distinguish standby letters of credit from demand guarantees or even the traditional commercial documentary credit. The documentary credit specialist should check the credit/guarantee instrument to ascertain the exact set of international rules under which the instrument is issued.
The ICC has adopted the International Standby Practices (ISP 98) as separate rules for standby letters of credit.
Recommended further reading: