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Guarantors’ obligations
22/11/2005 The Star Articles of
Law with Bhag Singh
The word “guarantee” is one of the most commonly used words. And it is often
used very casually and loosely. The result is that sometimes it gives all
the protection and on other occasions very little or even none.
This may come about because of the words that are used in particular
situations. In other instances it is the legal interpretation that matters.
One area where guarantees are frequently encountered involves the granting
of loans and credit facilities. But this area is not the only area where
guarantees are relied upon. In the sale of goods and rendering of services
the word guarantee is also thrown around though its purpose can be somewhat
different.
Let us look at guarantees in the context of loans, credit facilities and
similar situations including a guarantee for a scholarship. The position of
a guarantor for a study loan would be just like that of a guarantor of any
other loan.
The object of a lender in obtaining a guarantee is to secure himself. Thus
if the borrower is unable to pay for any reason, he can make a claim from
the guarantor.
Many guarantors have the wrong perception of their obligation. Such people
tend to think that it is just a formality. At worst they think that they
will have to pay only if the borrower is unable to pay, which they think is
unlikely to happen.
In some cases where a person borrows money he may even have charged his land
or other property as security.
It therefore comes as a shock to many guarantors when the lender sues them
for the loan amount even though all the steps required to obtain payment
from the borrower have not been completed and sometimes not even embarked
on.
In many cases the borrower has not absconded and the property is charged.
The guarantor sees it as unfair that he should be pursued.
On the part of the lender, however, where it is a financial institution or
an organisation involved in systematic granting of credit or loans, the
approach and objective is different.
If the relevant clause in the guarantee is looked at, it will be seen that a
guarantor usually becomes liable as soon as the borrower defaults. Once a
demand is made and the borrower does not pay a default occurs.
When this happens the guarantor immediately becomes liable to pay. Legally
in normal cases the lender does not have to sue the borrower first or take
action to foreclose on the charged properties.
Of course this usually does not happen. To be fair to financial institutions
they often take action against the borrower as well as to foreclose on the
property with a view to realising the proceeds of the sale to recover the
loan.
In many cases they may even have obtained judgement against the borrower but
may have difficulty recovering the debt anyway. As regards property that is
charged there may be other difficulties like it may belong to a third party
and a challenge to the foreclosure may be made.
In other cases the order to sell the property may be made, but when the
property is offered for sale by auction or otherwise there may be no buyers.
Of course the lender cannot wait indefinitely until the property is sold.
The guarantor often views it differently. In fact the guarantor may have
unwittingly put himself in a position of being more than a guarantor when he
signed the guarantee. He may have agreed to indemnify the lender in addition
to being a guarantor.
The words “guarantee” and “indemnify” though ensuring that the guarantor
will pay if the borrower does not, have different implications.
Whereas a guarantee is dependent on the legal liability of the borrower,
liability under an indemnity arises purely out of non payment. The
difference between a guarantee and an indemnity has been discussed in detail
in an earlier article.
The only alternative for a guarantor is to insist on the lender exhausting
all steps against the borrower and have this requirement stipulated in the
guarantee agreement.
However, it is unlikely any financial institution or other organisation
would agree to such a provision. This is because usually they are in a
position to dictate the terms on which they will give the loan or grant
credit.
What then about the guarantor who has paid the debt of the borrower while
the borrower is still around and the security is still unattached?
And what about guarantees given for goods and services which are not
honoured? These will be discussed in future.
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