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June 2003

Should I act as a Guarantor?

Beware Of The Significant Risks Involved

What is a Guarantor?

A Guarantor is a person who gives a promise or ‘Guarantee’ to a creditor or lender to be answerable for the debt or obligation of another (the principal debtor or borrower) if that other defaults.

Most guarantees provide that the creditor can call on the guarantor to pay the debt in full (if it is due) without requiring payment from the borrower and without exhausting the creditor’s remedies against the borrower or any securities given by the borrower.

Financial Position of Borrower

Because a guarantee exposes a guarantor to potential liability for another person’s debt without any direct benefit, logically nobody should give a guarantee. In practice however, the guarantor’s decision to give a guarantee is determined by weighing up the following:

1. What is the borrower’s ability to service and repay the loan?
2. What is the creditworthiness of the borrower?
3. What is the risk?
4. What is the likelihood of the debt being called up?

Your Obligations as Guarantor

If you choose to give a guarantee the following provides a summary of provisions frequently contained in standard guarantee documents:

  • Most guarantees are “All Obligations” guarantees, i.e. the guarantor is liable for all the principal debtor’s obligations to the creditor and are not limited to the particular transaction which gave rise to the request for the guarantee. The guarantor’s liability also extends to all debts that the principal debtor already owes to the creditor.
  • If the principal debtor has given the creditor a guarantee (i.e. is acting as a Guarantor) for yet another person or company, the guarantor will be liable for all claims against the principal debtor by the creditor relating to the other person or company.
  • If a guarantee is not limited in amount then it is unlimited.
  • The creditor may make a demand on and bring court proceedings directly against the guarantor without bringing proceedings or making any demand against the principal debtor or any co-guarantor. In other words the creditor can choose the target - or which target he fires at first.
  • If the creditor’s claim against the principal debtor is void or unenforceable, the creditor may still have a claim against the guarantor.
  • Where there are co-guarantors, the liability of each co-guarantor is joint and several so that each co-guarantor will be individually liable to the creditor for the whole of the guaranteed obligations.

Limited Guarantees

Many lenders expect unlimited guarantees where a limited guarantee would suffice. For instance, a borrower may fall short on available security for a lender by only a relatively small amount and the guarantee should be limited to the amount of such shortfall. If the lender requests more, you should require an explanation from the lender justifying the need for more.

Conclusions

In considering whether to act as a guarantor for a person or party other than your own company or your own family trust, our strong view is that you should never guarantee payment for more than you can afford and should never put your home or assets at risk. Seek our advice first.