Personal Guarantees

A guarantee is a promise to ensure that a third party fulfils its obligations and/or a promise to fulfil those obligations if that third party fails to do so. It is a contractual agreement that creates a secondary obligation to support a primary obligation of one party to another. For example, the secondary obligation may be to repay a loan made by a lender to a borrower. If that lender has doubts about the borrower’s ability to perform its primary obligation it may seek a guarantee.

Guarantees and indemnities are contracts and must conform to the basic requirements of a contract being:-

  • Offer;
  • Acceptance;
  • Intention to create legal relations;
  • Consideration.

Consideration for a guarantee or indemnity is subject to the general contractual principles (as stated above), therefore, the first two requirements are easily shown.

However, the Court of Appeal recently considered whether a binding offer to issue a guarantee had been made when it was offered by a bank as part of a wider transaction and other elements of the transaction did not complete. It was held that there was no obligation on the bank to issue the guarantee in those circumstances as the offer was conditional on the whole of the transaction going forward. The execution of the guarantee was no more than a step towards the completion of the whole transaction and must be regarded as being executed in escrow pending agreement on the other elements of the transaction.

In general contractual principles, past consideration is not valid consideration, and it is therefore not advisable to execute a guarantee after executing the underlying obligations (such as the loan agreement) because the underlying obligation will constitute consideration for the guarantee.

Consideration for a guarantee or indemnity can be problematic as the payment (usually) passes between the underlying obligor (borrower) and the beneficiary (lender) and not the guarantor. Guarantees are therefore often executed as deeds to overcome any argument about whether ‘good’ consideration has been given. If a guarantee is executed as a deed the guarantor will be bound from the date on which the deed is delivered.

For example, in the case of Holme v Brunskill it was established that if the guaranteed contract is altered without the guarantor’s consent, the guarantor will be released from the guarantee, unless it can be shown that the alternation was “unsubstantial”, or one which cannot be prejudicial to the guarantor. The judge’s view was that “the surety ought to be consulted” about amendments to the guaranteed contract and if they do not consent to the alternation, the guarantor will be discharged from the guarantee.

In respect of this, Chitty on Contracts advises that “in practice any well-drawn contract of suretyship will nowadays expressly permit variation of the obligations or the giving time, without discharging the surety”.

It would appear that all anyone can do is clearly set out how far a guarantee is intended to extend, and hope all eventualities are encapsulated. However, there is no certainty that drafting alone is sufficient.

It could be argued individuals who sign personal guarantees are more often than not commercially mindedbusiness people who make decisions andtake risks for a living i.e. directors. Thus they have a good understanding of enforcement and have carefully considered the consequences of being a guarantor. Therefore, it is advised that prospective guarantor’s seek comprehensive legal advice before signing a personal guarantee.