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Guarantees form a fundamental part of many loan contracts; for most lenders, having one or more guarantors for the borrower’s obligations under the contract is essential, as it provides additional security for their loan. However, there are several issues to consider where a borrower defaults and you attempt to enforce the guarantee, especially in circumstances where you may only get payment from some guarantors, not all.
As a lender, you must be careful to ensure that a release of one guarantor doesn’t release them all. It is a common occurrence; a borrower under a loan agreement has defaulted and repayment is being sought from multiple guarantors. But what happens where some of the guarantors go bankrupt and cannot pay? Can you negotiate repayment from the others separately, without releasing all?
The law in this area is quite strict: any variation to an original loan agreement (where that variation is not unsubstantial or is prejudicial to the guarantor), made without the consent of all guarantors, can have the effect of releasing all. Variations can include extending the time the borrower has to pay, increasing the loan amount (even where the guarantor’s liability is limited to the original amount) or releasing a co-guarantor. In essence, if the deal changes, then you risk losing your guarantee.
So what are some strategies to mitigate this risk? It is critically important to draft the initial loan contract in relation to the guarantee properly, as this can have a great bearing on how matters pan out in the future.
To avoid the above risks, the guarantee should be drafted to provide for the following:
1.The guarantor acknowledges that the lender may act as though the guarantor was the principal debtor;
2.The guarantor waives all rights (such as the right of rescission) that they would usually hold as guarantor; and
3.The guarantor provides consent to future variations of the original agreement (though this does require some specification as to the variations that can occur).
However, we advise that even in circumstances where the agreement provides for all these, it is still best practice to obtain consent from all guarantors at the time of the variation, to ensure that the guarantee is not released.
It is of vital importance when drafting contracts containing guarantees that these potential issues are taken into account and provided for in the original agreement.
Mark Love, Legal Director, Business Law
9th Floor, Canberra House,
40 Marcus Clarke Street, Canberra ACT 2601
E: [email protected]
T: 02 62740810
www.ballawyers.com.au
