Banks are increasingly likely to require personal guarantees for some of their loans, particularly if they are making loans to small to medium sized companies, or family trusts.
We are finding some confusion in the marketplace. Most clients have heard of guarantees and know roughly what they mean, but aren’t aware of their finer points. Some of those finer points can be important if anything goes wrong.
A guarantor is a person who gives a promise to repay the debt of a borrower. By agreeing to pay a debt the guarantor has made a guarantee to the institution or person lending the funds (“lender”). Frequently when someone gives a guarantee they are also giving an indemnity. An indemnity is a contractual promise to accept liability for any loss by the lender that is accumulated in the process of the recovery of a debt.
There are different types of guarantees: unlimited, limited, unsecured or secured. An unlimited guarantee generally gives the lender an ability to demand the guarantor repays all monies owing, whereas a limited guarantee has an agreed amount payable by the guarantor. An unsecured guarantee is not attached to any particular asset of the guarantor. In contrast, a secured guarantee grants security over a specific asset owned by the guarantor, e.g., their house.
Personal guarantees are becoming more common in the parent-child scenario. However, the parents sometimes underestimate the extent of the risk they assume when signing a guarantee. Regularly, the guaranteed loan represents a large portion of the parents’ assets and therefore may have significant consequences on the parents’ current and future living standards if the lender demands payment of the debt. It is important to note that a personal guarantee is not for a specific timeframe. Therefore, the guarantor may be liable for any current loans, future financing or credit card debts.
Guarantees are legally binding documents and are enforceable through the courts. Extinguishing the obligations under a guarantee can be difficult as the parties must adhere to the terms and conditions of the guarantee. Guarantors may request the lender to release them from their liability under the guarantee; however, it is the lenders’ decision to release a Guarantor from their obligations under the guarantee.
In the case Tait-Jamieson v Cardrona, Mr Tait gave a personal guarantee for the debt owed by a local organisation to Cardrona Ski Resort (“Cardrona”), however, did not sign the written guarantee prepared. When Mr Tait realised that he had not signed the guarantee he conveyed to Cardrona in verbal and written form that regardless of him not signing the guarantee he would underwrite the debt. Cardrona subsequently demanded payment of the debt from the guarantors. Mr Tait stated that the guarantee was not enforceable against him as he did not sign the written guarantee. However, the court held that Mr Tait had adequately expressed his intention to be contractually bound by the guarantee by his previous verbal and written correspondence and therefore must honour his obligations under the guarantee.
Tait-Jamieson v Cardrona demonstrates that once a person sufficiently expresses an intention to be bound by a guarantee, the guarantee is likely to be enforceable. However, in New Zealand, lenders who offer guarantees must also adhere to the responsible lending laws of the Credit Contracts and Consumer Finance Act 2003. These state that lenders must ensure a borrower, or guarantor, is likely to be able to make repayments towards the debt without suffering substantial hardship. This legislation was applied to the case of a pensioner who agreed to guarantee his son’s loan of $2,000.00. His son defaulted on the weekly payments immediately. The lender demanded the repayments from the pensioner which would have left a residue of $25.25 of his pension payment per week. The case was heard by Financial Services Complaints Limited which found that the pensioner was not a suitable guarantor and that the lender had breached their duties under the responsible lending laws. The judgement resulted in the lender discharging the pensioner’s liability under the guarantee.
While guarantees are frequently enforceable, there is an expectation that lenders will act responsibly when assessing the viability of a guarantor.
Finally, below are some considerations to contemplate before becoming a guarantor:
1. Receive independent legal advice;
2. Make sure you understand the wording of the written guarantee;
3. Be aware that the lender does not have to pursue the borrower “to the ends of the earth” before turning to the guarantor for repayment of the debt; and
4. If possible, engage in a limited guarantee to try and minimise any potential risk.
If we at Gaze Burt can assist you in any way with your decision on becoming a guarantor, please give us a call.