Challenging guarantees

This article was originally published by Pitmans LLP in 2014.

Personal guarantees given in the past to support corporate borrowing may well have been put in a drawer with no real expectation that they would ever again see the light of day. In these challenging economic times, however, more and more of them are being dusted down and used by lenders to recover unpaid debts. At this point the guarantee may be subject to a great deal more scrutiny than when it was given, with the guarantor (often a company owner / director) looking to avoid or reduce any liability and the lender conversely wanting to ensure that it maximises its recovery under the guarantee.

Guarantees are known to be technical documents, and this often leads guarantors who unexpectedly find themselves ‘on the hook’ to seek ever more inventive ways of avoiding or reducing liability. Conversely, over recent years lenders have been careful to plug at least the more obvious gaps through which a guarantor might otherwise try to wriggle.

So in what circumstances might a guarantee not be enforceable?

Is the guarantee valid?

First, the nature of the document should be examined. Is it in fact a guarantee, or is it an indemnity? A guarantee is a secondary obligation guaranteeing the obligations of another party (usually a borrower) and depends on that other having defaulted. An indemnity on the other hand is a free standing obligation not dependent on the borrower’s default but enforceable in its own right. Many documents nowadays will have been drafted to be a combined guarantee and indemnity.

The distinction can be very important because only guarantees and not indemnities are subject to the technical requirements of the Statute of Frauds 1677, non-compliance with which renders a guarantee unenforceable.

The main technical requirement for a guarantee to be valid is that it must be in writing and signed by the guarantor or a person authorised on the guarantor’s behalf. Reliance cannot therefore be placed on a verbal assurance that one party will ‘see another right’ or some such.

A guarantee is a contract and therefore must comply with the basic requirements of a contract including the need that there be ‘consideration’ for the promise – an issue frequently overcome by executing the guarantee as a deed.

Execution as a deed in itself gave rise to problems for the lender in the case of Bibby Financial Services Ltd v Magson and others (reported November 2011) as the guarantee fell foul of Section 1 of the Law of Property (Miscellaneous Provisions) Act 1989. This provides:

• ‘(3) An instrument is validly executed as a deed by an individual if, and only if:
  • it is signed;
    • by him in the presence of a witness who attests the signature; or
    • at his direction and in his presence and the presence of two witnesses who each attest the signature; and
    • it is delivered as a deed.’

It was this latter provision – delivery ‘as a deed’ – which caused the problem. The critical thing is that the person delivering the deed must show an intention to be bound by it – and something more than signing may be required. In this case, documents were produced for discussion in a pub. At a meeting in a pub on 27 August 2008, the guarantors had signed both a guarantee and a warranty, and their signatures had been witnessed. They contended that, although each had signed an unbound guarantee and an unbound warranty as a gesture of good faith, their expectation, in the light of discussions at the time of signature, was that clean versions of each guarantee and each warranty, incorporating as part of the typed text amendments to take account of their manuscript notations, would be produced and that revised forms would be signed afresh. Consequently the signed versions of the guarantees and the warranties had not been dated or delivered. The versions of the guarantees and the warranties relied upon by the lender were bound and did not have manuscript alterations. The court found on the facts that they had not been ‘delivered’ as required by law, and consequently were not enforceable.

A guarantee in standard form will be subject to a test of reasonableness under the Unfair Contract Terms Act 1977, thought he courts have made clear (for example in the 2008 case of Barclays Bank plc v Alfons Kufner) that many standard form clauses in contracts of guarantee will not be regarded as unreasonable as against experienced business people.

As with any contract, it is important to examine closely what has been agreed. As a matter of construction, does the guarantee actually cover the circumstances and claims which have arisen? If not, then the guarantor’s liability will not arise or will be reduced, even though the guarantee itself is valid.

Can the guarantee be discharged or avoided?

In certain circumstances, a guarantor’s obligations will be discharged; for example, if changes are made to the underlying agreement without the guarantor’s consent. (Note, however, that a term allowing such variation without having the effect of discharging the guarantee will be found in many standard forms.)

If the contract is induced by duress or undue influence, it may be set aside. This is one of the main reasons why lenders will insist that a guarantor obtains separate legal advice or at least attends a private meeting with the lender prior to giving a guarantee.

As in the case of any contract, a guarantee can be avoided in circumstances where a misrepresentation has been made to the guarantor. Further, whilst a lender is not under any general positive duty to disclose information to the guarantor, (including information it has about the debtor’s creditworthiness) circumstances can arise where the lender has a duty to disclose unusual facts not known to the guarantor.

In summary, very many considerations can affect a lender’s ability to make a recovery under a guarantee and it is worth both parties to the agreement having a very close look as soon as the guarantee looks likely to be invoked.

This is a very brief and general overview of some aspects of the law of guarantees and should not be relied on for advice in any particular situation.