Introduction:
Guarantee is defined as “a promise to answer for the debt, default or miscarriage of another”. “Contract of guarantee” is collateral undertaking to be liable for the default of another. The person who gives the guarantee is called “surety”, the person in respect of whose default the guarantee is given is called “principle debtor” and the person to whom the guarantee is called the “creditor”. When Liability is where a person does or delivers something to another without intending to do so gratuitously, he is entitled to receive compensation for the thing or restoration of the thing delivered if the other party has enjoyed the benefit of the thing done or delivered. It is of the essence of a guarantee that there should be someone liable as a principle debtor and the surety undertakes to be liable on his default. When a contract is formed between the parties, the principle debtor and the creditor have the essence of a surety or have someone liable as a surety of the transaction.
Guarantee
In the eyes of Law, a contract of guarantee has always been a solemn undertaking. Guarantor’s seldom derive any benefit, yet they can incur substantial liabilities through their suretyship. Whilst the common law was generally sympathetic to guarantors, it did not demand that the contract of guarantee be in writing. A guarantee is not a representation that the principle debtor is credit-worthy. The main and immediate object of the transaction must be that the guarantors, or their property, will be answerable to the creditor[1]. The liability of the guarantor is secondary or auxiliary in the sense that it is in addition to the primary liability of the principal debtor but does not prevent the creditor from enforcing the guarantee before instituting proceedings against the principal debtor[2]. The guarantor’s liability is secondary or accessory in the sense that it is contingent upon the principal debtor’s continuing liability and, ultimately, the debtor’s default[3].
Statute of Fraud, 1677
The principle object of the Statute of Fraud 1677 was to prevent fraud and perjury by withdrawing the right to sue on a certain agreement if they could only be established by oral evidence[4]. By requiring a guarantee to be proved by objective written evidence, the statute reduced the risk of ‘False claim’ would be accepted. The statute reflected the legislature’s concern that certain contracts might be established by ‘false evidence or by evidence of loose talk’ when it was never meant to make such a contract[5].
Suretyship
A contract of suretyship is in essence a contract by which one person (the surety) agrees to answer for some liability of another (the principle debtor) to the third person (the creditor). A contract of suretyship is formed, like any other contract, by offer and acceptance, supported by consideration. Suretyship as a contract may be constituted by a personal engagement on the part of surety, or by a charge on the property without any personal liability, or by both[6]. Prima Facie a surety does not merely undertake to perform if the principal debtor fails to do so, he undertakes to see that the principle debtor fails will perform[7]. Surety’s Liability is the liability of the surety is co-extensive with that of the principle debtor, unless it is otherwise provided by the contract[8]. The surety’s liability must not be different in kind or greater in extent than of the principle debtor[9], and there must be no liability imposed on the surety apart from the promise to answer the debt[10]. Types of scenarios in suretyships are discussed below.
Parties to the contract
In Duncan, Fox & Co v North and south wales Bank[11], Lord Selborne identified three classified situations of suretyship. In the first, there is an agreement to constitute the relationship of principal and surety for a particular purpose, and the creditor thereby secured is a party to this agreement in the sense that the creditor and the principal debtor agree from the outset that the surety’s liability is merely secondary and that the primary liability rests with the principle debtor[12]. In instances, like a mortgage, to which the creditor, the principal debtor, and the surety are all one party, the liability of a principle debtor and the surety may be joint or joint and several. Alternatively, the creditor’s acceptance of the surety’s secondary liability may be signified in a separate instrument to which the principle debtor is not a party. This is by far the most common form of suretyship.
In the second situation, there is an agreement between two co-debtors that one will assume the primary liability as principal debtor and the other will undertake the secondary liability as a guarantor. To this contract of suretyship, the creditor is a stranger. In the absence of notice of this arrangement, the creditor is entitled to treat both co-debtors as principle debtors since there is no contract of suretyship between the creditor and the guarantor. As between the co-debtors, one is guarantors for the other and, under the contract of suretyship, the guarantor will have a right of indemnity against the primary debtor, prima facie entitling it to full recovery for the money paid in discharge of the obligation. A similar type of suretyship can be implied from an agreement by continuing partners to indemnify a retiring partner against and past or future debts or liabilities incurred in the business. Whether or not such a contract of suretyship exists may be a complex question of construction.
Contract of Suretyship as against Principle Debtor
It is by no means unusual for a party to a contract to be principle debtor as against the creditor, but a surety as against another debtor. Such an arrangement is entered to avoid the technical rules of suretyship. In such an event, the transaction takes place according to the terms of the contract, that is to say, there will be no contract of suretyship between the principal debtor and the surety, but there will be no contract of suretyship between the surety and the creditor.
Creditor knows or later discovers that not principal but surety
The mere fact that two parties have, on the face of some written document or instrument, apparently constructed as joint debtors does not preclude the possibility that one of the debtors is, in fact, a surety: it is still open to one of the debtors to prove by parol evidence that the creditor knew that the intention of the debtors was that one should be a surety and not principal debtor[13]. Thus, it has been held that an agreement expressly declaring a party to be liable “as a primary obligor and not merely a surety” does not prevent that party from being surety for the purpose of determining the effect of the voidness of the main agreement.
Contract of Suretyship as against the creditor alone
A guarantee is entered into at the request, express or implied, of the principle debtor, and this suffices to create a contract of suretyship as against him, but the contract may not be entered into at his request at all. It often happens that a surety guarantees a loan made to a company at the request of the company’s parent or holding company, and the company-debtor may not itself be in a contractual relationship with the surety.
1. Grounds of Vitiation of the contract in terms of Suretyship
- Mistake – When the parties of the contract are under undue influence and are not aware of the hidden facts of the scenario of the initial terms of the agreement.
- Non est Factum- This ground of vitiation arises when a person who is incapable of entering into the contract for eg. Disability signs documents believing it to be essentially different from that which he has in fact signed, as long as he commits no negligence in so doing[14]. etc
2. Effects on surety of Vitiation of the transaction Guaranteed
- Incapacity of Principle debtor: Minor: Surety who has undertaken to meet a liability which was void as against the principle debtor on account of the latter’s minority, was himself liable was said to depend on whether the contract was a guarantee or an indemnity. If he had merely guarantee the liability, it was held that he could not be liable because there was no default by the minor in not meeting the liability, and the surety could not be called upon to meet his liability unless there was such default[15].
- Other invalidating cause: Where the transaction guaranteed by the surety is affected by some other invalidating causes like Fraud, Misrepresentation
Case Laws
In Berghoff Trading Ltd v Swimbook developments Ltd[16] a short-term load was granted to facilitate the sale of the interests of partners in a joint venture company. Under the loan agreement, inter alia, between the lender, the partner, and the joint venture company, the latter was described as the “borrower”. Each partner was defined as a guarantor but also as an “obligor” (being jointly and severally liable with the borrower). There was a “principle debtor” clause whereby the guarantor agreed to pay “as if they were the primary obligators” (in Cl. 19)[17]. It was considered by Lord Justice Rix that, as between the partners and the joint venture company, the other provisions including the “principle debtor” clause, might not have been sufficient to neglect the partners’ secondary status[18]. There was therefore some acceptance of the argument that the form of the principle debtor clause, emphasizing that the guarantors agreed to pay “as if they were principle debtors”, was in fact a recognition that they were not for all-purpose principle debtors, but only secondary obligators[19].
In Moschi v lep air services Ltd, Lord Diplock expressed the view that the nature of the guarantor’s obligation was “to see to it that the debtor performed his own obligations to the creditor”[20]. The guarantor’s undertaking to answer for the debt, default, or miscarriage of another within the Statute of Frauds can be applied to non-contractual liabilities of the principle debtor[21]. The distinctive feature of a contract of guarantee is the secondary obligation which is assumed by the surety or guarantor[22].
Many of the cases which have explored the nature of the guarantor’s secondary obligation are more concerned with the guarantor’s secondary obligation with the question of whether the guarantor’s promise falls within the Statute of Frauds.
Conclusion
Suretyship is a secondary obligation in a transaction of money or any goods between a Principle debtor (single or several) and creditor (single or several). Suretyship is necessary or recommended in a transaction because it gives the creditor a surety that the lended item is going to be returned one way or the other.
References:
[1] McPherson v Forlong [1928]3 W.W.R 45
[2] Mallett v Bateman [1865]16 CB (NS) 530 at 543
[3] Guild & co v Conrad [1894]2 Q.B 885 at 896
[4] Hoyle v Hoyle [1893]1 Ch. 84 at 98
[5] Steele v M’kinlay [1880] 5 App. Cas 754 at 768
[6] Smith v Wood [1929]1 Ch. 14
[7] Moschi v Lep Air Services Ltd [1973] A.C 331
[8] Indian Contract Act, 1872 §128
[9] Direct Acceptance Finance Ltd v Cumberland Furnishing Pty Ltd [1965] N.S.W.R 1504 at 1510
[10] Coady v J Lewis & Sons Ltd [1915]3 D.L.R 845 at 847
[11] (1880) 6 App. Cas. 1
[12] Duncan, Fox & Co v North and South Wales Bank
[13] Mutual Loan Funds Association v Sudlow [1858] 5 C.B. (N.S) 449
[14] O’Brien V Australia and New Zealand Bank Ltd [1971] 5 S.A.S.R. 347
[15] Coutts & Co v Browne- Lecky [1947] K.B. 104
[16] [2009] EWCS 413
[17] Berghoff Trading Ltd v Swimbook developments Ltd agreement, Cl. 19
[18] J C Phillip, (Sweet & Maxwell) The Modern contract of Guarantee, Para 32
[19] J C Phillip, (Sweet & Maxwell) The Modern contract of Guarantee,Para 30-32
[20] Moschi v lep air services Ltd [1973] A.C 331
[21] Re young and harston’s contract [1885] 31 Ch. D.168,CA
[22] Turner Manufracturing co Pty Ltd v Senes [1964] N.S.W.R. 692
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