Becoming a Guarantor: Understanding the Responsibilities and Risks

If you are looking to enter a loan, tenancy agreement or mortgage, you should anticipate your lender/landlord to ask you to provide a guarantor. A guarantor is a responsible third party who signs the agreement, subsequently guaranteeing that in the event of default, the payment or obligation will be fulfilled.

This guide will provide you with a comprehensive overview of guarantors and will cover the following key issues: 

• What is a guarantee? 
• Why are guarantees used?
• Guarantors v.s. Co-signers 
• What are the liabilities of a guarantor?
• Rights of guarantors 
• Who can be a guarantor?
• What formalities must be followed to create a valid guarantee? 
• How can I stop being a guarantor? 

Make sure you read until the end, as we also created a comprehensive list of our deed of guarantee templates, which have been reviewed by qualified lawyers.

What is a guarantee?

A guarantee is a legal commitment to pay or fulfil the debt or obligation of another person in the event of default by the person responsible for the debt or obligation.

Guarantees are usually created for debts and loans. They are also created for other payment obligations such as rent payments as part of a tenancy agreement and mortgage payments.

Guarantees involve three parties:

• Guarantor
• Beneficiary
• Principal

The giver of a guarantee is the ‘guarantor’. The person in whose favour a guarantee is made (i.e. the lender) is called the ‘beneficiary’. The person whose payment or performance is guaranteed is called a ‘principal’. Other names for this person include ‘debtor’ or ‘primary obligor’.

Why are guarantees used?

Guarantees are used because they serve as an additional source of security for lenders by ensuring the repayment of loans or fulfilment of other payment obligations.  

It serves as an additional source of security as it establishes the firm commitment and willingness by a third party (the guarantor) to be liable for fulfilling payment obligations to the lender if the principal fails to meet these obligations himself. 

For loans, guarantees are sought by lenders if they are doubtful or lack surety of the borrower's ability to meet their payment obligations under the loan. 

Guarantees are also sought in tenancy agreements by landlords to guarantee the payment of rent. Once again, landlords will seek a guarantee if they are doubtful or lack surety of a prospective tenant’s ability to meet periodic rental payments. This is particularly useful when dealing with college students or fresh graduates that are seeking to rent their first property.  

Guarantors versus co-signers:

Both guarantors and co-signers are similar in that they serve as additional security for lenders/landlords/mortgagees to ensure that the obligations as stated in a contract are performed. 

Guarantors and co-signers are different, however, with regards to their levels of exposure to liability. Guarantors are exposed to a lower risk of liability, whereas co-signers are exposed to a higher risk of liability.

A guarantor is exposed to less risk of liability because a guarantor is liable only after the beneficiary has every possible way of collecting payment/secure performance of obligations from the principal. In this sense, a guarantor is more of a backup and is only needed if the principal doesn’t perform its obligations.

A co-signer, however, is liable the moment a principal defaults, without the beneficiary needing to try all means to collect payment/secure performance of obligations from the principal. Once a principal defaults on its obligations, the beneficiary can demand performance from the co-signer straight away. Unlike a guarantor, a co-signer is equally responsible for repayment or performance rather than being a mere backup. 

What are the liabilities of a guarantor?

To understand the liabilities of a guarantor, we need to understand the legal characteristics of a ‘guarantee’.

There are three main legal characteristics of a guarantee:

• Secondary Obligation
• Accessory to a Primary Obligation
• Co-Extensiveness

Secondary Obligation:

Firstly, a guarantee is a secondary obligation. Secondary obligations are obligations that are triggered after one party commits a breach of contract. For a guarantor, in the context of a loan, this means that he is not liable to a lender under a guarantee unless and until the borrower fails to perform its obligations under the original contract.

Accessory to Primary Obligation:

Secondly, a guarantee is an ‘accessory’ to a primary obligation. In simpler terms, in the context of a loan, this means that the liability of a guarantor under a guarantee is dependent on the continued existence and validity of obligations in the agreement between the borrower and lender, which trigger the secondary obligation of the guarantor. If these primary obligations become discharged or void, the liability for the guarantee will not exist.

Co-extensiveness:

Finally, the liability of a guarantor under a guarantee is ‘co-extensive’. In the context of a loan, this means the liability of a guarantor under a guarantee can be no greater than the liability of the borrower in his contract with the lender.

Rights of Guarantors:

Guarantees confer three rights of significance on guarantors. These rights include:  

• Right to indemnity
• Right to set-off
• Subrogation

Right to indemnity

If a guarantor makes payment to the beneficiary on behalf of the principal according to the terms of the guarantee, the guarantor has a right to be indemnified by the borrower.

An indemnity, in this context, is a legal commitment by the principal to take responsibility for the losses of the guarantor. 

'Losses' include any amount paid by the guarantor under the guarantee. 'Losses' also include any interest on such sums and other costs incurred by the guarantor, such as legal costs in complying with the terms of the guarantee. 

A right to indemnity will arise for the guarantor if it is expressly agreed in any contract between the guarantor and principal. 

If an indemnity is not expressly agreed upon between the guarantor and principal, the right to indemnity will be implied by law so long as the guarantee has been given by the guarantor at the request of the principal.

Right to set-off

As stated above, a guarantor’s liabilities are co-extensive – the guarantor is only liable to the extent that the principal is liable to the beneficiary in the underlying contract. 

If the principal discharges its obligations under a guarantee, the guarantor can avail itself of any right to set-off of the principal. The guarantor will also be discharged from any of its obligations to the beneficiary under the guarantee.

Subrogation

If a guarantor performs the principal’s obligations according to the terms of a guarantee, the guarantor obtains any rights the beneficiary may have against the principal in the underlying agreement.

Rights under the underlying agreement might include property rights to security that a principal may have provided to a beneficiary in the underlying agreement.

It is important to note that this right of subrogation can be excluded expressly or impliedly through the terms of a guarantee.

Who can be a guarantor?

Generally, anyone who the beneficiary is willing to accept can serve as a guarantor.

For loans to a company, common guarantors usually include parent companies or directors of the company.

In the context of a personal loan or tenancy agreement, common guarantors include parents, spouses, brothers, sisters and close friends.

Being a guarantor can expose an individual to onerous obligations – they can, after all, be liable to pay off the remainder of the debt or rent.

Considering the onerous obligations guarantors are subject to, guarantors should ensure they can trust the person for whom they are serving as a guarantor.

For a beneficiary to accept an individual as a guarantor, they must ensure that the individual also has a good credit history and financial standing.

Especially in the context of personal loans or tenancy agreements, beneficiaries will also demand that guarantors be in the same country/jurisdiction as the principal and beneficiary. This is purely because the guarantee will be easier to enforce against a guarantor should the guarantor abscond or otherwise not come good on their obligations under the guarantee.

What formalities must be followed to create a valid guarantee? 

In most common law jurisdictions, there are strict requirements as to the formats that guarantees must adhere to. Generally, they must be in writing and signed by the guarantor or someone authorised to sign on behalf of the guarantor – e.g. an agent.

Apart from this, guarantees must fulfil all the conditions normally required for a contract to be valid. For instance, there must be an offer, acceptance and consideration.

The requirements for offer and acceptance are straightforward to fulfil. If the written guarantee is presented to the guarantor by the principal or beneficiary (depending on who is requesting the guarantee), the requirement for the offer is fulfilled. If the written guarantee is signed by the guarantor and returned to the principal/beneficiary, the requirement for acceptance is fulfilled.

The requirement for consideration is more contentious. Consideration demands that each party provides something of value to the other party whilst entering the contract.

In the context of a loan, if a beneficiary or principal demands that a guarantor enters into a guarantee before or at the same time as when the loan agreement is entered, then the presence of consideration is clear: the guarantor provides value by undertaking an obligation to fulfil the obligations of the principal should they default; the beneficiary provides value in return by agreeing to loan a sum of money to the principal.

If a beneficiary or principal demands that a guarantor provides a guarantee after a loan agreement is already entered into between the principal and beneficiary, then consideration is more difficult to satisfy. This is because of a rule in contract law stating that past consideration cannot constitute consideration for a new contract. In essence, the beneficiary agreeing to loan a sum of money to the principal will no longer suffice as consideration for the guarantee. 

To avoid the difficulties of fulfilling this requirement for consideration, guarantees are often executed as deeds. Guarantees are often executed as deeds as they need, not deeds are enforceable even in the absence of consideration.

To validly execute a deed, specific formalities must be complied with. These formalities include:

• The deed must make evident on its face that it is intended to be a deed

• For valid execution

  • By an individual – signed by the individual in the presence of a witness who attests the signature

  • By a company – should be done in accordance with the company’s articles of association; usually, this means execution by 2 directors (or a director and a secretary) or a director with the company seal.

• The deed should also be delivered to be valid – this requirement does not necessitate physical delivery. Rather, merely the inclusion of the following language in the deed: ‘duly delivered on the date’ with a signature is usually sufficient.

How can I stop being a guarantor?

There are two ways a guarantor can get out of being a guarantor:

• termination
• discharge

Termination

Firstly, a guarantor can terminate a guarantee.

A guarantor may have a contractual right to terminate a guarantee. This is the case if a clause to this effect – allowing a guarantor to terminate a guarantee – is included expressly in the guarantee itself.

If a clause to this effect is not included in the guarantee, a guarantor may nonetheless have a common law right to terminate the guarantee by notice.

Whether a guarantor has such a common law right to terminate the guarantee depends on the type of guarantee at issue.

In the context of loans, if a guarantee is to cover all loans a principal may enter into with a lender, whether existing or to be agreed upon and entered into in the future, typically a guarantor will have a common law right of termination by notice.

If, however, a guarantee covers only a specific loan and a specific sum of money conveyed by the lender to the principal; generally, a guarantor will not have a common law right of termination by notice.

Discharge

A guarantor can stop being a guarantor by discharging the guarantee. 

1) Performance by the principal 

A guarantee can be discharged if the principal performs all obligations in accordance with the underlying agreement. For example, in the context of a loan, if a borrower (principal) makes all required repayments in accordance with a loan agreement, the guarantee will be discharged. 

2) Performance by the guarantor 

If the guarantor performs the obligations as obliged to do under a guarantee, this will discharge the guarantee. 

3) Lender releasing the principal from obligations 

If the beneficiary relieves the principal of his obligations, the guarantor is also released. For example, in the context of a loan, if a lender releases a borrower from all payment obligations bringing the loan agreement to an end, the guarantor will likewise not be obliged to meet any of these payment obligations, and the guarantee will be discharged. 

4) Variation

Changing the underlying contract between the principal and beneficiary after a guarantor has given the guarantee will discharge the guarantor of any obligations under the guarantee. This is unless the guarantor consents to the variation if the variation is insubstantial or will have no real effect on the guarantor. 

5) Breach of contract 

A repudiatory breach of the underlying contract by the lender (a breach that goes to the root of the contract) will discharge a guarantor of his obligations under a guarantee. This is unless the breach is insubstantial. 

However, if a borrower breaches the underlying contract, a guarantee will generally not be discharged. 

6) Other factors which may vitiate a guarantee 

A guarantee is like any other contract. As such, it is subject to the same rules, including those which lead to a contract being voidable or otherwise set aside. This includes duress (for which the guarantee will be voidable), misrepresentation (for which the guarantee will be rescindable), and undue influence (for which the guarantee will be void). 

Effect of termination and discharge:

If the guarantor terminates a guarantee, he/she will not be liable for any payment obligation or any other obligation that a principal may incur after termination. However, the guarantor will still be liable for all the principal’s existing liabilities.

Discharge, however, releases a guarantor from both existing and future liabilities of the principal.

TEMPLATES

We have created comprehensive deed of guarantee templates suitable for loans, tenancy agreements, and mortgages.

We also offer variations of each deed of guarantee template to favour different parties involved in the transaction. 

You can find and select a suitable deed of guarantee template here: 

https://docpro.com/cat75/banking-and-finance/letter-of-comfort-guarantee-and-indemnity