The use of guarantees in everyday business life is common place. The type of guarantees vary, such as directors or shareholders guaranteeing the debts of a company (a personal guarantee) or one company in a group of companies guaranteeing the debts of another company in that group (cross company guarantee).
Drafting a guarantee can be complex. A poorly drafted guarantee, or a guarantee that does not accurately reflect the intentions of the parties, can have costly effects for the parties to it.
A simple, but ineffective form of guarantee might simply require the guarantor (the person guaranteeing the obligations of a debtor) to pay up if the debtor doesn’t. The problem here is that the guarantor may fairly say that it doesn’t have to pay anything until the creditor has dome absolutely everything to get payment from the debtor – right through to formal insolvency.
If it’s well drafted, the guarantee overcomes this problem by requiring the guarantor to take on the obligations of the debtor (as if it were the debtor in respect of those obligations). Effectively the guarantor “stands in the shoes” of the debtor. Most importantly, the person with the benefit of the guarantee (the creditor) can demand payment from the guarantor without even demanding payment from the debtor, let alone waiting to see if the debtor pays.
Clauses like this have been subject to recent case law. The court was asked to consider whether a guarantee containing such a clause created a debt in favour of the creditor, or whether the creditor merely had a right to sue the guarantor for damages for breach of contract if the guarantor failed to meet its obligations under the guarantee.
The court held that the wording of the guarantee made the debts of the debtor the direct debts of the guarantor; so that any debt due under that guarantee is immediately payable without prior demand for payment having have been made of the debtor or the guarantor.
Some guarantees are either badly drafted or do not accurately reflect the intentions of the guarantor and the creditor. In another recent case, the parties copied a form of guarantee that was wholly inappropriate for the circumstances. The court dismissed the creditor’s arguments that the guarantee should be interpreted to reflect the parties’ intentions. The court said that the sheer number of corrections and additions necessary to make the guarantee meant it would have to rewrite the document for it to make sense. The court said it was not its job to rewrite the whole agreement and decided that the guarantee could not be relied on as it stood.
These cases illustrate that creditors should make sure that guarantees are well drafted and tailored to the circumstances to reflect the intentions of the parties, and include wording to make them effective against guarantors swiftly and without room for challenge.
Written by Matthew Read, a Solicitor in the Nelsons Commerce and Technology group. To find out more about our Commerce & Technology group, click here.