Guarantees, whether issued by individuals or corporates form an essential feature of doing business and creating or receiving credit. In most cases, banks are usually on the receiving end of guarantees because they constitute one of the forms of consensual security available as collateral for loans created. The question may then be asked, how enforceable are guarantees? Are they viable forms of security?
Guarantees are, essentially, contracts where an individual or corporate entity promises to be responsible for the due performance of one party's obligations to a third party e.g. the payment of a debt. This typically arises where a company guarantees that it will repay a loan granted to its subsidiary in the event the subsidiary defaults; or where the Managing Director of a company, in his personal capacity, guarantees the repayment of the Company's debts. The courts have repeatedly held that where a person guarantees the liability of another, a distinct, separate and enforceable contract, is created between the guarantor and the creditor.
Whilst the creation of a personal guarantee and the resultant obligation is relatively easy to prove (except where coercion or fraud/forgery is alleged) and thus enforceable without much ado, the same cannot be said of a corporate guarantee. This is primarily because companies are structured such that the shareholders, board of directors, and the employees all have different roles in the management and administration of the affairs of the company. It is therefore important that before accepting a corporate guarantee from a borrower, the creditor must ensure that it was properly authorised and issued.
Ordinarily, the responsibility for the day to day management of a company rests with the board of directors which is vested with all such powers of the company as are not by Law or the articles required to be exercised by the members in general meeting. In other words, it is only the Board that can make decisions with respect to the management of the company's affairs or authorize any transactions involving and enforceable against the company. Consequently, the creation or authorization of a guarantee by a company will be the result of a decision by its Board (via a Resolution) as part of the day to day management of the company's affairs.
For huge corporate guarantees or guaranteeing a loan taken out by a subsidiary, having the Board's approval is best practice. In large organisations, however, it is difficult to imagine that the issuance of a guarantee in respect of its employees' external debts would form part of the agenda of any Board meeting. Whilst it may be discussed as one of the items on the agenda such that it becomes a corporate policy, for effectiveness, the implementation of such policy would most likely be delegated to a senior officer of the company. Nevertheless, it should be noted that the consequences of both guarantees on the company are the same; with the Company, and in some circumstances, the Board ultimately being held liable should things go awry
In conclusion, guarantees may be a more easily accessible form of security especially when compared to the complexity that usually arises with the creation of other forms of security such as mortgages, charges etc. Nevertheless, it is very important that Banks conduct the necessary due diligence to confirm the that the guarantee indeed originated from the company and has been validly approved. Otherwise, it might find itself relegated to the status of an unsecured creditor.
An article by the Firm's Banking & Finance Group, editors of the Banking & Finance Nuggets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.