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Negotiable
Financial Instruments > This page
Guarantees
Bankers'
Securities
What is a Guarantee?
Attributes of Guarantees as Security
Types of guarantee
General Considerations
Guarantee by a wife or elderly relative
Principal debtor obtaining the guarantee
Guarantee by a customer
Guarantees given by women
Misrepresentation, misapprehension, disclosure of information and mistake
Value and enforceability of the guarantee
Taking the Security (Member
section)
Guarantees by partners (Member
section)
Guarantees by limited companies (Member
section)
Consumer Credit Act guarantees (Member
section)
Monitoring the Security (Member
section)
Standard Clauses in a Bank Guarantee (Member
section)
Request for Information by the Guarantor (Member
section)
Action against co-guarantors (Member
section)
Determination of a Guarantee (Member
section)
Standby Credits and Bank Guarantees (Member
section)
Bankers'
Securities
What is a Guarantee?
A guarantee is a promise to answer 'for the debt, default or miscarriage
of another', if that person fails to meet the obligation: Statute
of Frauds 1677, s.4. Primary liability for the debt is incurred by the
principal debtor. The guarantor incurs secondary liability, that
is, the guarantor becomes liable only if the principal debtor fails to
pay. If the principal debtor's liability to the bank is void, the
guarantor will not be liable: Associated Japanese Bank (International)
Ltd v Crédit du Nord SA [1988].
A guarantee must be evidenced by a written
note or memorandum signed by the guarantors or their agent. Without
such written evidence, a guarantee is unenforceable. Bank guarantees
are, of course, always written contracts.
In these two respects, a guarantee differs
from an indemnity. An indemnity imposes direct or primary liability
to pay and need not be evidenced in writing: Mountstephen v Lakeman
[1871].
Bank guarantee forms are, in fact, dual purpose
documents. They operate as guarantees where the borrowing is enforceable
against the principal debtor - the guarantor by definition incurring secondary
liability - but as indemnities where it is not.
Attributes
of Guarantees as Security
Advantages
An unsupported guarantee is a very simple security to take - no registration
is involved and no complications concerning proof of title arise.
A guarantee can easily and immediately be enforced by court action.
As with any other security given by a third party (collateral security),
it can be ignored when claiming against the principal debtor.
As several parties can guarantee a loan, it is useful security where the
principal debtor is unable to provide security but offers a viable business
loan proposition.
Disadvantages
Unless supported by a cash deposit or other security, a guarantee
is always of an uncertain value as a security. A guarantor's financial
position can change very quickly. An unsupported guarantee should
only be accepted after careful investigation into the proposed guarantor's
financial circumstances.
Court action may be necessary to realise the security and a technicality
may defeat the bank's claim. For example, special rules apply to
guarantees taken from partnerships and companies. A defeat of the
ban's claim on a legal technicality would almost certainly be the result
of carelessness when taking the security.
Enforcing a guarantee may cause bad feeling, particularly if the guarantor
is a valued customer.
Litigation may be necessary to enforce payment where the guarantee was
not supported by other (realisable) security.
Types of
guarantee
Specific guarantee: the guarantor's liability to a particular
transaction between the debtor and the bank is limited to a specific sum.
Continuing guarantees of a limited amount: the guarantor
guarantees the debtor's liability to the bank for a specified sum, thus
limiting his own liability. If possible, banks usually obtain a
continuing guarantee.
General
Considerations
Undue influence
The basis of undue influence
Ensure that the guarantor is not unduly influenced by the bank or,
more likely, by the principal debtor, to sign the guarantee. If
undue influence is proved, the guarantee may be set aside by the court:
Davies v London and Provincial Marine Insurance Co. [1878]; Lloyds
Bank Ltd v Bundy [1975]; Bank of Credit and Commerce International
SA v Aboody [1989]; Woodstead Finance Ltd v Petrou [1985];
Goldsworthy v Brickell [1987].
Proof of domination alone is not sufficient. The guarantor must
also have suffered a real detriment as a result of executing the guarantee:
National Westminster Bank plc v Morgan [1985]. The guarantee
will not be set aside on the grounds of undue influence unless it can
be proved that the transaction is to the manifest disadvantage of the
person subject to undue influence.
Undue influence exerted directly by a bank is rare. More usually,
the principal debtor exerts it and is deemed to be acting as the bank's
agent in the transaction.
The doctrine of undue influence is founded in equity and its basis was
stated in Allcard v Skinner [1887].
Guarantee
by a wife or elderly relative
Problems are most likely to occur where a wife guarantees her husband's
borrowing or an elderly parent that of their child. Although no
undue influence is presumed to exist in such relationships, it can be
proved on the facts, e.g. where the wife has neither an interest in, nor
gains a benefit from, the transaction: National Westminster Bank
plc v Morgan [1985]. However, provided the bank does not have
actual or constructive notice that under influence has been exerted, the
guarantee will not be set aside: Midland Bank plc v Perry
[1988]. In the majority of cases undue influence arises where, at
the time of the transaction, a particular relationship of confidence existed
between the parties, thus giving rise to a presumption of under influence:
Tate v Williamson [1866].
A wife or elderly parent must obtain independent legal advice - specifically,
the main clauses of the guarantee must be explained.
Principal
debtor obtaining the guarantee
It is not advisable to ask the principal debtor to obtain the guarantor's
signature. Apart from the obvious risk of forged signature(s), the
debtor would almost certainly be deemed to act as the ban's agent and
the bank would be responsible for any misrepresentation or undue influence
which might be exerted: Avon Finance Co. Ltd v Bridger [1985];
Kingsnorth Trust Ltd v Bell [1986]; Coldunell Ltd v Gallon [1986];
Bank of Baroda v Shah [1988]; Midland Bank plc v Perry [1988];
Midland Bank plc v Shephard [1988]; Lloyds Bank plc v Egremont
[1990].
Guarantee
by a customer
The possibility of direct undue influence by a bank arises here.
In Lloyds Bank Ltd v Bundy [1975], for example, the guarantor relied
on the bank for financial advice, and the bank failed to avoid the conflict
of interest that arose where it took security from its customer to secure
the borrowing of another customer, Bundy's son.
The likelihood of the principal debtor being deemed to be the bank's agent
is possibly increased where both the principal debtor and guarantor are
customers of the bank.
A bank may breach its contractual duty to its customer by failing to explain
the guarantee and/or insisting that independent legal advice is received,
particularly where:
(a) the guarantor may be under the principal debtor's
dominance;
(b) the guarantor is not a business person or otherwise
does not fully appreciate such transactions;
(c) most of the guarantor's assets are already charged
as security.
Where such a breach of duty occurs, the guarantee will not be set aside
for undue influence but the bank may be liable to pay compensation to
its customers for any loss incurred as a result of the transaction, e.g.
the value of any security sold: Midland Bank plc v Perry
[1988].
Guarantees
given by women
Because of experiences of certain cases in the past, lenders take
a cautious approach when handling a guarantee given by a woman, especially
when she guarantees her husband's liabilities: Barclays Bank
plc v O'Brien [1993]. A woman may claim undue influence and
this will invalidate her guarantee. If she is a company director
or has her own business interests, it is unlikely for her to succeed in
such a claim.
Leading cases relevant in respect of claims of undue influence by a wife
are: Bank of Montreal v Stuart [1911]; Mackenzie v Royal
Bank of Canada [1934]; Chetwynd-Talbot v Midland Bank Ltd [1982].
Misrepresentation,
misapprehension, disclosure of information and mistake
Misrepresentation
The terms of the guarantee must not be misrepresented to the customer.
At law, misrepresentation entitles the party misled to avoid the contract,
whether the misrepresentation was innocent, negligent or fraudulent.
Misapprehension
A apparent misapprehension about the guarantee must be clarified by
the bank, as failure to do so may amount to a breach of its contractual
duty (if the guarantor is a customer) or misrepresentation: Lloyds
Bank plc v Waterhouse [1991]; Royal Bank of Scotland v Greenshields
[1914]. Insistence on independent legal advice should avoid such
problems: Barclays Bank plc v O'Brien [1993]; Davies v
London & Provincial Marine Insurance Co. [1978]. A bank
is not under a duty to explain the terms of a guarantee to a guarantor
who is not a customer of the bank: O'Hara v Allied Irish Banks
Ltd [1985].
Disclosure
A bank owes no duty to volunteer information about its customer which
might influence a prospective guarantor: Cooper v National provincial
Bank Ltd [1945]; National Provincial Bank of England Ltd V Glanusk
[1913]. The guarantors must make their own enquiries about the principal
debtor. A duty does exist, however, to correct any obvious mistaken
belief the guarantor holds about the principal debtor. This poses
a problem, because correcting the belief would almost certainly be a breach
of the duty of confidentiality. The correct course of action is
therefore to obtain the customer's consent before making the disclosure,
or arrange a meeting where questions can be put to the principal debtor
directly by the guarantor. If the principal debtor fails to co-operate,
the guarantee can be declined.
Mistake
Guarantors may subsequently claim that they mistook the nature of
the document signed: Saunders v Anglia Building Society [1971].
However, to avoid a guarantee on this ground, the guarantors must show
that they acted without negligence. Thus, provided the guarantors
understand the nature of the guarantee, signing the guarantee without
reading it will not warrant it being set aside: Howatson v Webb
[1907].
Value
and enforceability of the guarantee
The following points should be kept in mind.
Legal capacity
The guarantor must be legally able to enter into the transaction,
e.g. they must be an adult and not an undischarged bankrupt. A bankruptcy
search at the Land Charges Registry can be made in this latter respect
using form K16. This will reveal any petitions or bankruptcy inhibitions
against the guarantor. Added protection is provided by the standard
'indemnity clause' which ensures that the guarantee is directly enforceable
against the guarantor even if the borrowing is not. Under the Minors'
Contracts Act 1987, a guarantee of a loan to a minor is enforceable even
though the loan itself is not.
Guarantor's means
The guarantor should have adequate personal ..............
More
information is provided in the Member Area
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