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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 Crdit 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

Recommended further reading:
Bank Guarantees for officially supported exports 
The mechanics of prime bank SLCS and guarantees
Bank Guarantees (BGs)
Funding mega dollar projects utilizing bank guarantees (BG's) or other bank instruments

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