What Is A Guarantor?
A guarantor is a party to a transaction or credit agreement who voluntarily takes responsibility for ensuring the payment of another party’s debts in the event that they fail to meet their obligations to the vendor.
What Constitutes A Guarantee?
For legal intents and purposes a guarantee refers to a written statement by the party acting the guarantor which states that the party receiving the loan or credit will meet their obligations as outlined in the credit agreement.
Guarantors are responsible in the event a debtor fails to meet their obligations
Guarantors are bound by an enforceable contract which requires them to meet the debtor’s credit obligations in the event that they are unable to do so themselves, which means that the decision to act as a guarantor should not be taken lightly. In the event that the debtor fails to meet their obligations, the guarantor is often required to pay the amount owed right away, or they are likely to face litigation in an attempt by the creditor to secure the funds owed.
In recent years, there have been several high-profile cases where guarantors have managed to avoid paying funds owed to creditors. These cases, and others like them, often result from a guarantor being able to prove in court that they were not aware of their obligations to the creditor in the event of a debtor default.
These cases of guarantors escaping their credit obligations have raised suspicion among lenders and in many cases they have amended the agreements they make with guarantors and debtors to reflect this. This means that guarantor contracts are more likely to be enforceable in court, as creditors are taking extra steps to ensure that their agreements are enforceable.
Vital information for potential guarantors
Before signing a guarantee, parties intending to act as guarantor should obtain the following documents from the creditor:
- A copy of the loan agreement that the person receiving the credit intents to sign.
- A thorough outline of what is expected of the guarantor as part of the agreement.
Lenders are obligated to ensure that guarantors and debtors fully understand the nature of their obligations under the credit agreement, and the ramifications of failing to meet these obligations. If a lender fails to take these steps, or fails to produce written evidence that demonstrates the understanding between the parties, the contract between them and the guarantor may not be enforceable.
It is also very important that the guarantor understands the transaction to which they have agreed to maintain responsibility. Several things are especially important for potential guarantors to be mindful of, including:
- The extent of securities held by the creditor,
- Whether or not the debtor is or has been in default on any other agreements,
- Whether or not the debtor has any history with the prospective lender,
- If the debtor is a business owner, it is important to be aware of the strengths and weaknesses of their business in order to determine whether or not it is likely to earn back the funds owed under the credit agreement.
Potential guarantors would likely benefit from having an accountant examine the financial records and history of the prospective debtor.
Guarantors are able to negotiate limits to any guarantee they are willing to supply on behalf of the debtor, including in terms of both the amount of funds they are willing to offer as part of the arrangement as well as the timeframe for their guarantee.
It is a good idea to specify a limit to your guarantee, for example, informing the other parties that you are willing to guarantee the loan amount and interest only, and not any future advances or loans made as part of the arrangement. Recording these details in writing assists in enforcing your rights should a dispute occur.
All accounts guarantees
All accounts guarantees are made by a guarantor who agrees to cover all the costs owed by a debtor to the creditor at any point in time, including costs that relate to the following:
- Other loans or debts
- Overdraft/overdraw fees
- Chattel leases
- Credit cards
- Miscellaneous money owed as part of the agreement
All accounts guarantees include money that may not have been a part of the original debtor/creditor arrangement, or that may not have been directly specified in the original credit contract. Wherever possible, guarantors are advised to limit themselves to a fixed guarantee in order to reduce the risk posed to themselves, as well as the creditor and debtor in the event of a default by the debtor.
Unsecured or Secured Guarantee?
In most cases lenders will specify whether they require a guarantee to be secured or unsecured. A secured guarantee is when the creditor requires the guarantor to take out a mortgage over some part of the guarantor’s personal property in order to make their guarantee more enforceable.
Unsecured guarantees simply omit the mortgage requirement and go without the added security it provides.
There are certain key indicators which reflect whether or not a creditor is likely to seek a secured or unsecured guarantee:
- Whether or not the debtor is able to provide some sort of security for the event they are unable to meet their credit obligations.
- The relative credit risk currently associated with the debtor.
- The relative income and value of assets held by the party acting as guarantor.
Even where guarantors have become party to an unsecured guarantee, their personal property may still be used to meet the guarantee under certain circumstances. In order to liquidate your personal property to recover the debt, the creditor would need to obtain a court ruling against you which allows them to do so.
What happens should a debtor default?
The purpose of the guarantor arrangement is to secure the ability for the creditor to recover the funds loaned to the debtor, even if the debtor fails to make certain repayments on time etc. Any party considering acting as guarantor should remember that the creditor may pursue the guarantor for any funds owed by the debtor, even if the debtor is not pursued themselves. Guarantors are ultimately responsible for the repayment of the debt, and as such, they should be wary not to enter into any guarantor arrangement with a debtor they don’t trust.
What happens if the guarantor is unable to remedy a default by the debtor?
In the event that a debtor defaults, and the guarantor is either unwilling or unable to comply with the terms of the original credit agreement, namely agreeing to remedy such defaults as specified in the original loan, then they are liable for the damage resulting to the creditor and may face litigation. If the court is unable to enforce the original contract, which would require the guarantor to pay the amount owed plus any other costs such as interest, then they may order that the guarantor’s personal property be liquidated in order to meet the creditor’s requirements.
LGM Advisors is a leading Melbourne law firm, professionals in contract law. LGM Advisors have the skills, experience and expertise to ensure that you and your contract matter is consulted upon with the utmost professionalism. Contact LGM Advisors and speak to a contract lawyer today on (03) 9832 0608 or by email at contact@lgmadvisors.com.au.
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