Understanding WHAT IS A GUARANTEE
Where a subsidiary company is bidding for a contract but it has a poor credit rating, the procurement organization could obtain a guarantee from the parent company to reduce risks. But what is a guarantee?
Before we answer the what is a guarantee question, look at this example;
Alex and Bree go into a shop. Bree says to the shopkeeper, “let him (Alex) have the goods, and if he does not pay you, I will.”
What you have in this context is a contract of guarantee, in which the primary liability is with Alex and the secondary liability is with Bree.
What is a guarantee?
A contract of guarantee is also known as a contract of suretyship. This is a contract by one person to discharge the debt, default or miscarriage of another.
In large procurement arrangements, a company could end up with a bank guarantee which would mean that the lending institution ensures that the liabilities of a debtor will be met. In simplified terms, should the debtor fail to settle a debt, the bank will cover it. The bank guarantee enables the customer, debtor or the procurement organization in this case, to acquire good, buy equipment or draw upon a loan.
The use of the word guarantee is not in itself conclusive, given that the word is often used in ordinary commercial dealings to refer to warranty and at times to mis-describe what is in the law a contract of indemnity and not guarantee.
This therefore means that the words used to express the intentions of the parties will tell us if the promise made constitutes a guarantee. You will really have to pay attention to the contractual wording and the contractual terms.
Related: Understanding Terms of a contract
The characteristics of a contract of guarantee
A contract of guarantee has the following traits
#1 There must be three parties, that is, the principal, the debtor and the guarantor or surety
#2 There must be a primary liability in some person other that the guarantor (remember the example of Alex and Bree?). The guarantor must be liable only secondarily. The idea here is that the guarantor only steps in to pay if the principal debtor doesn’t pay.
Remember the creditor’s right to enforce a guarantee may not necessarily involve the guarantor incurring liability for the total amount of the debt
For instance
Jane may guarantee Ben’s loan to Cate, by the deposit of the title deed to her property. This means that the equitable mortgage will become the creditor’s buffer. In simpler terms, in the event of non-payment of the debt by Ben, which will trigger the subsequent enforcement of the guarantee, while Jane may have to forfeit the mortgaged property, she will not incur personal liability in respect of any difference between the value of her mortgage property and the outstanding balance of the debt.
#3 The guarantor is totally unconnected with the contract except for his promise to discharge the principal debtor’s liability should the principal debtor fail to do so.
This rules help in creating a difference between a contract of guarantee and that of indemnity. It also means that a del credere agent or an agent working on half commission employed by a stock broker is not a guarantor, because each has an interest in the contract by negotiating it.
Example: Sutton & Co v. Grey (1894) 1 QB 285 Pg 560
S & Co. , stockholders, agreed with G that in respect of clients introduced by G, G should have half the commission earned as a result of the introductions, and he would pay S & Co. half of any loss sustained in respect of them.
Held: the contract was not one of guarantee. Lord Esher M.R: “the test is whether the defendant is interested in the transaction, either by being the person to negotiate it or in some other way, or whether he is totally unconnected with it. If he is totally unconnected with it, except by means of his promise to pay the loss, the contract is a guarantee; if he is not totally unconnected with the transaction, but is to derive some benefit from it, the contract is one of indemnity.”
Notice this is different is a shareholder in a company promises to pay the company’s debt in order to prevent its goods from being taken in execution. This turns out to be guarantee because the shareholder has no legal interests in or charge upon the goods. ( Harburg India Rubber Co. v. Martin (1902) 1 K.B 778)
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