A guarantee is a contractual promise by one person (the "Guarantor") to another person (the "Beneficiary") to meet the liabilities of a third party (the "Principal") in the event that the Principal fails to perform its obligations pursuant to the underlying contract made between the Beneficiary and the Principal. A guarantee is often sought when the Beneficiary has doubts about the Principal's ability to meet its obligations and they are looking for a third party with deeper pockets from which they can seek recovery if the Principal defaults in the performance of its obligations.
If you are asked to be a Guarantor what do you need to think about?
You are taking a serious financial risk; if the Principal does not pay or perform its obligations under the underlying contract then the Beneficiary can demand that you meet those obligations.
What do you know about the nature of the underlying contract and the extent and nature of the Principal's obligations under it?
Get a copy of the final form underlying contract and understand the Principal's obligations and liabilities under it.
Get a draft of the guarantee as soon as possible and take independent legal advice to ensure that you have complete clarity on the nature and timing of your obligations.
What control (if any) do you have over the Principal so that you can ensure that they meettheir obligations?
The level of control will vary depending on the nature of your relationship with the Principal. If you are its parent company then this is not an issue. If the relationship is more remote then you may need to work out what regular information you require from the Principal and what leverage, if any, you can exert to ensure that they comply with their obligations.
What financial information do you have, and need in the future, from the Principal?
You need to get yourself comfortable with the Principal's financial standing and its ability to meet its obligations, not just on the date of signing the guarantee but over the term of the contract.
Can the guarantee be limited so you know the maximum amount that can be claimed from you or the precise obligations that you will be responsible for?
It is good practice to ask for the obligations to be limited in scope. If it is a guarantee of payment obligations, consider whether or not the maximum amount guaranteed includes costs and interest, or are costs and interest an additional figure on top of the maximum amount guaranteed.
Can the guarantee remain in place for a fixed period of time?
Seek confirmation that the guarantee will have an end date after which you will have no further liabilities arising under the guarantee. This gives you certainty on the term of your liabilities
Are there any other guarantors that can share the potential burden with you?
It may be the case that there is more than one Guarantor of the liabilities of the Principal under the contract. However this does not automatically mean that your liability under the guarantee will reduce proportionately – you need to check the wording very carefully if this is the commercial agreement between you to ensure that the wording is consistent with your understanding. There are often provisions in the guarantee that mean that the Principal can proceed against you first and claim against you for the full amount of the debt. It would then be up to you to proceed against the other guarantors for them to pay their proportionate share.
What will be the impact on your relationship with the Principal?
If the Principal fails to perform its obligations under the contract and demand is made on you, there is the clear risk of a damaged relationship between you in the future; particularly if the guarantee is a personal one. Is this a risk you wish to incur?
Legally, can you give a guarantee?
If you are a company/LLP you need to check your constitutional documents to ensure there are no restrictions on you giving a guarantee or formalities that need to be observed in authorising the guarantee. A company/LLP will also need to check any finance documents to see if there are any restrictions in there on it entering into a guarantee, in particular to see if it needs lender consent to granting a guarantee.
Clearly providing a guarantee is not something to be undertaken lightly. All of the above points need to be given due consideration. A potential guarantor needs to assume that the worst case scenario will unfold, namely that the Principal will fail to perform its obligations and that the Guarantor will have to undertake them instead.This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.