THE PROTECTION OF A GUARANTOR’S RIGHTS IN A LOAN TRANSACTION AND THE EXTENT OF HIS LIABILITY

BY: IGECHI ICHEGBO ESQ.

INTRODUCTION

Loans are generally secured or collateralized by assets which include floating and fixed assets, shares of the company, cash in bank, and in some cases personal guarantee of individuals. In several circumstances, the borrower might not have enough assets or any collateral for the loan. It is on such occasions that such the borrower is compelled to bring in a third party who can stand or use his assets to secure the loan facility. Such persons are referred to as “Third Party Guarantor”. The contract binding the borrower, the lender and the guarantor is generally called “Contract of Guarantee” or “Unconditional Personal Guarantee and Indemnity”

 This article expounds on the responsibilities of a guarantor, the risks involved and how to protect guarantors’ rights and interests in loan transactions.

DEFINITION OF TERMS 

A. Guarantee:

A proper definition of Guarantee is an undertaking to answer for the payment or performance of another person’s debt or obligation, in the event of default by the person primarily responsible for it. This definition of guarantee has gotten a judicial backing as elucidated in the case of Chanmi v. U.B.A Plc {2010}  6 NWLR {Pt. 1191} 474 at 478 Ratio 1, where the Supreme Court of Nigeria defined a guarantee thus: 

“Guarantee has been defined as a written undertaking made by one person to another to be responsible to the other if a third person fails to perform a certain duty, e.g. payment of debt…”

Black’s Law Dictionary 7th Edition at page 711 defined Guarantee as “an assurance that a contract or legal act will be duly carried out.”  

B. Guarantor:

According to the Black’s Law Dictionary 7th Edition page 711, a guarantor is defined as “one who gives security for a debt.” 

A guarantor’s liability does not begin until the principal debtor is in default. Furthermore, a guarantor is a term used to describe an individual who promises to pay a borrower’s debt in the event that the borrower defaults on his loan obligation by pledging his assets as collateral against the loan.

 

CREATION OF GUARANTEE

A contract of guarantee creates some rights and liabilities between the lender and the guarantor. It is often created in several ways which are all recognised under our laws. A guarantee may arise by any of the following means:

1. Tripartite Deed of Legal Mortgage: It is a legal document in which the guarantor who is the mortgagor transfers his interest in assets to the mortgagee/creditor for the purpose of securing a loan given to the Borrower. Once there is an agreement between the parties mentioned above, a tripartite legal mortgage has been created. A standard tripartite legal mortgage involves the mortgagee (lender), mortgagor (guarantor), and the borrower of the loan.
2. Deed of All Assets Debenture: This is a charge over the entirety of a company’s assets in favour of a lender or creditor transferring the temporary interest to the lender/creditor. The deed of all asset debenture can only be discharged upon the final liquidation of the loan availed to the borrower or debtors as the case may be.
3. Surrender of Shares: A guarantor may undertake to relinquish his shares, to serve as security/collateral for the loan in the event the borrower fails to liquidate his debts.
4. Post-dated Cheques: This is a situation where a guarantor undertakes the liability of a debtor, by issuing post-dated cheques in favour of the creditor to liquidate full or a part of the loan that was granted to the debtor in event of default.

 

GUARANTORS LIABILITY TO THE CREDITOR

1. Crystallization of Liability upon Borrower’s Default:

The guarantor to a facility automatically becomes liable to the creditor upon the default by the borrower, and it is well established that failure of the borrower to liquidate the facility as agreed crystallizes the right of the creditor against the third person guarantor. In the case of C.B.N v Interstella Comm. Ltd. {2018} 7 NWLR {Pt.1618} Page 294 at 308, the Supreme Court of Nigeria held that; 

“A guarantor is technically a debtor because where the principal debtor fails to pay his debt, the guarantor will be called upon to pay the money owed. However, the fact that the obligations of the guarantor arise only when the principal debtor has defaulted in his obligations to the creditor does not mean that the creditor has to demand payment from the principal debtor or from the guarantor or give notice to the guarantor before the creditor can proceed against the guarantor, nor does the creditor have to commence proceedings whether criminal or civil, against the principal debtor unless there is an express term in the contract requiring him to do so.”

Furthermore, the liability of the guarantor crystallizes the moment a default occurs on the part of the borrower as seen in the Supreme Court decision in Fortune International Bank Plc v. Pegasus Trading Office (GMBH) &2 Ors (2004) 4 NWLR (Pt. 863) page 369 at 389 Para D-E thus:

“The fact that the obligation of a guarantor arises only when the principal has defaulted in his obligations to the creditor does not mean that the creditor has to demand payment from the principal or from the surety or give notice to the surety. Nor does he have to commence proceedings against the principal, whether civil or criminal unless there is an express term in the contract requiring him to do so.”

2. Guarantee Creates A Separate Contract Between The Guarantor And The Creditor:

Upon the execution of a contract of guarantee, there exists a separate contract between the creditor and the guarantor, which can be enforced by the creditor when there is a breach without recourse to the borrower, who is the principal debtor. Thus this is as expressed emphatically in the case of UBA Plc v Chami (supra) Page 479 Ratio 2 where the Court held as follows;

“Where a person personally guarantees the liability of a third party by entering into a contract of guarantee or suretyship, a distinct and separate contract from the principal debtor’s is thereby created between the guarantor and the creditor.”

3. Guarantor’s Direct Liability To A Creditor:

It is pertinent to state that once a debt has accrued and a guarantee has been called upon by the creditor, the guarantor becomes directly liable to the creditor independent of the borrower’s liability to the creditor. The creditor can choose to proceed to recover the loan from the guarantor without approaching the principal debtor.

A guarantor is directly liable to liquidate the debt of the principal borrower, in the event that the principal borrower defaults or refuses to honour his repayment obligation. In fact, it is of no moment whether or not the guarantor benefited from the loan granted to the principal borrower; it is sufficient that there exist a guarantee from the guarantor and the principal borrower has defaulted in his repayment obligation. In the case of Crown Flour Mills Ltd v Olokun (2008) 4 NWLR at page 298 Para F-H the Court held thus:

“…….in a contract of guarantee, the law has moved to the center to make right of the creditor to so proceed against the guarantor less conditional….. a creditor is entitled to proceed against the guarantor without or independent of the default of the principal debtor.”

Also in UBA Plc v Chami (supra) page 479, Ratio 3 & 4, the Court held that: 

“A contract of guarantee can be enforced against the guarantor directly or independently without the necessity of joining the principal debtor in the proceedings to enforce the guarantee. Thus, a surety may be proceeded against without demand from him and without first proceeding against the principal debtor…when the principal debtor fails to pay his debt, as in the instant case, the liability of the guarantor under the guaranty crystallises. The right of the creditor is therefore not conditional as he is entitled to proceed against the guarantor without or independent of the incident of the default of the principal debtor.”

 

STEPS A GUARANTOR MUST TAKE TO PROTECT HIS RIGHTS IN A CONTRACT OF GUARANTEE

It is appropriate for every guarantor to take certain steps so as to protect himself to reduce the risk of standing as a guarantor. As earlier discussed, there are a number of risks associated with the role of a guarantor, it is only proper that we have a second look and consider the factors to look out for before a person can accept being a guarantor to a prospective borrower, these factors are listed below:

1. How does the borrower intend to repay the loan granted to him? A guarantor has the responsibility to conduct a background check or carry out a feasibility study of borrower’s projection with respect to the projects or business to which the borrower intends to apply the loan, so as to determine how the borrower intends to liquidate the loan.
2. What borrower’s asset is available to indemnify the guarantor in case of any default in the loan and the guarantor is obliged to repay the creditor’s loan? The Guarantor has a responsibility to assess or value the borrower’s assets available to indemnify him where the borrower defaults in the loan and the guarantor is obliged to repay the creditor’s loan. Furthermore, the guarantor must take proper steps to ensure that the borrower’s assets available to indemnify him are not encumbered or not attached to any legal issue that will frustrate the guarantor.
3. Whether the guarantee is for a fixed amount or entire loans granted to the borrower by the creditor? The guarantor is advised to properly examine the loan documents or contract so as to ascertain the extent of his liability. Where the guarantee is for a fixed amount without interest, the guarantor is liable to the creditor only to the extent of his guarantee without being liable for accrued interest, but where the guarantee is for the entire loan granted to the borrower, the guarantor is liable to pay the entire loan sum where the borrower defaults.
4. In the event of a default on the side of the principal debtor, does the guarantor have the financial capacity to undertake the liabilities guaranteed against? The guarantor aside from pledging his immovable assets for the discharge of his obligation under the loan arrangement, the guarantor must be able to ascertain that he has the financial capacity to liquidate the borrower’s debt in the event of the borrower’s default without losing his immovable assets in the discharge of his guarantee obligation.
5. What asset does the guarantor intend to put up as security or collateral? The guarantor must diligently identify the assets {floating or fixed} which he intends to nominate as security/collateral for the borrower’s loan. The assets so identified must be such that can adequately discharge his obligation as the guarantor under the loan agreement.

 

WAYS A GUARANTOR CAN SHIELD HIMSELF FROM UNNECESSARY LIABILITIES.

1. Right to Discharge: A guarantor’s obligation to liquidate the debt of the primary debtor co-exists with the existence of the debt. Hence where the principal debtor has completely liquidated his debt or where the guarantor steps into the shoes of the principal debtor to liquidate the debt, he is discharged from the Guarantee or he can immediately liquidate the debt before interest accrues and eventually escalate the debt.
2. Right to Limited Undertaking and Liability: The guarantor’s right to liquidate the principal debtor’s indebtedness only to the extent of his undertaking. Where a guarantor’s undertaking is limited to a certain sum of money, he is under a legal obligation to discharge the guarantee only to the extent of his undertaking. Hence the creditor cannot recover from the guarantor any sum beyond the guarantor’s undertaking. For example, a guarantor can exclude/insist on the non-payment of the debt interest save for the exact money loaned or a specific sum.
3. Right to Set-Off: A guarantor has the inherent right to a set-off where there is a corresponding or mutual responsibility between the guarantor and the creditor. Therefore, where the creditor is also indebted to the guarantor, the guarantor can exercise his right to set-off his liability against the creditor’s liability to him.
4. Right to Proper Account on Proceeds of Sale: In the event that the guarantor’s asset is disposed of in the repayment of the principal debtor’s obligation, the guarantor has the right to demand a detailed account on the proceeds of the sale so as to ensure that the assets were sold at the best market price. Consequently, he has a right to request a refund where the asset sold is more than sufficient to completely liquidate the principal debtor’s indebtedness.

PROTECTION OF A GUARANTOR

The obligation of becoming a guarantor simply implies that he will be liable for the repayment of the loan in event of default by the debtor to liquidate his indebtedness. In most cases, the guarantor suffers a great deal. In order to avoid this, the guarantor must take steps to prevent or protect himself even when he has consented to a guarantee contract. 

The following are ways a guarantor can ensure the protection of his interest in a loan transaction;

1. Reduce Liability: A guarantor should always try to reduce as much as possible to the amount guaranteed in the contract of guarantee, so as to have a limit to the guarantee. This would ensure that the guarantor accepts liabilities within his means.
2. Personal Scrutiny and Execution of Documents: A guarantor should make sure the loan agreement and all other relevant documents relating to the loan granted to the borrower are personally and properly scrutinized by him. Also, a lawyer should review same or an expert in the field for the purpose of the loan. The guarantor should also make sure he has copies of all relevant documentation and confirm all necessary information about the credit/loan agreement. This is to ensure an informed decision to guarantee a loan granted to a borrower.
3. Carry out Background Checks: A guarantor should carry out a thorough background check on the purpose of the loan and the most importantly the alter-ego of the company or entity he is standing guarantee for, in order to be certain that he is a person of reputable character and the ability of the borrower to utilize the loan for the purpose for which it was given.
4. Ensure Good Relationship with the Borrower: There is need for a prospective guarantor to access his relationship with the borrower to avoid a situation where the borrower cannot be located by either the creditor or the guarantor when the loan crystallizes into indebtedness. This is important because the guarantor also reserves the right to proceed against the principal debtor upon the discharge of the indebtedness to the creditor. There is a need for a guarantor to guarantee a loan granted to a person with close proximity to the guarantor.
5. Good Synergy between the Borrower and the Guarantor: It is essential to go through the terms of the agreement in detail and discuss it with the borrower so as to avoid future complications. This will further strengthen the resolve of the guarantor towards making a decision to enter into a guarantee contract.
6. Co-Signatory to the Loan Account: The guarantor must also request that he is a co-signatory to the loan account so as to help regulate and monitor the account. This is important because the guarantor can supervise the usage of the loan and ensure same is not diverted for other purposes asides from the reason it was granted.

TERMINATION OF A GUARANTEE

There are instances where a guarantor may choose to exercise his right to terminate the contract of guarantee. This calls for concern when fraud is detected, misappropriated or for other personal reasons.

It must be borne in mind that it is very difficult to terminate a contract of guarantee, especially when the borrower has already taken benefit of the loan and expended the money for other purposes. In such instance, a creditor will never allow, consent or approve the termination of the contract of guarantee, except the loan has been fully repaid or a replacement is produced and certified to be in the same standard with the outgoing guarantor because a creditor must be placed in the position as at when the contract of guarantee was executed. Nevertheless, below are factors that can lead to the request for termination of a contract of guarantee. 

 

1. Misappropriation of the Loan: A guarantor may terminate the guarantee contract where the principal debtor misappropriates the credit for other purposes other than for which the credit was granted to the knowledge of the creditor. For Example: where a borrower obtains a loan granted to him for business purposes but decides to direct same to seek political elections; in such a circumstance, the guarantor is obliged to bring same to the notice of the creditor and demand for a release of the obligation in the guarantee, after the guarantor must have ensured a replacement of the guarantor or the loan has been repaid till date.
2. Misrepresentation and diversion of loan: Where the guarantor was deceived into entering a guarantee contract, such a contract may be vitiated on the ground of misrepresentation and fraud. This is usually applicable where the guarantor is shielded from certain clauses or arrangements in the loan agreement.  where such is discovered by the guarantor, the guarantee agreement ought to be terminated, but before this can apply, it must be proven that the creditor is aware.
3. Coercive Consent: Where the guarantor is coerced or induced into giving consent to guarantee a loan on behalf of a borrower, it vitiates the guarantee. Where the consent of the Guarantor was obtained by duress, the guarantor may terminate the guarantee contract on such basis. This would apply especially where there is proof that the creditor is culpable in the inducement or duress.
4. Fraud: Where a guarantor’s assent to a guarantee has been procured by fraud by the person to whom it is given and there is proof to that effect, there is no binding contract. Fraud in this context may consist of suppression, concealment or alteration of the contract without the knowledge of the guarantor.

 

CONCLUSION

Conclusively, being a guarantor should not be taken as a mere formality because it is a commitment that he is liable to the creditor, upon failure of the debtor to perform his obligation. The guarantor should be willing to perform his obligation, as the failure to do so could amount to the creditor taking up recovery actions against him. In such an event, a guarantor who has taken all precautionary steps as suggested in this article can invoke any of the options stated above to seek redress against the debtor and discharge his liabilities. Finally, a person should never stand as a guarantor to an entity, company or persons not well known, because it is as dangerous as the entire loan itself.