The Liabilities of A Guarantor
Being a guarantor is a financial responsibility. Consider carefully before you agree to be one. MoneySENSE highlights the things you should be aware of when you become a guarantor.
Case Study
Lee Mei agreed to guarantee a loan that her sister, Hui Yi, took to start a business. Hui Yi's boyfriend, Mark, agreed to co-guarantee the loan. After a year, Hui Yi's business floundered and she could not repay the outstanding amount of $50,000. Mark disappeared.
Lee Mei was shocked when the bank relied on a "joint and several liability" clause in the guarantee to demand that she pay the $50,000 owed by Hui Yi together with interest, bank charges and other costs.
If you are a guarantor, pay attention to the "joint and several liability" clause in a loan agreement. It allows a bank, without giving any reason, to ask you alone (even if there are other guarantors) to pay any amount owing to it under the guarantee.
The bank can also demand repayment from the guarantor, without trying first to recover from the borrower, if appropriate provision is made under the guarantee.
You should also be aware of the implications of the following terms, often contained in guarantees;-
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"Principal Debtor" clauses. The intent of such clauses is to make the guarantor liable as if the guarantor had borrowed the money himself. So even though the borrower may escape liability, the guarantor remains liable.
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Payment On Demand. Payment must be made by the guarantor when the bank makes a demand. The guarantor is liable for further charges, legal costs and interest if payment is delayed. Thus you should note what constitutes service of a demand by the bank according to the guarantee.
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Restructuring. The loan may be restructured at the bank's discretion, but such restructuring does not release the guarantor from his obligations.
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Continuing Security. The guarantee secures all the borrower's debts presently outstanding, as well as future advances to the borrower, subject only to the overall limit stated in the guarantee plus interest, bank charges and costs. The guarantor is liable for this outstanding amount until the bank explicitly releases the guarantor from his obligations.
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Subordination. Any rights the guarantor may have against the borrower are subordinated to those of the bank - that is, the guarantor is only entitled to enforce such rights after the bank. The guarantor cannot protect himself by taking security from the borrower that may prejudice the rights of the bank.
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Concurrent Remedies. The bank may proceed against the guarantor to recover the loan without first having to take action against the borrower. The bank may also take action against the guarantor at the same time as any proceedings against the borrower.
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Set Off. The bank may deduct any monies owned by the guarnator with the bank, for instance the guarantor's monies held in a savings account with the bank, from any amount due under the guarantee.
A guarantee imposes an obligation on you to settle the loan if the borrower does not. If you cannot do so promptly, serious consequences will ensue. For instance, your credit history will be affected. It might be difficult for you to obtain credit in future even if the amount under the guarantee is eventually settled. If you are in default of $10,000 or more, you may be subject to bankruptcy proceedings. A bankrupt faces many restrictions including prohibitions on taking a loan, engaging in business and going abroad.
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Things to Note When Considering to be a Guarantor:
- Understand your liability. Ask the bank the following questions. What is the amount of liability you are committing to? Under what circumstances will the bank call on you to pay up the liability? Does the bank have recourse to your monies in the bnak if you fail to pay up as a guarantor? Is your liability limied to a specific amount or is it limited? When will your liability as a guarantor be discharged and how will you be notified?
- Ask the borrower for all his loan documentation. Do not limit your enquiries to the guarantee. It will help you to better assess your risk. For instance, is there any other security given for the loan, such as a mortgage? Additional security may lower the risk. Assess the creditworthiness of the borrower. For business loans, the terms of loans of this type will vary, and may be more onerous than expected, while the commerical reality may not justify your risk.
- Consider alternatives. For instance, a memorandum (or pledge) of deposit may be sufficient. It is a promise to deposit certain monies with the bank which can be set off against and deducted from the balance outstanding on the loan. A pledge would limit your liability to the amount of the deposit.
- Understand the Rights and Obligations of Co-Gurantors. If you are not the only guarantor, you have rights against, as well as obligations to, your fellow guarantors. You may be able to comple your fellow guarantors to contribute to the settlement of the loan even if the bank is unwilling to pursue them. Conversely, you may become liable to your fellow guarantors.
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