Last updated 3 August 2016
Guarantees are binding agreements that involve three parties: the lender, the borrower and the guarantor.
Guarantees are sometimes required by lenders before they agree to lend money, for example when the lender suspects that the borrower is in a category of consumers at a higher risk of being unable to repay the loan.
A person becoming a guarantor promises to repay the loan if the borrower will not or cannot do so. Since guarantors are responsible for loan repayments, once the borrower stops making repayments it can cause serious financial hardship to the guarantor. It involves more than helping out a friend or relative who needs money or wants to buy goods on credit.
The National Credit Code (Credit Code) contains special provisions in relation to loan contracts secured by a guarantee. A guarantee is unenforceable unless:
- it is in writing and signed by the guarantor (the person giving the security)
- the guarantor receives a copy of the loan contract before signing the guarantee (s 57)
- the guarantee does not secure more than the loan (i.e. it cannot be for all monies lent).
Liability of a guarantor
The guarantor is liable for the total amount of the borrower’s liability and for the reasonable costs of enforcing the guarantee. Under the Credit Code, once a borrower is in default, a lender can sue:
- the borrower first
- both the guarantor and borrower together
- the guarantor alone. This can only be done if the:
- borrower has already been sued, a judgment has been obtained (s 90) either with or without the guarantor, and they have failed to pay within 30 days after a written demand has been made
- the borrower is insolvent
- the lender unsuccessfully searched for the borrower and gives notice to the guarantor that they intend to sue
- the court says that the borrower is unlikely to pay any part of the loan
- the borrower is a minor.
Guarantees of minors
A minor is a person under 18 years of age. A guarantor is not liable for the minor’s debt unless the guarantee had a prominent statement (above or below the place for the signature) that if the guarantor pays the loan they might not be able to recover any money paid on the minor’s behalf because the minor has no legal liability to repay.
Rights of a guarantor
The guarantee must be entered before the lender gives the loan to the borrower, unless the guarantee document is a deed (a document that contains the words ‘signed sealed and delivered’). Otherwise, the guarantee is unenforceable as it is not given in exchange for a loan.
A guarantor can ask a court to set aside the guarantee if it was unfair (see Unjust Contracts below).
Cancelling a guarantee
A person who agrees to guarantee a loan can, by written notice to the lender, withdraw from the agreement at any time prior to the provision of credit to the borrower.
A guarantor may also withdraw from the guarantee after the provision of the credit if the loan contract is materially different to the proposed loan contract given to the guarantor before they signed the guarantee (s 58 Credit Code).
The guarantee of a continuing credit contract is cancelled as at the date when written notice is given to the lender, and the guarantor does not have any obligations for future liabilities. The guarantee remains valid for existing obligations (s 55(4) Credit Code).
The guarantor pays the debt
The guarantor is entitled to recover monies paid from the borrower, if that is possible. The guarantor is also entitled to any security over the borrower’s property held by the lender.