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EVERYDAY LAW: Contract considerations

Cecil McCarthy

EVERYDAY LAW: Contract considerations

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Today I discuss an email from a guarantor who is inquiring whether he can withdraw from his contract of guarantee because the borrower has started to default on his loan.
A contract of guarantee is essentially a contract by which one person (the guarantor) agrees to answer for some liability of another (the principal debtor) to a third person (the creditor).
A person who has agreed to be a guarantor does not only undertake to perform the contract if the principal debtor fails to do so, but he undertakes to see that the principal debtor will perform.
The guarantor is normally liable to the same extent as the principal debtor for damages where the principal debtor fails to fulfil his obligation under the contract.
There are different types of contracts of guarantee.The most common kind of contract is that in which all three parties concerned are parties of the contract.
Here both the principal debtor and the creditor agree that the guarantor’s liability is a secondary liability only, and that the principal debtor is primarily liable for the obligations guaranteed. Whether a guarantee can be revoked depends on the nature of the contract.
If the guarantee is given in return for the promise of the lender that he will enter into the transaction with the principal debtor, then the guarantee will constitute a binding contract as soon as it is given and accepted.
The facts outlined in the email do not fully disclose the nature of the contract.
However, if the terms of the guarantee permit revocation it will only relate to future disbursements.
It will also stipulate a period of notice that must be given before the guarantee can be revoked.
The bank has a duty of confidentiality to its debtor. However, since the guarantor is at risk he is entitled to know the amount of his risk.
The bank will usually disclose to the guarantor the extent of the debtor’s liability up to the limit of the guarantee.
As between the guarantor and the principal debtor, the guarantor is entitled to be indemnified where he has met the liability for which he is the guarantor.
Depending on the nature of the guarantee, the guarantor may be able to reduce his future liability, by serving a notice on the creditor determining the guarantee.
He will, however, remain at risk during the period of notice.
A contract of guarantee is a very special contract. You should always seek legal advice on the rights and obligations under such a contract before entering into the contract.
Another matter that sometimes arises under contracts of guarantee is the issue of variation.
At Common Law a variation of a creditor of his contract with the principal debtor may release the guarantor from liability, since the contract has been varied without the guarantor’s consent.
This result is, however, avoided by including a clause in the contract which provides that the guarantee will not be discharged if the principal debtor is given extra time for repayment of if there is some other variation of the terms of the repayment of the debt.
I would strongly advise that you seek legal advice on the terms of your contract.