Guarantees and Suretyships: The Differences Explained
Suretyships and Guarantees are common ways in which creditors protect themselves from the risks associated to debt defaults. Lenders will often seek suretyships and/or guarantees if they have doubts about a debtors abilities to fulfil their obligations under an agreement. Sureties and Guarantors take on a serious financial risk when entering in to such transaction, and it is imperative that they are fully conversant with the implications.
Although there are many similarities between suretyships and guarantees, the distinctions between the two transactions, and the obligations assumed under each of them, are distinguishable.
What is a Suretyship?
There are three parties to a suretyship namely: the creditor; the principal debtor and the surety.
A suretyship is the guarantee of the debts of one party (the principal debtor) by another (the surety). A surety can either be a juristic entity (such as a company) or an individual that assumes the responsibility of paying the debt in the case of the debtor being unable to meet it’s obligations in terms of the underlying agreement. For instance, a surety may sign a surety contract to assist their child obtain a car loan, to start a business, or some other transaction considered by the lender to be relatively high-risk. If and when default of the initial debtor arises, the creditor may exercise his right to be paid under the suretyship subject to the rights of the surety to claim back against the principal debtor.
In South Africa, the General Law Amendment Act 50 of 1956 requires that a suretyship agreement needs to be in writing and signed by the surety to be enforceable.
A surety is accessory in nature, which means it cannot exist without a principal obligation. In other words, a surety will only be obliged to pay or fulfil the obligation under a suretyship when the surety is validly called upon by the creditor. A suretyship is terminated when the principal obligation is extinguished either due to performance by the principal debtor or due to impossibility of performance or invalidity of the debt or when the surety agreement is terminated in accordance with the provisions of the agreement.
What is a guarantee?
There are three parties to a suretyship namely: the creditor; the principal debtor and the guarantor.
"Guarantees are usually entered into to provide an alternative pocket to pay if the first should be empty".
A guarantee is a contract between the guarantor (the entity or individual that provides the guarantee) and the creditor whereby the guarantor agrees that, upon the occurrence or non-occurrence of a certain event, the guarantor will perform those obligations for the creditor. The guarantee usually does not make his agreement to answer for the principal debtors debt or default, contemporaneously with the principal or by the same agreement.
A guarantee does not have any formal requirements such as having to be embodied in a written document, although it is strongly recommended to record the terms of a guarantee in a valid written agreement.
A creditor may seek from its debtor a guarantee from a third party rather than a suretyship and one of the benefits of doing so is that the suspension of claims by creditors against a principal debtor which is placed under business rescue in terms of the Companies Act 71 of 2008, which would include the suspension of a creditor’s claim against a surety, will not suspend the creditor’s rights against the guarantor.
Whats the difference between a guarantee and a suretyship?
The main distinction is that a suretyship is based on ‘secondary’ liability whereas the guarantee is based on ‘primary’ liability.
A guarantee is a distinct promise to pay and is not dependent on the principal obligation. The guarantor may not raise any objections or defences based on the underlying transaction. This means the guarantor pays upon the first written demand (claim) on the part of the beneficiary, i.e. on presentation of the confirmation specified in the guarantee text and any required documents.
In light of the foregoing, creditors may prefer to enter into a guarantee agreement, as the guarantor's obligation thereunder is separate from the underlying obligation of the debtor (unlike a surety agreement), thus rendering it difficult for the party providing security to avoid performance under the agreement. That said, whether or not a guarantee agreement can be obtained (as well as the terms and conditions of any such agreement) would be subject to the negotiation power of the parties.
