Guarantees - a type of legal obligation that often accompanies contracts.

In our last two articles, we have looked at some issues around contracts that Farmer Freddy and his family faced when they were at Fieldays. Today, we are going to consider guarantees - a type of legal obligation that often accompanies contracts.

When is a guarantee not just a guarantee?

A few years have passed, and Freddy's son Jack is marrying a nice coastal girl called Diane. Jack and Diane want to buy a farm but can't raise the finance. Freddy agrees to help by guaranteeing their obligations to the bank. Not to be outdone, Diane's mother Phyllis agrees to guarantee the loan too.

Freddy knows the basics - that as guarantor of Jack and Diane's obligations, he may have to perform their obligations if they default he doesn't bother taking independent legal advice before he signs the printed, standard-form guarantee.

Jack and Diane put a new cowshed on the farm and buy some new machinery. They also treat themselves to a flash overseas holiday, and Jack buys a new V8. Just what he always wanted. Now, Jack and Diane owe not just the original $3 million they borrowed to buy the farm, but $4 million.

What are some issues Freddy could face as guarantor?

Naturally Freddy is worried about Jack.

"But", he figures, "at least my liability is limited to the original $3 million they borrowed when I signed the guarantee. Also, with Phyllis as co-guarantor, at worst, I'm up for $1.5 million - and that's before we sell the farm."

Unfortunately, Freddy signed an unlimited all obligations guarantee. This means that he has guaranteed all of Jack and Diane's debt to the bank, not just the $3 million purchase price.

And even though Phyllis has also guaranteed the loan, liability under a guarantee is usually joint and several. This means that Phyllis and Freddy are both individually liable for the whole amount, as well as being liable jointly. Of course, if Freddy did end up having to pay under the guarantee, and he paid more than Phyllis, he would have recourse against Phyllis for that extra amount.

Things get worse though. Freddy finds out that the bank has discharged Phyllis's guarantee.

"That doesn't seem right!" thinks Freddy.

If the guarantee was silent on this, Freddy might have been right here. But, unfortunately, the printed, standard-form guarantee he signed did allow the bank to discharge one guarantor without automatically discharging a co-guarantor. Therefore, despite Phyllis' guarantee being discharged, Freddy is still potentially liable for the full $4 million.

What's more, Freddy's guarantee is not just a guarantee. It also contains a clause where he agrees to be a principal debtor. This means Freddy is in the same position - vis-à-vis the bank - as Jack and Diane so the bank can call on him to perform Jack and Diane's contractual obligations even if they are not in default.

"Crikey dick!" thinks Freddy, "I think I'll have a cup of tea and a lie-down."


The content of this document is necessarily general and readers should seek specific advice on particular matters and not rely solely on this document.
If you would like further information on any of the topics in this document, please contact your usual Auld Brewer Mazengarb & McEwen adviser.
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