In Practice: Advising A Guarantor

This article was first published in the July 2024 issue of Butterworths Journal of International Banking and Financial Law.

In this article Knowledge Counsel James Bell looks at issues to consider when protecting the guarantor's position in finance transactions (or indeed other commercial transactions) and how that might be negotiated.

Corporate guarantees will typically be drafted using a beneficiary-friendly template as a starting point. In syndicated loan finance transactions, the Loan Market Association's guarantee clause is the form preferred by lenders. The same form of clause is used in bilateral loans. Alternatively a standalone guarantee document may serve to record credit support extended by a parent company, director or other person not party to the core finance documents. The Pension Protection Fund (PPF) has its own standard form guarantee, under which a company may give a guarantee in favour of the scheme trustees to cover shortfalls in a related defined benefit scheme and potentially qualify for a PPF levy reduction. Such templates have similar operative clauses to those discussed in this article. Other forms of guarantee, such as those extended by the British Business Bank or demand guarantees offered by financial institutions, take a very different form, with standard terms and conditions incorporated by reference.

Unsurprisingly, there is no industry standard Guarantor-friendly template. So when looking at the documentation from a Guarantor's perspective, how can we protect the Guarantor's position and how might this be negotiated?

It takes three to make a guarantee. In this article "Principal" refers to the principal debtor; "Guarantor" is the surety for the Principal's primary obligations; and the "Beneficiary" refers to the Principal's creditor (e.g. finance parties, in a loan finance context). In practice there will frequently be more than one entity in each category.

1. Consider the scope of the guaranteed obligations
2. Revocability
3. Timing issues
4. Can onerous "extras" be deleted?
5. Guarantors in a corporate group
6. Individual Guarantors
7. Don't fight the boilerplate!
8. Bespoke provisions
9. Formalities
10. Is a guarantee appropriate in the circumstances?

1 Consider the scope of the guaranteed obligations

A Guarantor should be advised of the wide and unpredictable liability that could result from giving an "all monies" guarantee, since this could potentially include future debts – even debts which were originally lent by third parties and subsequently acquired by the Beneficiary.

In the loan finance context, guaranteed obligations are more likely to be narrowed down to debts arising under a single loan agreement and associated finance documents. However construction provisions will typically state that any reference to a finance document or other agreement is taken to include subsequent amendments from time to time. A Guarantor should be aware of this risk, although in practice material amendments to debt documents (anything arguably outside the original "purview") usually require "confirmation" from Guarantors.

The scope for amending guarantee provisions in favour of a Guarantor will depend on the commercial context. When lending to a corporate group it is common for multiple group companies to be "on the hook" as part of a "cross guarantee" structure, each with joint and several liability. In such cases there may be less opportunity for a departure from precedent language. However individual persons acting as Guarantors (or entities with less immediate connection to the Principal) might be able to agree a "hard cap" on the amount recoverable under their guarantee. When company directors act as Guarantors, their exposure will more commonly be capped.

Ideally the guaranteed obligations will be restricted to payment obligations. A first draft will typically require a guarantee of punctual "performance". In a loan finance context, this might not be problematic, but even then some of the Principal's obligations could be impossible for a third party to perform. Consider for instance whether a Guarantor might be able to comply with information undertakings or more onerous tasks (e.g., in another context, taking over building works under a construction contract)?

2 Revocability

Guarantee templates will usually state that the guarantee is irrevocable. Depending on the context, a Guarantor may wish to consider whether it should be able to unilaterally revoke a guarantee, particularly in cases where an "all monies" guarantee is given or where the Guarantor has less of a connection with the Principal. If there is no such express provision, common law rules will come into play to determine whether the guarantee can be revoked¹.

3 Timing issues

A Guarantor will only want its obligations to be triggered once the Principal has failed to pay. If a guarantee were expressed to be "on demand", this could be construed as an indemnity or performance bond. It is more likely for a guarantee to include an undertaking to pay debt "when due". However debt frequently falls "due" subject to a grace period for non-payment, so a Guarantor would ideally want its obligation to be triggered once the debt is due "and payable".

A guarantee "cocktail"

Upon closer inspection, the main guarantee clause will comprise a cocktail of obligations. This will consist of:

1. a guarantee (a secondary obligation triggered by the Principal's non performance);
2. an undertaking to pay; and
3. an indemnity, triggered if any guaranteed obligation becomes unenforceable, invalid or illegal.

Guarantors should be wary of any departures from the usual formula employed here, since this could have unintended consequences. For instance a reference in (1) to the Guarantor acting "as principal debtor" would convert the guarantee into a primary obligation.

In the above example, limb (1) might require a Guarantor to guarantee "punctual performance". Limb (2) might require the Guarantor to make payment "immediately on demand". A Guarantor might wish to soften the impact of this wording to give it more time to pay, such that the Guarantor's obligations arise after failure by the Principal to pay a demand within X days.

A more extreme Guarantor-friendly option is to offer a "guarantee of collection". In such cases, the Beneficiary must first claim against the Principal in the usual way. If it fails to "collect" the amount due after employing all the means within its power to collect it (for instance where a court judgment remains unsatisfied), only then can the Beneficiary ask the Guarantor to pay.

4 Can onerous "extras" be deleted?

A first draft stand alone guarantee may be peppered with clauses which exceed the bare minimum necessary to provide credit support for the Principal's obligations. Consider whether additional indemnities can be deleted? Should the Guarantor be paying for associated costs and expenses, or agreeing to pay default interest (over and above that due under the primary contract)?

Copious representations (particularly detailed commercial reps) and undertakings should be carefully considered, since a technical breach of these provisions could lead to a default under the underlying debt.

It's common for the guarantee to state that the Guarantor should not attempt to set off any debt due to it from the Beneficiary against an amount owed by the Guarantor under the guarantee. However this should be considered on a case-by-case basis; a Guarantor may not, in the circumstances, want to lose the benefit of valuable rights accrued as against the Beneficiary.

5 Guarantors in a corporate group

Where money is lent to a group of companies, it is common to require joint and several "cross guarantees" from all the companies in the group. Some entities may wear two hats, for instance with the borrower also being a Guarantor. This structure enables lenders to "cherry pick" upon enforcement, allowing them to claim against an entity with liquid assets at the most opportune level in the corporate structure. A strong borrower may argue that a sole guarantee from a parent company should instead be sufficient, whereas a highly leveraged group might be required to make all subsidiaries guarantors. This may be onerous, particularly for a large group with foreign subsidiaries. A more sophisticated solution is to require the borrower group to adhere to a "Guarantor coverage" ratio. Members of the group representing an agreed percentage (e.g. 75-85% of the group's consolidated EBITDA or gross assets) would be required to be Guarantors.

6 Individual Guarantors

Natural persons often suffer from a very uneven bargaining position. In December 2023 the Federation of Small Businesses issued a super-complaint to the Financial Conduct Authority to highlight the lending practices of some banks that excessively demand personal guarantees for business loans. Entrepreneurs are sometimes forced to put their homes or other assets on the line when taking out finance. Individuals will be best advised to negotiate a cap on their liabilities; this should be at a level sufficient to show they have a 'skin in the game' without impacting unduly on their personal circumstances.

A creditor will be unable to enforce a guarantee against an individual if it is established that the guarantee was entered into under undue influence, of which the Beneficiary has either constructive or actual notice. A lender will be keen to avoid the risk of a guarantee being set aside on this ground, especially (but not only) where partners or spouses act as Guarantors. Thus individual Guarantors are usually required to take separate legal advice, evidenced by 'independent advice' certificates. It is not uncommon for banks to require standard form solicitors' certificates which would be difficult to give, for instance requiring lawyers to confirm that the relevant Guarantor "fully understood" the terms of the guarantee. Any such certificate should confine itself to objective, verifiable statements.

7 Don't fight the boilerplate!

Much of the guarantee word count will be boilerplate. There is little to be gained from trying to amend many of these terms, which have their origins in established caselaw - often dating from the 19th century, or earlier. Such provisions are designed to protect against a guarantee falling away or its value being eroded. Typically, the following issues are addressed:

• Waiver of defences: Owing in part to the principle of "co-extensiveness", whereby the Guarantor's obligation will never be greater than that of the Principal under the primary contract, certain acts or events (such as amendments to the underlying obligations or delays in pursuing the primary debtor) may result in a guarantee falling away. The Guarantor will waive these rights.
• Deferral of rights: This "non-compete clause" defers common law rights of Guarantors, such as rights of subrogation, contribution and counter-indemnity. It is intended to ensure that a Beneficiary does not have to compete with a Guarantor for the assets of the Principal, especially in the event of that Principal's insolvency.
• Continuing guarantee: If not expressed to be "continuing", the amount guaranteed would be reduced (and possibly extinguished) over time by credits on the debtor's account extinguishing earlier debt (and therefore the Guarantors' liability). Without this technical clause, a guarantee of an overdraft or RCF would be of little value.
• Reinstatement / clawback: If any payment to a creditor is set aside (e.g. because it constitutes a preference or transaction at an undervalue), the creditor will not want the amount that it can recover from a Guarantor to be reduced. The issue here is that once the Beneficiary has been paid, at common law the guarantee will have fallen away; reinstatement provisions aim to prevent this happening. Parties often negotiate the scope and timing of this provision. In practice however, its effect is frequently cancelled by comprehensive release provisions when the underlying debt is refinanced.

8 Bespoke provisions

It is in all parties' interest to ensure that notice provisions are accurate and practical, since many disputes relating to guarantees hinge on compliance with notice formalities. Outside the corporate group context, the mode of service and assumptions about deemed receipt may warrant more careful consideration.

In a cross-border deal (particularly when dealing with Guarantors in civil law jurisdictions), the guarantee is likely to feature detailed "guarantee limitations" relating to local law corporate benefit or financial assistance restrictions on the giving of guarantees. For instance, it may be necessary to limit the amount guaranteed to the net asset value of the Guarantor entity or to the amount of the relevant debt facility.

Since the Triodos case in 2005, guarantee documentation commonly includes a "Guarantor intent" clause, the rationale being to try to push the boundaries of what might be considered within the "purview" of the day one guarantee, such that subsequent amendments to the guaranteed obligations do not cause the guarantee to fall away. In the loan finance context, a standard form clause (drafted by the Loan Market Association) is usually deployed without bespoke amendment. However, it may benefit all parties to focus on the scope of the amendments expressly contemplated by this clause, to reflect the specifics of the transaction.

9 Formalities

Whilst the Statute of Frauds 1677 sets the bar very low in terms of the formalities required to create a valid guarantee, in cases where the Guarantor is not party to other transaction documents, it is not uncommon for the Beneficiary to require the Guarantor to execute the guarantee as a deed.

10 Is a guarantee appropriate in the circumstances?

There may be situations (for instance if local law guarantee limitations or execution formalities are particularly restrictive), where it is necessary to consider alternative credit support. In some jurisdictions a promissory note or bank guarantee may be considered as an alternative to a corporate guarantee.

In cross border trade, a seller of goods will often require comfort that a purchaser is good for the money. An unsecured guarantee from another group company may provide little additional comfort. In such cases the solution is likely to be for the buyer to procure a letter of credit or similar instrument from a reputable international bank.

James Bell is Knowledge Counsel in the Finance department at Travers Smith LLP

Related articles:

Syndicated lending and the "purview doctrine": how to preserve guarantees when varying the guaranteed obligation | (2017) 8 JIBFL 459

Preserving guarantor liability: an update | (2021) 11 JIBFL 747

Footnote

1. Revocation of continuing guarantees: principles and rationale – (2019) 7 JIBFL 438.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.