Obtaining an Enforceable Guarantee

There are many circumstances where businesses might give credit – even without formally doing so.  Providing goods or performing services in advance of full payment is extremely common, but if a company or sole trader you are dealing with has financial problems or a poor credit history, then you may not get paid.

Taking security over a company or business with assets is one way of helping you manage your risk, but this article summarises some basics in respect of guarantees and how to ensure that guarantee is enforceable. The law of guarantees is complex, so this basic summary is not intended to replace legal advice – getting appropriate legal input into the drafting and enforcement of guarantees will avoid a lot of potential risk.

First, you will want to ensure that the guarantor has the means to pay the guarantee if called upon, so a credit check will be useful here.

Once you are satisfied you have an acceptable guarantor, then you want to ensure that you have clear written terms and it is very clear that the guarantor has agreed to those terms, preferably with a written (or by agreement, electronic) signature.  The Property Law Act 2007 provides that a guarantee must be in writing and signed by the guarantor.

You also want to ensure you can enforce the guarantee without having to exhaust all of your avenues of recovery from the business or other person that owes you the principal obligation.  This is often achieved from having what is called a "principal debtor" clause – a clause that says the guarantor owes you the same obligation as the principal party and can be treated as owing that obligation directly and separately from that party.

If you seek a guarantee from a real person (not a body corporate – known as a "personal guarantee") it is also very important to ensure that the guarantor is a person that has a vested interest in the business or you will need to take further steps to make sure that there is nothing in the background that could make the guarantee unenforceable.  

Personal guarantors can sometimes avoid enforcement of a guarantee if they were subject to duress from the principal debtor, or lacked clear understanding or some form of incapacity that led to the signing of the guarantee or because the debtor is able to exert some form of undue influence over the person providing the guarantee. There are a number of ways to try and avoid this sort of enforceability issue, but the best way to ensure this form of guarantee is enforceable is to ensure that the guarantor first obtains independent legal advice.  New Zealand Courts largely follow guarantee enforcement principles set down in a case known as Royal Bank of Scotland Plc v Etridge (No. 2) [2002] 2 AC 773 which (to generalise) makes it clear that in all but the most exceptional circumstances, a creditor can enforce a personal guarantee against a debtor that has received independent legal advice.

Last, quite separately from any guarantee you obtain, you should also obtain an indemnity from the person providing a guarantee. An indemnity is a different obligation at law from a guarantee and can sometimes be enforceable when a guarantee is not. A guarantee is an obligation to answer for another person's default. If a borrower has defences against a claim by you, a guarantor will have the same defences as a borrower.  An indemnity is a separate obligation by the person providing the indemnity to indemnify you for loss however caused.  A carefully drafted, separate indemnity may therefore be enforceable where a guarantee is not.

In summary, a guarantee can be a good way of protecting yourself from a client or customer's insolvency, but you should make sure that the person providing the guarantee is creditworthy and the guarantee itself is enforceable – and you have an indemnity available as a back-up.

We are happy to help draft or advise on any guarantee or indemnity matters you may require assistance on.

Please contact:

Andrew Knight on (021) 729 470 (aknight@mcveaghfleming.co.nz)

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