Understanding Contracts of Guarantee:
A contract of guarantee is typically used in commercial and financial agreements, such as loans, leases, and contracts. A ‘Guarantee’ was defined in Chami v. U.B.A Plc (2010) 841 SC as “a written undertaking by one party (guarantor) to assume responsibility for a third party’s obligation (typically a debt) should that party fail to perform”.
A contract of guarantee, though often not perceived as a form of security due to the absence of an interest in specific property, is in fact a legally recognized and enforceable form of security. While it is preferable to obtain a guarantee rather than to proceed without any form of security, in many cases, guarantors remain unaware of the seriousness of their obligations, particularly where the principal debtor has consistently met their obligations. This is because these guarantors enter into contracts of guarantee routinely or as a mere formality, without reviewing the terms or appreciating the legal implications.
The true extent of the guarantor’s liability often only becomes apparent upon the default of the principal debtor, at which point the guarantor may face significant legal and financial consequences. Accordingly, due diligence and a thorough understanding of the terms are essential before entering into any contract of guarantee.
Conditions for a Valid Guarantee
For a guarantee to be enforceable, the following conditions must be met:
- Existence of an agreement between the parties;
- The agreement must be in writing, and if not under seal, it must be supported by valuable consideration.
- Absence of fraud;
- No element of illegality.
When Does a Guarantor’s Liability Arise?
A guarantor’s liability is secondary, arising only upon the default of the principal debtor, unless otherwise specified. This liability crystallises immediately when the third person is unable to pay its outstanding debt. Thus, a guarantor is technically a debtor because, where the principal debtor fails to repay a debt, the guarantor will be called upon to pay the loan so guaranteed. In African Insurance Dev. Corporation V. Nigeria Liquefied Natural Gas Ltd (2000) 4 NWLR (Pt 653) 494 at 505 – 506, the Supreme Court stated that:
“The fact that the obligations of the guarantor arise only when the principal has defaulted in his obligations to the creditor does not mean that the Creditor has to demand payment from the principal or from the surety or give notice to the surety before the creditor can proceed against the surety Nor does he have to commence proceedings against the principal whether criminal or civil, unless there is an express term in the contract requiring him to do so This ruling empowers creditors to act swiftly against guarantors without exhausting remedies against the defaulting debtor.”
A guarantor holds significant responsibility for a debt if the principal debtor defaults, assuming primary and joint liability, meaning they can be sued independently or with the debtor. This liability may continue for future obligations if the guarantee remains active. In cases involving multiple guarantors, each is accountable according to the terms of their agreement. Even after revocation of the guarantee, the guarantor remains liable for any debts incurred prior to the notice of revocation.
Rights and Protections for Guarantors
Though secondary in liability, guarantors have legal protections, including:
- The right of subrogation: After fulfilling their obligation, guarantors can assume the rights of the principal creditor against the principal debtor to recover sums paid.
- The right to insist that the creditor first exhaust remedies against the principal debtor or collateral, if contractually stipulated.
- The right seeks indemnification from the principal debtor to settle the debt, including costs or interest incurred where the principal creditor sues them successfully.
- The guarantor is protected where the Guarantee is invalidated by actions of the principal creditor. There exists a burden of proof on the principal creditor to establish that it performed its obligations successfully and the debtor breached the terms of the contract, which must be discharged before the liability of the guarantor can arise or would arise. This is because equity will not allow a person to profit from its deliberate wrongdoing, and a party cannot rely upon their own wrongdoing. See NITEL Trustees Ltd v Syndicated Inv. Holdings Ltd (2023) 5 NWLR (Pt. 1876) 93 at 121, F-G. The Guarantor may decide to seek relief afterwards.
- The right to invoke defences available to the principal debtor, such as:
- Force majeure
- Common law doctrine of frustration of contract
A contract of guarantee is distinct from the principal contract, so the guarantor may have additional independent defences depending on the nature and terms of the contract. For example, where there is a revocation clause (by notice) or death of the principal debtor (provided it occurred before the guarantor was proceeded against).
Discharge of Guarantee Obligations
A guarantor can only be released from their liability under the contract once the conditions outlined in the loan agreement are fulfilled. Discharge of liability is possible under the following:
- Full satisfaction of the obligation;
- Extinguishment of the principal debt by the parties;
- Expiry of the limitation period;
- Judicial presumption terminating the contract.
Limitation Period and Acknowledgement of Debt
Rights of action founded on simple contracts (including guarantees) must be initiated within six years from the date the cause of action accrues. However, where the guarantor is liable or accountable for the claim, acknowledges or makes any payment against the claim, the right is treated as having accrued on the date of the acknowledgement or payment.
Conclusion
Guarantee contracts play a vital role in commercial transactions. While guarantors provide critical credit support, they must fully understand the scope and implications of their liability. Similarly, creditors must ensure compliance with legal and contractual procedures to enforce guarantees effectively.
