VocabuLaw

Guarantee

What is it and what does it mean?

Description of the legal term Guarantee:

In the context of British law, the term guarantee refers to a contract whereby a person (the guarantor) agrees to be responsible for the debt, default, or failure in duty of another (the principal debtor). The guarantee is an ancillary contract that typically requires consideration to be valid and is subject to the statute of frauds, meaning it needs to be in writing to be enforceable. This type of legal agreement is widely utilized in financial transactions, where lenders require an additional level of security when providing loans to individuals or businesses.

The guarantee should be distinguished from an indemnity, which is a contract to compensate for any loss suffered, and as such, does not require the default of a third party for it to take effect. A guarantee is contingent and dependent upon the principal debtor’s failure to fulfill their obligations, and this is what distinguishes the two.

Another notable characteristic of a guarantee is that it is generally a secondary obligation. It comes into play only when the principal debtor fails to fulfill their obligations. The guarantor’s liability is co-extensive with the principal debtor; it cannot exceed what is required of the principal debtor. Guarantors are entitled to the benefit of any defense that would have been available to the principal debtor.

Further, guarantees can be either limited or unlimited. A limited guarantee is one where the guarantor’s liability is capped at a specific amount, while an unlimited guarantee means the guarantor could be liable for the full amount of the debt plus any interest or costs accrued due to the default.

Guarantees are also subject to certain defenses unique to suretyship, such as the discharge of a guarantor due to variations in the terms of the principal contract unless consented by the guarantor, or if the lender has released security without the guarantor’s consent.

Legal context in which the term Guarantee may be used:

Consider the situation where a small business owner is looking to take out a loan to expand their operations. The bank, however, is concerned about the creditworthiness of the business and is not willing to give the loan on the sole credit of the business. In this case, the bank may ask for a guarantee from a third party, usually someone with a stronger financial standing, such as the business owner personally or another company with a substantial net worth. If the business owner agrees and signs a guarantee contract, they agree to pay the loan in case the business fails to do so.

In another case, a parent might provide a guarantee for their adult child’s mortgage. Here the parent does not transfer funds but agrees to fulfill the mortgage obligations should the child default. This provides the lender with a greater level of confidence in lending to the child, potentially securing a contract that might not have been possible based solely on the child’s financial situation. However, should the child fail to make their mortgage payments, the parent would then be responsible for making these payments, up to the limit specified in the guarantee, if it is a limited one.

The term guarantee is essential in the British legal system as it provides a safety net for lenders and allows for better access to credit for borrowers who might otherwise be unable to secure necessary financing. Guarantees help in spreading the risk of lending and can facilitate economic transactions that might be too risky to undertake without such an arrangement, therefore playing a significant role in the functioning of the British economy and legal practice.

This website is for informational purposes only and may contain inaccuracies. It should not be used as a substitute for professional legal advice.