It is important that people understand what it means to have a suretyship versus a guarantee document signed, whether as the person signing it to offer security for someone else’s debts, or as the person who is owed a debt by someone else and requires additional security for it. In circumstances where one can negotiate the type of document to be signed in respect of a debt owed, an understanding about the differences between a suretyship and a guarantee will be vital.
This article is based on what is wording that is commonly found in suretyship and guarantee documents, but of course the wording can differ, which could change some of the points detailed below.
What is a Suretyship?
There are 3 players involved in a suretyship relationship: the ‘creditor,’ who is owed money by a person (who is called the ‘principal debtor’), and the ‘surety’ who undertakes to pay to the creditor the outstanding debt owed by the principal debtor IF the principal debtor failed to meet its payment obligations (i.e. defaults on the loan) without lawful reason. The creditor and the surety must sign a written agreement to record the suretyship obligations.
How do Suretyships differ from Guarantees?
There are a variety of different types of guarantees, but in general, the key differences between a guarantee and a suretyship are these:
- Even if the suretyship wording is recorded in a separate document to the loan agreement, the validity of the suretyship document is dependent on the validity of the loan agreement. Guarantees however are not dependent on the validity of the loan agreement, so even if something invalidates the loan agreement, the guarantor can still be called on by the creditor to pay.
- While suretyships are essentially secondary obligations owed to a creditor (and as such a surety can only be called upon to pay if the principal debtor failed to pay), guarantees are primary obligations owed to a creditor, and as such the guarantor’s obligations to the creditor rank equally to the principal debtor’s obligations to the creditor, and the guarantor can be called on to pay the creditor even if the principal debtor has not breached the payment terms.
Recent case law also confirmed that even though a suretyship may include the very common words that “the surety binds himself/itself as surety and co-principal debtor in solidum with the principal debtor” does not change the sureties obligations under that document from a secondary obligation to a primary obligation. In other words, by including those words, the surety did not undertake a separate independent liability as a principal debtor.
[see the case Liberty Group Limited v Illman (1134/2018)[2020] ZASCA available at http://www.saflii.org/za/cases/ZASCA/2020/38.html.]
The effect of the National Credit Act on Suretyships and Guarantees:
If a loan (or other credit facility or credit transaction) falls within the ambit of the National Credit Act, No. 34 of 2005 (“NCA”), then the suretyship that is signed to secure that loan ALSO falls within the ambit of the NCA. And because a surety is entitled to the same defences as the principal debtor (other than those that are personal to the principal debtor), the surety gets the defences and protections available under the NCA (including the defence of reckless lending), and the creditor must ensure it complies fully with the NCA when it calls for payment under the suretyship.
As mentioned above, a key feature of suretyships is that the validity of the suretyship agreement is reliant on the validity of the credit agreement. On this basis, if the credit agreement is unlawful and therefore void because it did not comply with the NCA, the suretyship is also void, and so the surety escapes having to pay the creditor. This is however not the same for guarantees which will not become void just because the loan does.
The effect of Business Rescue under the Companies Act on Suretyships and Guarantees:
If a principal debtor is a juristic entity and is placed under business rescue in the terms of the Companies Act, No. 61 of 2008 (“Companies Act”), and the business rescue plan that is put in place discharges or decreases the debt that was owed by the principal debtor to the creditor, the surety’s obligations under the suretyship document are likewise discharged or decreased. However, the guarantor’s obligations are not discharged or decreased and the creditor can still pursue the guarantor for the full guaranteed amount.
So who wants which document signed?
If you are the creditor- you will ideally want a guarantee signed to best protect repayment of the debt owed to you, and to potentially escape the ambit of the NCA and any compromise on the collection of the amount of debts if the principal debtor is in business rescue. For the opposite reasons, if you are the person offering to sign a suretyship or guarantee in respect of debt someone else owes a creditor, you will far prefer to sign a suretyship and not a guarantee.
Drafting, reviewing of advising on Suretyships or Guarantees
We would be happy to offer our services to assist with drafting, reviewing or advising on any suretyship or guarantee documents, whether on behalf of a creditor or a surety/guarantor. Please give us a call!