What is the difference between a Suretyship and a Demand Guarantee?
When you want to secure any debt owed to you by a third party (such as a borrower, tenant or purchaser under an extended credit term agreement), there is a big difference between getting a Suretyship or a Demand Guarantee signed in your favour. The differences are as follows:
- Suretyships:
- a surety’s obligation is accessory, or secondary, to that of the principal debtor;
- under a suretyship agreement, the person signing as surety undertakes that the principal debtor will perform his (the principal debtor’s) obligation to the creditor (i.e. the lender) and that he (the surety) will be liable to the creditor if the principal debtor does not perform.
- the intention of the parties who sign the suretyships agreement is that the surety will be called upon to pay (or, instead, to perform the principal debtor’s obligations under the underlying contract) only if the principal debtor defaults in performance, and then only to the extent of the principal debtor’s liability and subject to any defences available to the principal debtor.
- Demand Guarantees:
- a demand guarantee creates a primary duty which is not materially conditional on bringing proof of the breach or failure of the primary obligor (i.e. the debtor) under the transaction.
- under a demand guarantee, the guarantor must pay if the documents presented with the demand for payment from the creditor (i.e. the lender) comply with the documents that are mentioned in the text of the demand guarantee, and even if the lender and the debtor have not stipulated that there is a default under the original underlying contract.
- as such, a guarantee is not linked to the performance by the debtor in respect of the underlying contract.
- a guarantee will usually contain wording such as:
“the guarantor hereby (as principal obligor and not merely a surety), irrevocably, unconditionally and on the basis of a several and discreet obligation enforceable against the guarantor whether or not any or all of the guaranteed obligations are enforceable against the debtor”
Therefore the fundamental difference between an accessory suretyship and a demand guarantee is that the liability of a surety is secondary, whereas the liability of the guarantor is primary.
How does Business Rescue under the Companies Act affect Suretyships and Demand Guarantees?
Since the Business Rescue sections recorded in the new Companies Act (no. 71 of 2008) came into effect, the distinction between having a suretyship or a demand guarantee signed to secure any debt owed to you by a COMPANY OR CLOSE CORPORATION has become very significant.
- Business Rescue and Suretyships
Once a business rescue plan is adopted under the Companies Act, a creditor may lose its ability to claim against a surety. This is because the suretyship is accessory / secondary in nature, so if the underlying debt is discharged, the claims against the surety also end.
What creditors can do: creditors can claim against sureties before a business rescue plan is adopted, make sure that their rights of recourse against sureties are provided for in the business rescue plan, and ensure their suretyship agreements specifically preserve the creditor’s rights to recover from the surety despite discharge of the principal debt in a business rescue plan.
- Business Rescue and Demand Guarantees
The Business Rescue process has no effect on a creditor’s rights to claim against a guarantor under a demand guarantee, as the guarantee is a primary obligation.
What if you signed the Suretyship/Guarantee by mistake?
The Supreme Court of Appeal recently held in Airports Company SA Limited v Masiphuze Trading (Pty) Ltd, that a party who had signed as a surety for a landlord’s claims under a lease agreement could not rely on the defence of ‘justifiable error’ to avoid being bound by the suretyship agreement. This defence can be used if the error is reasonable and is not induced by the other party to the contract. It depends on the facts. In this case the court held that the surety was an experienced businessperson, and he did not check the documents he was signing, which was not reasonable. In addition, the court held that the other party did not mislead the surety in any way when he signed the suretyship, and the suretyship agreement was not ‘obscure’ or ‘hidden away’ within the bundle of documents to be signed.