CHAPTER 15

GUARANTEES

Introduction

A guarantee is “a written promise by one person to be responsible for the debt, default or
miscarriage of another incurred to a third party”. A guarantee is essentially an undertaking by a
third party, known as the guarantor to a Bank to be responsible for the default of a debtor in the
settlement of the debtor’s obligations.

Legal Requirements for a Valid Guarantee

In Ghana guarantees are governed by the Contracts Act 1960 Act 25. Section 14 (1) of the act
provides that a contract of guarantee shall be void unless it is in writing and signed by the
guarantor or his agent or is entered into in a form recognized by customary law – Elluah V
Ankumah 1968 GLR

Guarantees and Indemnities

To be enforceable, the original guarantee contract must be enforceable. In Coutts and Co, V
Brown Lecky 1947 a bank lent money to a minor who failed to repay. The bank tried to enforce
the guarantee provided. The court held that the bank could not do so since the guarantee was
linked to a transaction that was not legally enforceable. The case is relevant to undischarged
bankrupts and companies acting ultra vires. Banks overcome this by inserting an indemnity
clause which makes a bank guarantee both a guarantee enforceable against the principal
debtor, with the guarantor bearing the secondary liability and as an indemnity where the
guarantor is primarily liable. . An indemnity is a primary liability which in effect means payment
will be made in any case, while the guarantee is a secondary liability.

The second difference is that an indemnity does not have to be in writing e.g. agent and
principal; forged share transfer form – Sheffield Corporation V Barclay 1905.

In Mountstephen V Lakeman [1871] it was held that an indemnity imposes a primary liability to
pay and need not be evidenced in writing.

Liabilities Covered

A guarantee may either be specific or continuing.

Specific guarantee – covers one specific transaction

Continuing guarantee – covers present or future debts and prevents the rule in Clayton’s case
operating to the bank’s disadvantage

Types of Guarantee - Sole Party and Multi-party

A guarantee may be offered by one party, whereby it is termed a sole party guarantee or by
more than one party whereby it is termed a multiparty guarantee.

In a multi-party guarantee, all guarantors must sign the unaltered form:

 In National Provincial Bank V Brackenbury 1906 the fourth guarantor died before
signing. None of the guarantors was liable.

 In James Graham & Co. Timber Ltd V Southgate Sands & Others 1985 the fourth
guarantor’s signature was forged. The court held that it was not enforceable against any
party.

 In Ellesmere Brewery Co. V Cooper 1896 the fourth guarantor altered the amount for
which he was liable and signed. The guarantee was not enforceable.

Multi party guarantees may be joint, several or joint and several. They may also be either
supported or unsupported with the guarantor’s personal assets, to cover lending to the principal
debtor who may be a person or a company.

Where the guarantee is joint, the bank can proceed against the guarantors in the event of the
debtor's default only jointly (together at the same time). Secondly in the event of death of one
guarantor, the obligation devolves on the remaining guarantors and not the estate of the
deceased.

In the case of a joint and several guarantee, in the event the debtor defaults in paying back the
facility, the bank can proceed against the guarantors jointly (at the same time) or severally (at
different times) against individual guarantors. A late guarantor's liability also devolves on his
estate.

In the case of joint and several guarantees given by directors the bank must consider the
following issues:

 It is important to check whether company regulations empowers directors to offer such

guarantees
 The bank should also consider the possibility of conflict of interest and commercial
justification for the borrowing
 A board resolution should be taken to serve as authority from the company for the borrowing
to be contracted.
 Joint and several guarantees are taken especially where there is some doubt about
repayment possibilities
 The bank must take care to avoid ill will especially in circumstances where the directors do
not understand the import of the guarantee.

Advantages of Joint and Several Guarantees

 Whole debt can be enforced separately consecutively (one after the other) or jointly (all at
once)

 In the event of death, bankruptcy or mental incapacitation, the bank can claim from the
estate of the deceased or representatives of the other two.

 The credit balance in the name of the guarantor or surety can be used to recoup the money
through set off.

Letters of Comfort
In some instances, company regulations may prevent a company from providing a guarantee
covering its subsidiary’s borrowing. Again, some companies may not wish to enter into such
guarantees because they have to be disclosed in their financial reports as contingent liabilities.
In such situations, they may be prepared to issue a letter of comfort to the bank. A letter of
comfort is letter providing comforts to the lender in lieu of the guarantee to enable the lender
provide the facility.

The courts have held that the legal effect of a letter of comfort depends on the intention as
embodied in the word used in the letter. In Kleinwort Benson V Malaysia Mining Company,
the Parent company stated in the letter of comfort that it is its general policy to ensure that its
subsidiaries meet their financial obligations. The court of appeal held that it was not legally
binding on the parent company to settle the debt. Since the letter did not expressly promise that
such a policy would be continued in the future.

Duties of the Bank

Duty of Disclosure before security is signed

It is important to know that a guarantee is not a contract “uberrimae fidei” i.e. of utmost good fait
and as such, the bank does not have a general duty to pass on information about the principal
debtor to the guarantor

In Hamilton V Watson, the court stated that the banks should disclose anything that might not
naturally be expected to take place between the debtor and the creditor to that effect that the
surety’s position shall be different from that which he naturally expects.

In Cooper V National Provincial Bank 1945, where the principal debtor’s account could be
operated by his wife, who was an undischarged bankrupt, the court declined to set the
guarantee aside. The court held that it was within the category of what the guarantor could
naturally expect in the contract between bank and customer. The guarantor is required to make
his own enquiries.

Again in Lloyds Bank V Harrison 1925 the guarantee was not set aside where the bank did
not disclose that the principal debtor was in serious financial difficulties when the guarantee was
taken and that the bank manager was predisposed to giving advice to the customer regarding
the business. The court rejected the claim of the guarantor that this amounted to control of the
customer’s business.

In Cornish V Midland Bank plc 1985 it was held that the bank has no duty to explain the
nature of a guarantee document to a customer. However if it volunteered to do so then it had
the duty not to misstate the position.

Also in O’hara V Allied Irish Bank 1984 it was held that a bank has no duty to explain the
nature of the document to a stranger (non-customer)

Risks to the Bank in Taking Guarantees

The major risks encountered by the bank in taking guarantees are:

 Guarantor’s claim of forgery

 Guarantor’s claim of ‘non est factum’
 Guarantor’s claim of misrepresentation or misapprehension
 Guarantor’s claim of undue influence

Forgery

A forged signature is no signature – section 22 Bills of exchange Act. James Graham Timber
Co. Ltd V Southgate Sands 1985 – signature of one of the joint and several guarantors forged.
First National Security V Hegarty 1985 – girlfriend forges wife’s signature.

Non est factum

This cannot succeed if claimant has been careless e.g. in Saunders V Anglia Building
Society 1970 where an old lady failed to put on her glasses to read the document in question.

For a claim to be successful:

 The one should have a disability

 The document should be radically different from what she thought she was signing.
 The one should not have been careless and should have taken every precaution to
ascertain the contents and significance.

Misapprehension/Misrepresentation

The Bank must correct any misapprehension and not create any misrepresentation

The terms of the guarantee must not be misrepresented to the customer. At law,
misrepresentation entitles the party misled to avoid the contract whether misrepresentation was
innocent, negligent or fraudulent. A transaction may be set aside for misrepresentation or undue
influence, whether procured by the Bank or customer.

To prevent misapprehension e.g. where the guarantor thinks the debtor has no other liabilities.
The bank must correct any likely misapprehension at the first opportunity.

In Barclays Bank V O’Brien, the wife thought the charge on the matrimonial home was limited
in value to GBP 60,000.00

In Lloyds Bank V Waterhouse, the illiterate farmer thought the guarantee was for the purchase
of a new farm. However it was an unlimited guarantee.

However, the bank must have in contemplation its duty of secrecy under Tournier V National
Provincial (1924) –. If the security is third party, he must arrange a meeting between the bank,
debtor and mortgagor/guarantor

Mckenzie V Royal Bank of Canada (1934) it was held that the bank mistakenly advised a
potential guarantor that other securities will be realized unless she entered into the guarantee. It
was deemed unenforceable.

In Royal Bank of Scotland V Greenshields 1914, – not answering direct questions of the
guarantor
Undue influence

Undue influence occurs when one party to a contract is unable to exercise his own freewill on
deciding whether or not to enter the contract. Undue influence occurs only in third party
securities and occurs in a situation where surety is not allowed to exercise his own free will

The courts have identified two main classes of undue influence. These are:

 Class 1 Undue Influence – this amounts to actual undue influence

 Class 2 Undue Influence – this is when the law will presume that there has been undue
influence. Class 2 undue influence is further divided into two classes
o Class 2 A – where there is conclusive presumption of undue influence from
relationship where there is a clear trust/dependency relationship
o Class 2 B – where the guarantor has to prove the existence of a relationship of trust
before the court will presume there is a presumption of undue influence..

Under Class 2A Undue influence is presumed in the following situations:

 Parent and dependent child (when it is the child raising undue influence by the parent)

 Guardian and ward

 Doctor and patient

 Solicitor and client

 Trustee and beneficiary

 Religious advisor and disciple

Presumption of undue influence must be rebutted by the party attempting to enforce the security
contract.

In the case of Class 2B e.g. parent and child (when it is the parent who is raising undue
influence) and banker and customer, undue influence must be proved by the guarantor. The
courts will consider undue influence to have arisen if it is proven that there is an appropriate
degree of trust, confidence or influence.

For a claim to succeed where there is a presumption of undue influence, the following
conditions must be present:

 Undue influence must be exercised by the bank or its agent – Kings North Trust V Bell
Avon Finance Company Ltd. V Bridger 1985

 The bank must have actual or constructive notice of undue influence – Midland Bank V
Perry 1987
 The transaction must be manifestly disadvantageous to the claiming party – National
Westminster Bank plc V Morgan 1985

If the claimant is unable to establish presumed undue influence, it is open to him to try to prove
actual undue influence, termed class 1 undue influence. The requirement here is for the
claimant to show that the other party had the capacity to influence him, the other party so
influenced him, that the influence was undue and that it caused the complainant to enter into the
transactions. It is not necessary for the complainant to show manifest disadvantage – CIBC
Mortgages V Pitt 1994 AC 200 HL

Undue influence by the Bank

Undue influence by the bank occurs when the bank gives the guarantee form to the principal
debtor to be given to the guarantor or in rare cases where the bank has some influence on the
guarantor. In Lloyds Bank V Bundy 1975 an old farmer tended to rely very much on the
advice of a bank and signed a guarantee form in favor of his son. His total liability under the
guarantee was more than he had accepted and the courts decided that the facts of the case
showed that there had been undue influence. In Lloyds Bank V Bundy it was stated that undue
influence by the Bank has been found to be rare

Overcoming Undue Influence

It is not advisable for the Principal debtor to obtain the guarantor’s signature. Apart from the
obvious risk of a forged signature, the principal debtor will almost certainly be deemed to act as
the Bank’s agent and the bank would be responsible for any misrepresentation or undue
influence.

Undue influence can be overcome by insisting the guarantor secures an independent solicitor. A
clause can be incorporated in the guarantee document to the effect that such independent
advice has been provided: “signed by the above-named after the contents have been explained
to him by me”.

If the guarantor is not willing to take this route, he will be asked to sign a “free will clause”.

Additional Duties the Bank Owes to the Guarantor

In Standard Chartered Bank V Walker & Walker 1985 it was held that a receiver appointed by
the bank owed a duty to the guarantor to obtain the true market price value of any direct
security. However, the bank should not interfere.

This can be contrasted in the decision in China & Southsea Bank Ltd. V Tan San Gin 1989
where increased liability was due to a fall in price of shares held as security.

Specific Clauses in Bank Guarantee Forms

 Whole debt clause – removes a co-guarantor’s right of subrogation until the whole debt has
been paid.

 Determination of guarantee by notice

 Death does not determine guarantee – Beckett V Addyman 1882

 Continuation of account despite determination of guarantee

 Consideration clause which states that the guarantee is being granted in consideration of
the bank granting the facility to the principal debtor.

 Payments can be made into a suspense account – this clause allows the bank to prove in
the insolvency of the principal debtor for the whole amount whilst having the guarantor’s
payment in the suspense account.

 Power to open new account on determination of guarantee

 Guarantee remains the property of the bank

 Conclusive evidence clause

 Change in constitution of parties. This clause will state that the guarantee continue to bind
the parties irrespective of the change in constitution of the principal debtor.
o Under section 15 (1), of the Contracts Act 1960 Act 25 a continuing guarantee given
to a third person (e.g. the bank) in respect of the transactions of a partnership is, in
the absence of agreement to the contrary, revoked as to future transactions by any
change in the constitution of the partnership. This means where the constitution of
the partnership is changed, the guarantee is revoked in the absence of agreement to
the contrary
o Section 15 (2) also provides that a continuing guarantee given to a partnership is not,
in the absence of agreement to the contrary, revoked by any change in the
constitution of the partnership.
 Indemnity clause – this makes the guarantor primarily liable in the event that e.g. the
principal does not have capacity to borrow.

 Security from debtor – the guarantor undertakes not to take security from the debtor

 Action against principal debtor – not allowed unless guarantors have paid the full debt.

 Clause excluding guarantor’s common law rights in the event of variation, release,
compounding and granting of time. For example any variation e.g. change in interest will
extinguish the guarantor’s liability. If the bank releases any of the principal debtor’s security,
the guarantor’s liability will be reduced by the lost amount. By compounding the lender
accepts less than full payment. Under common law, the guarantor is also discharged when
the principal debtor is granted time.

Rights of Guarantor

 Section 16 (1) of Contracts Act provides that where the guarantor pays off the creditor,
he can take over the securities held by the creditor in respect of the debts. He is deemed to
have done so on the implied authority of the principal debtor until the principal debtor pays
him

 A guarantor has the right of contribution from co-guarantors.

 He can claim indemnity from the principal debtor

 He has the right to know the extent of liability

 He has the right to be informed of any facts that would naturally dissuade him from entering
into the guarantee – Hamilton V Watson

Advantages of Guarantees as Security

 Easy to take

 Lack of formality, registration procedures

 Can easily be enforced by court action

 As with any other third party security, it can be ignored when claiming against the principal
debtor.

 Moral dimension – borrower less likely to default

 If given by a director, it increases his commitment to let the project succeed

 Funds can be placed in a suspense account – Re Sass 1896

Disadvantages of Guarantees

 Depends on financial stability of guarantor

 A technicality may defeat the bank’s claim especially in the case of company guarantees

 May result in bad feeling

 Litigation may be necessary to enforce payment especially with unsupported guarantees.

 Early settlement may result in the credit being reclaimed as a preference