Guarantees of non-performing loans and other liabilities – guaranteed success?

January 2025 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

January 2025 Issue

In theory, guarantees – both personal and corporate – are supposed to be contractual promises that provide certainty to the beneficiary that a guarantor will discharge another party’s debt or obligation in the event of default by that other party. However, in practice, the certainty presumed by entry into such documentation is often far from guaranteed, at least without court or arbitration proceedings being required. This is particularly relevant in the current climate – with economic hard times leading to increased default and fraudulent borrowing, lenders turning their attention to other routes to recovery, and indeed banks and other financial institutions looking to trade their non-performing loan portfolios. This article will seek to explore in outline some of the common pitfalls with guarantees, the types of defences relied upon by guarantors, and how these issues might be avoided or navigated.

Was the guarantee ever given? Surprisingly, it is not uncommon for there to be argument about whether a guarantee was ever entered into as a matter of fact or law. We have seen this manifest in many forms, such as whether the guarantee complied with the requirements of the law under which it was purportedly made, whether it was validly executed and indeed whether the guarantor ever signed the guarantee itself – including questions as to whether the signature on the documentation is genuine. Indeed, by legislation from 1677, a guarantee must be in writing and signed by the guarantor or some party authorised by the guarantor. The best way to ameliorate such risks is to seek to ensure that the process of obtaining a guarantee is a robust one, which ideally involves lawyers and is properly documented. The record-keeping process also needs to be robust – guarantors sometimes struggle to access the documents that prove what actually happened.

Duress or undue influence. Another defence increasingly being relied upon by guarantors is that they were under duress or unduly influenced, pressured or coerced into entering into a guarantee. We have had cases where this has been argued by defendants in various forms, for example: (i) financial pressure; (ii) political pressure; (iii) threats; and (iv) scenarios where undue influence is presumed by reason of the nature of the relationship between the parties. Again, properly documenting the process by which the guarantee is obtained is key, including seeking to ensure that the guarantor has the benefit of independent legal advice.

Misrepresentation. A similarly common defence for guarantors is that that they were induced into entering the guarantee in reliance upon a misrepresentation, whether fraudulent or negligent. This can include, for example, misrepresentations as to the state of indebtedness of the borrower (which can trigger consideration of 19th century legislation) or the scope of the guaranteed obligation. In such cases, having a full documentary record can be key in undermining such defences.

Regulation and statute. Sometimes there are regulatory requirements of which beneficiaries can fall foul. For example, we have been involved in cases where the underlying lending constitutes a regulated activity under the Financial Services and Markets Act 2000 such that the agreement is unenforceable. It is therefore important to ensure that any arrangements comply with regulation. Similarly, consumer rights and unfair terms legislation sometimes needs to be considered. In certain circumstances, a guarantor might argue that certain clauses are unfair as a matter of statute and therefore unenforceable. There are various relevant factors in this regard, and therefore before entering any suite of documentation, beneficiaries should seek to ensure that they ameliorate the risk of any terms being held to be unfair.

Guaranteed obligation. There can sometimes be a question as to whether the guarantee relates to the underlying obligation or liability in respect of which it is being called upon. This is often a matter of drafting, so it is prudent to seek to ensure that the documentation pertaining to the underlying liability dovetails with the guarantee documentation. This is not only initially when the obligations are entered into, but if any changes are made to the underlying obligation so that the guarantee is updated to be consistent with those changes.

Demands. Before pursuing a guarantor, there will often be a need to make a formal demand first. To avoid any suggestion of a demand being, for example, non-compliant with the terms of the guarantee, it is important that the demand complies with any contractual requirements and contains sufficient detail and clarity such that the recipient can understand the basis for the demand and what is being demanded.

Waiver, etc. Guarantors will often argue that the beneficiary of the guarantee has waived its rights or agreed not to enforce them for a period of time or taken some step or made some representation which prevents the beneficiary from seeking to enforce the guarantee, whether temporarily or permanently. Accordingly, as soon as it becomes apparent that a guarantor may not satisfy its obligations, it is prudent to involve lawyers to seek to ensure that any steps taken – for example, by way of negotiation – do not unwittingly give a guarantor extra time or an opportunity to argue that the beneficiary agreed not to pursue any claim at all. The terms of the contract may equally be relevant to the issue.

Dispute resolution clause. If a liability is outstanding, then how is the position to be resolved? While negotiation can sometimes be fruitful, and on occasion is mandated by the terms of the guarantee, there are many instances where the beneficiary of the guarantee has no option but to pursue legal proceedings, whether by court litigation or arbitration. In our experience, it is common for a recalcitrant guarantor to seek to make an issue about the proper forum for a legal claim. That can manifest in many forms, for example because of: (i) the lack of any dispute resolution clause in the documentation; (ii) the clause being incomplete, inconsistent or open to different interpretations; or (iii) the nature of the clause providing for different options. Where there is room for doubt, there may also be a strategic advantage for the guarantor in commencing proceedings in a particular jurisdiction. That may, for example, be due to the opportunity to benefit from the legal tools available in that forum – such as the wide variety of tools available in England to creditors including worldwide freezing orders and search orders. There might also be time or cost benefits in selecting a particular jurisdiction, and indeed a forum might be preferable because that is where the guarantor or its assets are located. Taking legal advice when drafting dispute resolution clauses, and when seeking to rely upon them, is key. This equally applies to the selection of, and reliance upon, the clause in the documentation that sets out the law to govern any disputes.

Limitation. If a guarantor intends to start legal proceedings, it should make sure that they are commenced in good time, otherwise any claims risk being time-barred. There may be a provision in the documentation setting out the deadline for proceedings to be commenced, alternatively lawyers will be able to advise upon the deadline as a matter of law.

As with other forms of security, guarantees have an important function in that they seek to provide comfort that a guaranteed obligation will be performed, therefore facilitating an underlying transaction to take place. However, nothing is ever completely guaranteed. It is apparent that guarantees do not necessarily do what they say on the tin – at least, not initially – without sufficient care being taken as to both their entry, management and enforcement.

Jon Felce is a partner at Cooke, Young & Keidan LLP. He can be contacted on +44 (0)20 3409 6085 or by email: jon.felce@cyklaw.com.

Jon Felce

Cooke, Young & Keidan LLP