Personal Security: Guarantees, Indemnities, and Protection of the Surety
Personal securities are forms of security that are enforceable against a person rather than against goods. They are usually created through contracts of suretyship, where a third party, the surety, guarantees the performance of an obligation or the repayment of a debt.
A common example is when a parent company guarantees the debts of its subsidiary, or when a guardian guarantees a loan taken by a minor. In such arrangements, the creditor has two sources of security: the principal debtor and the surety. If the principal debtor fails to perform, the creditor can demand performance from the surety.
1. Guarantee vs. Indemnity
Contracts of suretyship take two main forms:
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Contracts of guarantee: The surety has secondary liability. The principal debtor is primarily responsible, and the surety steps in only if the debtor defaults.
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Contracts of indemnity: The surety has primary liability. The surety is directly responsible to the creditor regardless of whether the principal debtor has defaulted.
The distinction may appear subtle and is often determined by interpreting the wording of the contract. Courts generally look at the essential nature of the arrangement to decide whether it is a guarantee or an indemnity.
Example:
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A bank lends $50,000 to a small business. The director of the company signs a guarantee, promising to cover the loan only if the company defaults.
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If instead the director agreed to directly pay the loan regardless of the company’s performance, this would be an indemnity.
This distinction is important because guarantees require certain formalities under law, such as being in writing (Statute of Frauds), whereas indemnities may not. Guarantees are also co-extensive with the principal contract: if the principal contract is voided, the guarantee is usually void as well, but indemnities remain enforceable independently.
2. Formation of the Contract
Contracts of guarantee follow the usual rules of contract law. For example:
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Consideration: The creditor’s advance of money or provision of goods/services under the principal contract is usually sufficient consideration for the surety’s promise.
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Timing: Consideration must not be past; a guarantee made after the loan is granted is generally invalid unless there is a promise of further advancement.
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Writing requirement: Guarantees must be in writing and signed by the guarantor. Oral guarantees are generally unenforceable.
Example:
Courts interpret guarantees strictly in favor of the guarantor, reflecting the principle that entering a guarantee can expose someone to significant liability.
3. Relationship Between Surety and Creditor
Once a valid guarantee is in place, it creates a legal relationship between the creditor and the surety. The key points are:
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The surety’s obligation is not directly to pay, but to ensure the debtor performs.
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The creditor’s remedy against the surety is limited to damages if the surety fails to enforce the debtor’s obligations.
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The guarantee is co-extensive with the principal contract: the surety cannot escape liability by claiming the principal contract has been repudiated.
Example:
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A tech startup borrows $20,000. The CTO guarantees repayment. If the company fails to pay, the creditor can hold the CTO responsible. If the company fully repays, the guarantee is discharged.
4. Discharge of the Surety
A surety is released from liability when:
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The principal debtor performs their obligations.
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There are material changes to the principal contract without the surety’s consent, which can discharge the guarantee.
Example:
5. Protection of the Surety
Guarantees can be risky, particularly in consumer credit contexts. Legal protections exist:
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Pre-October 2015 guarantees: The guarantor may rely on protections under the Unfair Contract Terms Act (UCTA) and Unfair Terms in Consumer Contracts Regulations (UTCCR). These laws may protect guarantors when both they and the debtor are “consumers.”
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Post-October 2015 guarantees: Protections are covered by the Consumer Rights Act 2015.
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Business-to-business guarantees are still generally governed by UCTA.
These rules ensure that guarantors are not unfairly trapped by onerous or unclear contractual terms.
Example Scenario:
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Situation: A small design studio borrows $10,000 from a local bank. The director signs a guarantee, agreeing to cover the debt only if the studio defaults.
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Formation: The guarantee is signed in writing, following all statutory requirements. The bank’s advance of funds serves as consideration.
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Relationship: The director’s responsibility is secondary, meaning the bank must first pursue the studio.
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Discharge: If the studio repays the loan in full, the guarantee is discharged. If the bank changes the loan terms significantly without notifying the director, the guarantee may also be discharged.
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Protection: Since this is a small consumer-style loan, the director may rely on the Consumer Rights Act 2015 to challenge unfair clauses.
This example shows how personal security, guarantees, and protections for the surety function together to balance the interests of creditors and guarantors.
What is the key difference between a guarantee and an indemnity?
In a guarantee, the surety has secondary liability; in an indemnity, the surety has primary liability.
In a guarantee, the surety is always directly responsible; in an indemnity, the surety is secondary.
Which formality is usually required for a guarantee to be enforceable?
It must be in writing and signed by the guarantor.
It can be oral or written, with no signature required.
When is a surety discharged from liability?
When the principal debtor performs their obligations or if there are material changes to the contract without the surety’s consent.
Only if the principal debtor repays part of the debt.
What is the consideration that makes a guarantee contract valid?
The creditor’s advance of money or provision of goods/services under the principal contract.
The guarantor’s oral promise alone.
If a guarantee is co-extensive with the principal contract, what does this mean?
The surety’s liability is tied to the validity and terms of the principal contract.
The guarantee exists independently of the principal contract in all cases.
Which law governs consumer guarantees signed after October 2015 in the UK?
The Consumer Rights Act 2015.
The Unfair Contract Terms Act 1977 only.
In a guarantee, who does the surety primarily protect?
The creditor, by ensuring the debtor fulfills their obligations.
The debtor, by guaranteeing they won’t default.
