A guarantee is a binding promise from one person (the guarantor), to be answerable for the debt or obligations of another (the debtor or borrower), if that other person defaults. Guarantees become enforceable against the guarantor by the person to whom the guarantee has been given (the creditor) when debtors have defaulted on their obligations.
In this article, we consider the circumstances where a guarantee may be unenforceable. That can be good or bad depending on which side you are on.
A guarantee is a contract and will not generally be enforceable unless all of the formalities for legal contract formation have been satisfied. As such, like all other contracts, a contract of guarantee must be supported by consideration passing from the creditor to the guarantor, unless the contract takes the form of a deed.
Typically, a guarantee is given in consideration for the creditor agreeing to enter into some type of agreement with the debtor at the request of the guarantor. Accordingly, a guarantee should occur at the time of the provision of credit to the borrower or debtor, otherwise a guarantor can deny that it has received any benefit (which benefit may be merely the provision of a loan to the borrower) in exchange for giving the guarantee and in those circumstances the guarantee may not be binding.
In addition to the above:
- in states where the Statute of Frauds continues to apply, guarantees are required to be in writing; and
- if obligations of co-guarantors are joint and several (meaning each guarantor is both jointly and separately responsible for the obligations of the debtor and not necessarily in equal proportions), there is legal authority that a guarantee is not binding and is unenforceable unless each guarantor named in the document executes it.
Enforcement of guarantees
Even if a guarantee has been created in a manner which the law of contract considers to be binding, other laws are available to guarantors to avoid ttheir obligations on in the guarantee. These laws, which are discussed below, are found in legislation as well as the common law.
Misleading or deceptive conduct
Like any other contract, a guarantee can be set aside on the grounds that a party has entered into it acting on misleading and deceptive conduct on the part of the creditor or debtor. Most bank creditors will ensure that guarantors obtain independent legal advice in order to ensure that they understand and are not misled of their obligations.
Creditors have a limited general duty of disclosure to a guarantor. Guarantees have been set aside on the basis of a failure by the creditor to disclose unusual information such as the terms of the loan to the debtor in order for the guarantor to be able to properly consider the risks involved. The more onerous the loan, the more risk there is for the guarantor that the debtor may default and they will be called on to meet the obligations under the guarantee. Furthermore, if a guarantor asks a question of the creditor, the creditor must answer it truthfully. A creditor must also disclose the truth about any misapprehension or unfounded assumption a guarantor may be acting upon.
Duress or Undue Influence
If a guarantee is procured by duress or undue influence by the creditor or debtor, it may be voidable. To succeed, a guarantor would need to show that the provision of the guarantee was not an independent act of the guarantor, acting of its own free will, understanding of the terms of the guarantee and based on full information.
In Australia, in previous legal cases where a creditor (such as a bank) has relied upon ta husband to procure his wife’s consent to act as guarantor for a loan in circumstances where there has been actual undue influence upon her by the husband, the guarantees have been set aside other than in circumstances where the wife as guarantor has received competent and independent advice.
In the absence of undue influence, the Courts have found that it would be unconscionable for a creditor to enforce a guarantee against a wife (which can theoretically work in reverse with a husband) if she (or he) fails to understand the significance and effect of the transaction.
This is the most common ground for guarantors seeking to set aside a guarantee. Where it can be established that a guarantor was under a special disability or disadvantage in dealing with a creditor and the creditor has sought to take advantage of this situation, a court may set aside the guarantee. Examples of circumstances involving unconscionability include sickness, old age, drunkenness, emotional dependence and/or illiteracy.
Statutory relief against unconscionable conduct is provided by the Australian Securities and Investments Commission Act 2001 (Cth), and the Competition and Consumer Act (Cth), and the Corporations Act 2001 (Cth) and, these are sometimes referred to as general consumer laws.
Non est factum
This defence means “not my deed” and focuses on the absence of any proper consent of the guarantor to the guarantee document signed. It is available to those who are unable to read due to blindness or illiteracy and to those who are unable to have any understanding of the significance of the transaction because of some other disability.
A contract of guarantee can be unenforceable because of illegality. Some examples include:
- where the making of the guarantee is expressly or impliedly prohibited by statute; and
- where the effect of the guarantee is contrary to or infringes public policy.
If you are seeking to obtain a guarantee or become a guarantor, we recommend that you seek legal advice.
If you or someone you know wants more information or needs help or advice, please contact us on (08) 8344 6422 or email [email protected].