A guaranty is a legal commitment by one party (the guarantor) to take responsibility for another party’s (the debtor) financial obligation if that debtor fails to meet their obligations. If the debtor defaults on their payments, the guarantor becomes responsible for fulfilling those financial obligations.
A surety is somewhat similar to a guarantor in that it’s also a form of financial guarantee. The key difference is in the level of involvement: a surety is directly responsible for the debt and is usually involved from the beginning of the contract.
If the principal party defaults, the surety must fulfill the obligation immediately. A guarantor, on the other hand, is typically only involved when the debtor has proven they cannot or will not fulfill their financial obligation.
The right of subrogation allows a party (such as a guarantor or surety) who has paid off a debt on behalf of another party (the debtor) to step into the shoes of the original creditor. This means the guarantor or surety can then pursue the debtor for the repayment of the debt they’ve satisfied.
What Legal Rights Do Guarantors Have?
Although the role of a guarantor is often associated with potential liability, guarantors rights include:
Right to Access Information
This right gives the guarantor the authority to obtain information about the debtor’s financial situation and the status of the loan or obligation. The purpose is to allow the guarantor to assess the risk level and potential liability associated with the guarantee.
For instance, consider John, who has agreed to act as a guarantor for a bank loan that his friend, Michael, is taking out to start a business. As a guarantor, John has a right to access Michael’s business plan, credit history, and other financial details to understand the likelihood of Michael defaulting on the loan. John also has the right to regularly check the status of the loan repayments to monitor if Michael is fulfilling his obligation.
Right of Subrogation
The right of subrogation comes into play after a guarantor pays off a debt on behalf of the debtor. This right enables the guarantor to seek repayment from the original debtor.
For example, if Michael defaults on his bank loan, and John, as the guarantor, steps in to repay the loan to the bank, John then acquires the right of subrogation. This means John can legally pursue Michael to recover the money he paid to the bank on Michael’s behalf.
Right to Demand Performance
The right to demand performance means that the guarantor can require the debtor to fulfill their obligations before the guarantor is asked to step in. This right is designed to protect the guarantor from prematurely assuming the debtor’s obligations.
Take the same example. Consider that if Michael misses a payment on his loan. John, as the guarantor, can invoke his right to demand performance, requiring Michael to make good on the payment before John is asked by the bank to fulfill the obligation.
Right to Indemnification
The right to indemnification entitles a guarantor to be reimbursed by the debtor if the guarantor ends up paying off the debtor’s obligation.
Continuing with the previous example, if Michael defaults on his loan and John pays the remaining balance to the bank, John has the right to be indemnified by Michael. This means Michael is legally obligated to repay John the amount he paid to the bank, plus any additional costs John may have incurred due to the repayment, such as legal fees or interest payments.
What Defenses Do Guarantors Have for Not Paying off the Debt?
Just as with debtors, guarantors have several defenses they can potentially use. Debtor’s defenses include:
Fraud or Misrepresentation
This defense arises when the debtor or creditor has manipulated the truth or intentionally misrepresented key facts related to the debt or the guaranty. If a guarantor can demonstrate that they were led to guarantee the debt based on such false information, they may be relieved from the obligation.
For instance, consider a situation where Emily agreed to be the guarantor for her brother, John’s business loan. However, John misrepresented his business plan and told Emily that the loan was for a significantly smaller amount. If Emily can prove this misrepresentation, she may not be held responsible for the debt.
Duress involves a situation where the guarantor was coerced or forced into becoming a guarantor. If the guarantor can show that they were pressured into giving the guaranty under threat or extreme influence, they may use this as a defense to avoid liability.
For example, if Emily was threatened or blackmailed into becoming a guarantor for John’s business loan, she could potentially use duress as a defense. Emily would need to provide evidence of the coercion for this defense to hold up in court.
A guarantor can revoke their guarantee for future obligations at any time, but they remain liable for any debts that were incurred before the revocation. This is a proactive step a guarantor can take if they no longer wish to be responsible for the debtor’s future debts.
For example, suppose Emily has seen some irresponsible financial behavior from John, and she no longer wishes to be his guarantor. Emily can revoke her guaranty, and she will not be responsible for any new loans John takes out after her revocation. However, she would still be liable for the existing loan she guaranteed before the revocation.
Variation of Contract
If the original contract between the debtor and the creditor changes without the guarantor’s knowledge or consent, the guarantor may not be held liable. This could involve changes in the loan amount, repayment terms, or other significant details.
For instance, if John and the bank agreed to increase the loan amount or extend the loan period without informing Emily or seeking her approval, Emily might not be responsible for the increased amount or extended period. The rationale behind this defense is that Emily agreed to guarantee a specific debt under specific terms, and any change to those terms without her consent would not be her responsibility.
How Does Bankruptcy Affect Debt?
In general, when a debtor declares bankruptcy, it can result in the discharge of certain debts, which releases the debtor from personal liability for those debts. However, this doesn’t necessarily absolve a guarantor of their responsibilities. If the primary debtor has their debt discharged in bankruptcy, the creditor can still seek payment from the guarantor.
Filing for bankruptcy has a significant impact on creditworthiness. Depending on the bankruptcy chapter, it will remain on your credit report for up to ten years. During this time, obtaining new credit or loans may be challenging, and if available, it may come with higher interest rates or less favorable terms.
Should I Contact an Attorney if I Make a Guaranty Agreement?
Yes, it is highly advisable to seek legal advice before entering into a guaranty agreement. Financial and legal responsibilities associated with being a guarantor can have significant implications. A lawyer who understands financial law can help you understand the terms, potential risks, and liabilities of the agreement and ensure your rights are adequately protected.
Therefore, before signing any such agreement, make sure to consult with a debt lawyer to navigate this intricate process effectively.