A guaranty is an arrangement between a creditor and a debtor. The guarantor agrees to pay for the debtor’s debts only if the debtor defaults and only after the creditor has unsuccessfully attempted to collect from the debtor. For example, assume someone wants a loan from the bank to open a business. The bank questions that business’s ability to make money. In that situation, the bank would require a guarantor to sign the loan in case the debtor cannot pay.
Guarantors have several rights that extend beyond that of the debtor. These rights include:
- Right of Subrogation – This right allows the guarantor to recover from the debtor if the guarantor has paid the debtor’s debts. For example, the guarantor has creditor rights if the debtor claims bankruptcy.
- Right of Reimbursement – This right will depend on the contract formed between the debtor, creditor, and guarantor. For example, most guaranties contracts allow a guarantor to recover out-of-pocket expenses in paying the debt of the debtor. Some contracts even allow the guarantor to recover the full amount of the debt paid.
- Right of Contribution – This right only comes into play when there is more than one guarantor. A contract with co-guarantors should specify the exact percentage each guarantor is responsible for. If one guarantor pays more than his/her share, the right of contribution allows that guarantor to recover from the other co-guarantors.
There are instances where a guarantor can be released from paying the debt. However, they must have a legally recognized defense. Some defenses include:
- Debtor’s defenses – Any defense used by a debtor can be used by the guarantor.
- Contract modification – If the contract the guarantor signed is modified without their consent, it is not binding.
- Possession of collateral – A debtor often provides collateral to a creditor. If the creditor takes possession of the collateral without the guarantor’s consent, the guarantor can deduct the value of the collateral from what they owe as the guarantor.
- Other defenses – The guarantor can also claim defenses separate from the debtor. For example, the guarantor can claim:
Guarantor agreements are quite common in creditor-debtor transactions. However, the rights and defenses of a guarantor can be complex and confusing. For example, a surety is like a guarantor but they have completely different obligations. Consult an experienced business attorney to learn more about your guarantor agreement or to seek advice about whether to become a guarantor.