WEEK 12.

2 Guarantors

How many 1. Creditor and Guarantor (Shareholder or Director or Third party)

relationships? 2. Guarantor and Principal Debtor
3. Co-guarantor and other co-guarantors
4. Creditor and Principal Debtor (the underlying debt)
Definitions A guarantee is a promise to be liable for the debt, or failure to perform some
other legal obligation, of another
• Guarantor/Surety – the person who makes the promise
• Creditor – the person to whom the promise is made (Bank)
• Principal Debtor – the person whose obligation is guaranteed (Bank’s
customer)
Oral guarantee? Can be - Not easily accepted by court
But more sensible to be written – should not just copy and paste and rely on
precedents
Guarantor General Principles:
and Creditor 1. A guarantee is a contract
2. Co-extensiveness
3. Various types of guarantees
4. Rule in Clayton’s case
5. Revocation
6. Subrogation
7. No right to call on Creditor to resort first to securities
General Principle (1) – Contract
contractual  Formality
principles Consideration is required – but does not need to be in writing (s14 LARCO)
apply But still advisable to be in writing
 Consideration
- Deed
• No need for consideration
• Impact on limitation period (extends from 6 to
12 yrs)
• Formality under new CO s127
 Undue Influence
Husband and Wife - Etridge (No 2): The solicitor will need to:
- explain the nature of the documents and the practical consequences
these will have for the wife if she signs them;
- point out the seriousness of the risks involved;
- state clearly that the wife has a choice; and
- check whether the wife wishes to proceed.
- Law Society Guideline and Code of Banking Practice (s.24.2)
**Should be on the top of the guarantee
 Corporate Capacity
• Governing law – law of the place of incorporation
• Ultra vires:
• Exist under Hong Kong law? (CO s.115, 116, 117, 120) Companies can
do anything unless the provision restricts
 • Restriction in Articles / other contracts? Shareholder approval?
• Fiduciary duties of directors & ability to vote (3rd party not affected;
and no constructive notice is assumed / bound the 3rd party)
 Financial Assistance (s.275)
Prohibits a company (the guarantor) guaranteeing a loan made to another
company (principal debtor) to buy the guarantor’s shares.
(Whitewash exemptions: if after satisfying certain solvency test, the financial
assistance:
• together with all other financial assistance
previously given and not repaid, is in aggregate not more than 5% of the
paid up share capital and reserves; (s.283)
• is approved by written resolution of all members
of the company; (s.284) or
• is approved by an ordinary resolution, and no
court order has been made restraining the giving of the assistance on
the application of shareholders holding at least 5% of the total voting
rights or members representing at least 5% of the members of the
company.” (s.285))
 Unfair Preference
 when an insolvent company makes a payment that puts
a creditor in a better position than it would otherwise have held.
 A liquidator can apply to court to set aside an unfair preference made
by the company within six months (or two years if it relates to an
associate) before its liquidation but five years if an undervalue
transaction.
 Companies (winding up and Miscellaneous Provisions)
Ordinance s.265A-267A
 An “associate” is widely defined.
 Esp. careful w/ Upstream guarantee (parent company is
B and G is subsidiary) vs. downstream guarantee. (Guarantee from
parent company of B) - No commercial benefit to subsidiary – G may
not be enforceable? Rolled Steel
 Others: Intention; Misrepresentation/Mistake
• Default rules can be changed by contract
• Contra proferentem – court will construe the guarantee against the
drafter of the guarantee
• Usually more favourable to the Guarantor
Consideration - Past consideration is generally not consideration
- What can constitute consideration in guarantee?
• Advance or promise to make an advance to
Principal debtor
• Forbearance to enforcement (without) =/=
Forebearance - before
- No need to be in writing - LARCO s.14
General Principle (2) Co-extensiveness (=coterminous)
The  A guarantee obligation is secondary to the obligation the performance
obligation of of which is guaranteed.
a Gtor flows  The Guarantor will be liable to the Creditor only when the Principal
from the Debtor does not perform his (the Principal Debtor’s) obligations.
obligation of  If the Principal Debtor’s obligation turns out not to exist, or is void,
the guarantee diminished or discharged, so is the guarantor’s obligation.
Guarantee vs. Indemnity (primary)
 An indemnity is an undertaking by one party to keep the other party
harmless against loss and is not dependent on the continuing liability
and default of the Principal Debtor.
 Primary obligation.
 Statute of Frauds.
Neither primary and secondary guarantee has to be in writing (due to
amendment of LARCO)

Guarantor can be sued under indemnity even the guarantor’s primary

obligation fails for whatever reason e.g. B is ultra vires/ is a minor
General Principle (3) Various types of Guarantee
1. Joint, Joint
several, or - Guarantors are together liable for the full debt, and thus all joint guarantors
joint and should be joined in any action. Guarantor’s liability terminates with his death
several (rule of survivorship). = If A dies, estates not responsible for the debt
liability? - If Plaintiff recovers judgment from only one of the joint guarantors, that does
not bar his right to sue others (S5, Civil Liability Contribution Ord)
- Release of one does not discharge the others (S 5, Cap 377).
- If only one joint guarantor sued, he can recover from the other guarantors
provided they are liable for the same damage / debt (S3 Cap 377).

Several: Each guarantor (and his estate) is individually liable for his share
only, and each may be sued separately. (but not responsible for each other)

Joint and several: like joint guarantee except: estates continue to be liable
even the guarantor dies
• on death of guarantor, liability passes to his
personal representative;
• can bring an action against any one of them in
respect of the whole debt.

 Creditor prefers joint and several

Prospective • Prospective guarantee relates to future liabilities between
vs. Creditor and Principal Debtor. (Guarantor agrees to guarantee payment to
retrospective Creditor amounts owed to Creditor by Prof all sums which may become due
and owing from Principal Debtor to Creditor in respect of loan which
Creditor may advance hereafter to the Principal Debtor”)
• Retrospective guarantee relates to a pre-existing liability
between Creditor and Principal Debtor. (“in respect of the sum of $1,000
already advanced to Principal Debtor at the date hereof”)
Specific vs. • Specific guarantee covers a particular liability, or a particular
continuing transaction or series of transactions.
 • Continuing guarantee covers liabilities or transactions which
continue to occur between the principal and creditor e.g. revolving facility.
• E.g. “you may let Principal Debtor have a loan up to $500 for
which I will be answerable at any time” – Specific (limited)
General Principle (4) –Rule in Clayton’s case – first in first out
1. Where there are a several debts, the principle debtor has the right to apply
payment to debts
2. If he does not make a specific application at the time of payment, and the
creditor/bank does not exercise the right of application  no specific
appropriation
3. It is presumed (i) that the first sum paid in its first drawn out, and (ii) that
the first item on the debit side of the account is discharged or reduced by the
first item on the credit side.

* BUT If have continuing provision in guarantee, then it’ll override the rule in
Clayton’s case
General Principle (5) - Revocation
Guarantor will be discharged if the creditor, without the consent of the Guarantor:
 Releases the Principal Debtor, or gives him more time;
 Varies the terms of the underlying debt with the Principal Debtor, unless the
variation is insubstantial; (applies even where the variation would seem commercially
beneficial to the Guarantor unless the alternation is unsubstantial or that it cannot be
otherwise than beneficial to the surety – Holme)
 Releases security that the Creditor holds for the guaranteed debt;
 Releases any co-guarantor who is jointly or jointly and severally liable with the
Guarantor;
 Acts in bad faith towards the Guarantor;
 Invalidity of guaranteed debt.
 Therefore, get the Gtor to agree with the change before the change effects
General Principle (6) - Subrogation
 A guarantor who has performed the obligations of the Principal Debtor which are the
subject of his guarantee is entitled to stand in the shoes of the Creditor and to enjoy all
the rights that the Creditor had against the Principal. S15 LARCO
 When - Arise at the moment Guarantor has paid in full all that he must pay to the
Creditor under the guarantee, unless he has waived the right.
 Where Guarantor gave a guarantee for the whole amount (1000) limited to a
specified sum (100)  even after payment of 100, the creditor entitled to hold
all the securities given for the principal’s liability until the whole amount of the
debt was discharged.
 BUT Guarantor’s liability for a part of the debt, payment will entitle him to an
immediately exercisable right of subrogation.
 BUT guarantor’s right of subrogation can be effectively negated by judicial use
of an appropriation clause and/or suspense account.
Putting in suspense acct – increase the recovery = 100 + 50% of 1000 = 600
but if not suspense acct – 100+ 50% of (1000-100) = 550

Drafting: 1. Make sure guarantor waives right of subrogation 2. Negate right by use of
appropriation clause or suspense acct
General Principle (7) - No Marshalling = No right to call on Creditor to resort to securities first
Yip Kim Po
“The creditor had three sources of repayment. The creditor could:
 sue the debtor,
 sell the mortgage securities or
 sue the surety.
All these remedies could be exercised at any time or times simultaneously or
contemporaneously or successively or not at all. Tan Soon Gin
Guarantor Indemnity from Principal Debtor
and Principal If the Guarantor gives a guarantee at the request of the Principal Debtor,
Debtor there arises an implied undertaking by the Principal Debtor to indemnify the
Guarantor for any sums the Guarantor pays under the guarantee.

When: Arises on actual payment by Guarantor to Creditor.

Difference from Subrogation:

• right to an indemnity is an independent right of the guarantor
against the Principal Debtor (=/= a right arising out of subrogation to the
rights of the Creditor against the Principal Debtor)
• the Guarantor may bring an action in his own name against the
Principal Debtor.
When with Right to contribution from co-guarantors (S3 Cap 377).
more than 1
Guarantor General rule: all the sureties are liable to contribute equally (unless the
proportion are stated) towards the common debt, and if they are not liable in
Guarantor equal proportions, then they must contribute a pro rata amount.
and Co-
Guarantor If one of the Guarantors has paid more than his share of the common liability,
he is entitled to recover the excess as contribution from his co-guarantors. (no
matter the co-guarantors are liable jointly, jointly and severally or severally.)
When: Arises when Guarantor has paid his guarantee in full.
Comfort  Common for parent to issue a comfort letter to secure subsidiary’s
Letter borrowing.
 Distinguished from comfort letter issued by accountant.
(when  It may be a guarantee and legally binding (depends on the drafting of
situation does the doc – yes if guarantee to pay)
not allow BUT not binding if only the policy of the parent co. (Malaysia Mining)
guarantee) “It is [the parent’s] policy to ensure the business of [the subsidiary] is at all
times in a position to meet its liabilities to [the bank] under the above
arrangements.” – policy can be changed – no undertaking not to change in the
future – not a letter of guarantee – not responsible to repay the bank if the
subsidiary defaulted “
Points on  Can be incorporated into the agreement or can be a standalone
drafting document.
 Importance of finding the right precedent.
 Just don’t blindly follow it!