No Guarantee for Guarantors?
Jamaica’s insolvency laws offer protection to a debtor who is declared a bankrupt from his creditors in that as at the date of bankruptcy interest no longer accrues on the debt but does this protection extend to a person who guarantees a loan for that bankrupt?
No, it does not. Bankruptcy of the principal debtor does not relieve the guarantor of the debt. A guarantee is a secondary agreement in which a person is liable for the debt or default of another (the principal debtor) who is the party primarily liable for the debt. A guarantee has to be in writing and a guarantor has a right to be indemnified by the principal debtor. A guarantee may also be made by more than one guarantor jointly and/or severally.
A guarantee may arise in a situation where the guarantor undertakes that he is responsible for the principal debtor’s obligations to the creditor and that he, the guarantor, will be liable to the creditor if the principal debtor does not perform his obligation.
Let’s look at a practical scenario. Say Ned took out a loan from Stark Finance for one million dollars at an interest rate of twenty per cent and asked Tony, his co-worker, to guarantee the loan. Ned began servicing the loan until he defaulted on payment. Stark Finance contacts both Ned and Tony concerning the default and make a formal demand on both parties for the full payment of the debt. Ned tells Tony he is unable to service the debt because his position at the office was made redundant due to the downturn in the economy from the covid-19 pandemic and eventually files for bankruptcy. Under our insolvency laws, as at the date of bankruptcy, Ned would have some form of protection from his creditors because he would no longer be required to service his loan in the way he normally would in that interest would no longer run as at the date of bankruptcy unless the unlikely event occurred that there is a surplus after payment of claims of creditors.
When Ned is declared a bankrupt all his debts are calculated as at the date of bankruptcy. A certificate of assignment is issued by the Supervisor of Insolvency. Generally, the date of the certificate of assignment is the date of bankruptcy. Once someone is declared a bankrupt all their debts as at that date vests in a trustee who is appointed to administer the estate of the bankrupt for the benefit of the bankrupt’s creditors. All payments to creditors cease and the assignment takes precedence over all judicial attachments, garnishments, certificate of judgments except those that have been completely executed by payment to the creditor or the rights of a secured creditor.
Tony, on the other hand, as guarantor for Ned’s loan, is however not automatically protected under bankruptcy laws as guarantor for Ned’s loan unless and until he himself applies for bankruptcy and is declared to be a bankrupt. Stark Finance is fully within its right to pursue Tony in furtherance of his guarantee for the full extent of Ned’s debt in accordance with the terms of the contract of guarantee.
Where there is more than one guarantor, the contract of guarantee will generally indicate if the liability of each is joint (meaning each is liable for the whole) or several (meaning each is liable only for its proportion). Where there are two or more guarantors, unless the contract of guarantee states otherwise, the creditor may choose which of them he wishes to sue. The creditor generally cannot be compelled to sue another guarantor who he does not wish to sue, though that person may be joined by the guarantor who has been sued for a contribution. In most cases, the creditor goes after the guarantor with the deeper pockets.
As soon as the guarantor has paid to the creditor what is due to the creditor under the guarantee, he is entitled, unless he has waived his right to do so, to step into the shoes of the creditor and recover what he has paid out. Thus on payment, but not before, the guarantor has the right to the benefit of all the securities which the creditor has received from the principal debtor before or after the creation of the guarantee, whether or not they existed at the time the guarantee was given. The debtor is therefore not protected from a guarantor who seeks an indemnity.
There was a case in which a creditor sought to enforce a guarantee against a guarantor debtor who guaranteed a debenture for a limited liability company. The company was dissolved before the debt was satisfied. The debtor who guaranteed the debenture was also eventually declared a bankrupt. The creditor who sued attempted to enforce the guarantee against the debtor’s trustee in bankruptcy, but the trustee rejected the proof on the ground that the limited liability company had been dissolved and the debtor was no longer subject to any liability under his guarantee. The creditor brought the matter to court where the court found that the creditor is entitled to prove for the value of the guarantee that the guarantor had given. The court rejected the view that because the principal debt is gone, therefore the liability under the guarantee to pay the interest on the debenture is also gone. The court opined that the principal debt is gone but not by any act of the creditor. It is gone by operation of law. The principal debt will never be repaid but the obligation of the debtor to pay the interest under his guarantee remains.
A guarantee has been described as the lifeblood of international commerce. A person who acts as guarantor is presumed to be solvent and is not afforded certain protection under the insolvency laws for a reason. A guarantee is one way in which creditors protect themselves from the risk of debt default. Lenders will often seek a guarantee to secure a loan agreement. A guarantor takes on a serious financial risk when he gives a guarantee and it is important that such a person is aware of all the implications.
Jahmar Clarke is an Associate at Myers, Fletcher & Gordon and is a member of the firm’s Litigation Department. Jahmar may be contacted via email@example.com or www.myersfletcher.com. This article is for general information purposes only and does not constitute legal advice.