Enforcement of Guarantees; Is the Lender Obligated to Pursue the Principal Debtor first?
A guarantee is an undertaking to answer for the payment of another’s debt or the performance of another’s duty, liability or obligation. This is a separate agreement between a creditor and a third party whereby the third party agrees to take up the liability of the principal debtor in the event of default. Like any binding contract, a contract of guarantee has to satisfy the requirements of contracts, being offer, acceptance and consideration. Guarantees in Kenya are governed by The Law of contract Act Cap 23. Section 3(1) of the Act stipulates that all contracts of guarantee have to be in writing and signed by the guarantor in order to be enforceable in a Court of Law.
In additional to providing security for repayment of the debt in form of properties and creation of charges over the same, lenders usually require issuance of guarantees as additional security. In this article, we address the question whether the lender needs to pursue the principal debtor first before enforcing the guarantees.
Types of guarantees
- Personal guarantees; This is a binding agreement by an individual to take up another’s liability in the event of default. The individual undertakes to settle any outstanding debt by the principal debtor either by taking up the installments or by offering an asset as security.
- Corporate guarantees; A corporate guarantee is the undertaking by a company to take up another’s liability in the event of default. The shareholders of the company must give their consent for the company to be allowed to act as a guarantor.
- Limited & unlimited guarantees; A limited guarantee just as the name suggests implies that in the event of default, the guarantor’s liability is capped at a certain amount of the debt. An unlimited guarantee on the other hand means that in the event of default, the guarantor is liable for the whole amount borrowed including interests and antecedent costs.
Is the lender obligated to pursue the principal debtor first?
A contract of guarantee becomes enforceable once the principal debtor defaults in making payment as per the contract and the creditor has notified the guarantor of the default. The lender need not pursue the principal debtor first. Upon default by the principal debtor, liability attaches immediately and the lender can proceed with the sale of any security offered by the guarantor. This was affirmed by the Court of Appeal in case of Fidelity Commercial Bank Limited vs. Kenya Grange Vehicle Industries Limited [2017] Eklr as follows; “This Court explained in Kenindia Assurance Company Ltd V. First National Finance Bank Ltd Civil Appeal No. 328 of 2002 that guarantees are special contracts and are; “…… in the nature of a covenant by the appellant to pay upon the happening of a particular event. It is a form of security of guaranteeing payment by a third party. In such cases, the most important factor to consider before liability can attach is whether there has been default. Once default is established and there has been a formal demand the other conditions are of a secondary nature and may not be used to defeat the security.”
The High Court took the same position in Rose Chepkirui Mibei v Jared Mokua Nyariki & 2 others [2015] eKLR and found as follows: “The second argument of the applicant is that the bank ought to have pursued the borrower before proceeding to offer the suit property for sale. The husband of the plaintiff acted as guarantor. There has been default. Once there is default and notice is given to the guarantor, his obligation under the guarantee must take effect immediately. Unless the parties have agreed through contract, that the guarantor will not be called upon to make good the money owed by the principal debtor, the creditor is under no obligation to first pursue the principal debtor and leave alone the guarantor.”
Contracts of guarantee act as a security to creditors and it is the guarantor’s duty to ensure the principal debtor adheres to the terms of the loan to avoid taking up the liability. The consequence of breach by the principal debtor and receipt of a notice from the creditor notifying the guarantor of the breach is that the guarantor also bears the liability of the debt.
Conclusion
Lenders need not pursue the principal debtor first before enforcement of guarantees as liability accruing upon default by the principal debtor is primary in nature and not secondary. Also, noting the implications of default by the principal debtor, one should exercise great caution and conduct due diligence prior to agreeing to act as a guarantor.
The Debt Recovery Restructuring and Insolvency team at CM Advocates LLP prides itself in having a wide variety of resources, skills, and experience on matters of Insolvency including but not limited to the liquidation of Companies and Limited liability partnerships (LLPs) having a high-end client portfolio. We are practical and innovative in our approach and offer quick turnaround timelines. We will be delighted to receive your feedback, and inquiries and offer our services on this and any other of our practice areas.
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The Debt Recovery Restructuring and Insolvency team at CM Advocates LLP prides itself in having a wide variety of resources, skills, and experience on matters of Insolvency including but not limited to the liquidation of Companies and Limited liability partnerships (LLPs) having a high-end client portfolio. We are practical and innovative in our approach and offer quick turnaround timelines. We will be delighted to receive your feedback and inquiries and offer our services in this and any other of our practice areas.
Disclaimer
This alert is for informational purposes only and should not be construed as legal advice.