A guarantee is a promise given by a third party to fulfil the obligations of a borrower in the event of default by the borrower. There are various different types of guarantees and the general law surrounding them is well established. However, since the start of the recession, more lenders are finding themselves needing to call on guarantors to fulfil a defaulting borrower’s obligations and as a result, more guarantors are seeking to challenge the validity of guarantees through litigation. The Courts are therefore seeing an increase in disputes relating to guarantees.
The Basic Law
The basic law on guarantees dates back as far as the Statute of Frauds Act in 1677. A guarantee has to be in writing and signed by the guarantor for it to be valid. A guarantee is also a contract and must therefore fulfil the basic requirements of forming a valid contract, namely, (1) An offer, (2) Acceptance, (3) An intention to create legal relations and finally (4) Consideration. Often the final requirement of consideration is circumvented by executing the guarantee as a deed, which dispenses with the requirement for consideration.
There are two main types of guarantees: pure guarantees and conditional payment guarantees. A pure guarantee is a promise by a guarantor for which he/it will be automatically liable if the borrower defaults, for example, the guarantor guarantees that the borrower will fulfil its obligations in relation to a specific term of an agreement eg. a time for payment clause. A conditional payment guarantee is the more common form of guarantee, which tends to take the form of a guarantor agreeing to step in to perform an obligation when a borrower is in breach of an obligation. Such a clause is common in a tenancy agreement or is often given by the director of a company with respect to the debts of a company.
Duty of Disclosure by Creditor
Another basic principle relating to guarantees is that a beneficiary of a guarantee is not under a duty to disclose material facts to a guarantor, unless the guarantor specifically makes an enquiry. However, there is an exception to this general rule in that unusual facts should sometimes be disclosed to a guarantor.
The recent case of North Shore Ventures Ltd. v Anstead Holdings Inc and others  EWHC 1485 (Ch) has explored this point in more detail and provided some useful clarification. This case related to the high profile Russian businessman and politician, Boris Berezovsky who has been living in exile in the UK for several years. A company called North Shore Ventures (which was associated with Berezovsky) had made a $50 million loan to Anstead Holdings under a loan agreement governed by English law. Two individuals, Mr Formichev and Mr Peganov (who were the decision makers for Anstead despite not being directors) agreed to act as guarantors for the loan agreement.
Anstead Holdings drew down money under the loan agreement and the monies were paid into a Swiss bank account. In October 2003 the Swiss authorities froze $18 million of the money in the Swiss bank account due to North Shore’s association with Berezovsky, who was being investigated for money laundering. A considerable amount of the $50 million loan had been repaid but the dispute centred largely upon the $18 million frozen in the Swiss account for a period of 4 years.
When North Shore tried to enforce the guarantee, Mr Formichev and Mr Peganov tried to argue in their defence that the guarantee should be set aside because North Shore had not disclosed that Mr Berezovsky was being investigated for money laundering in Switzerland. The Court made judgment in favour of the Claimant, North Shore. The Court held that whilst a Creditor could be obliged to disclose an unusual feature other than one in relation to the actual contract, there was no obligation to disclose anything which the guarantor could reasonably be expected to know.
In this case, it was noted that Mr Formichev had worked with Mr Berezovsky and therefore had knowledge of his business and financial affairs. The Court also noted that the money laundering investigations had been in the public domain and were covered extensively in the international press. The Judge therefore held that it was reasonable to conclude that Mr Formichev knew, and could reasonably be expected to have known about the Swiss investigations. In relation to Mr Peganov, it was held that he could reasonably be expected to have been told of the position by Mr Formichev therefore he was also fixed with notice.
The case is being welcomed by lenders who consider it to be a common sense approach as they should not be expected to have a high burden of disclosure including facts which the guarantor could reasonably expect to find out themselves.
For guarantors, the message should be to carry out extensive investigations and checks before entering into a binding guarantee contract which could reasonably result in a liability for the guarantor. Guarantors should also ensure that they understand exactly what they are signing and have made provision to be able to perform the relevant obligation should they be called upon to do so and not to fall into the trap of assuming that the worst case scenario will never materialise. Sadly in the current economic times, the worst case scenario is a realistic possibility.
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