A guarantee is a contract to answer for the debt of another, such as a car buyer’s parents promising to pay the creditor under a car finance contract if the son or daughter defaults. More formally put, a guarantee is a contract made by one person (A – the promisor on the guarantee contract – the guarantor or surety) with another (B – the promisee on the guarantee contract – the creditor) to pay a debt or to perform an obligation of a third person (C – the debtor, the principal debtor or the principal on the principal contract) who has or who is expected to have a primary liability to the creditor.
To enforce its debt or obligation, the creditor (B) can sue the principal debtor (C) for the contract debt because the debtor’s liability is primary, or the creditor can sue the guarantor (A) on the contract of guarantee as the guarantor’s liability is secondary.
A guarantee is a class of contract that is governed by section 4 of the Statute of Frauds 1677.
Pursuant to the Statute of Frauds, a contract of guarantee must satisfy the following two requirements to be legally valid and enforceable:
- the contract of guarantee, or some memorandum or note of it, must be in writing;
- the contract or memorandum or note must be signed by the party to be bound or an authorized representative of that party.
Apart from the Statute of Frauds requirement of evidence in writing just noted, the other major formal requirement affecting guarantees may be the WA Consumer Credit Code if obligations under a credit contract are guaranteed and the guarantor is a natural person or a strata corporation (section 9). If applicable, this legislation requires the contract to be in writing signed by the guarantor and other important formalities before a regulated contract can be enforceable.
The operation of the guarantee itself is a matter of negotiation, and it may be retrospective or prospective, limited or unlimited, conditional or unconditional, continuing with divisible consideration or continuing with indivisible consideration.
The guarantor is not liable to the creditor until there is an accrued liability such as default by the principal debtor. There is no implied condition precedent that the creditor is to give notice of the debtor’s default or that the creditor must first sue the debtor. Once liable, the guarantor’s liability must be the same as that of the debtor because the guarantor’s liability is co-extensive with that of the debtor. If the debtor is a minor (a person under the age of 18 years), the guarantor is still liable on the guarantee.
The conduct of the guarantor may be “misleading or deceptive” under sec 52 of the Trade Practices Act 1974 (Cth) or Fair Trading Act equivalents. So, for example, if a guarantor induces a creditor to believe by their words or conduct that they will guarantee the borrower’s transaction when they will not, then the creditor may make a claim against the Guarantor for misleading and deceptive conduct.
The guarantor’s liability arises when the principal debtor defaults; the guarantor is not entitled to any cross-claim available to the debtor against the creditor.
The duration of the guarantor’s liability depends on the agreement – some guarantees are limited to a single transaction, and others, called continuing guarantees, cover a number of transactions over a period of time.
A guarantee may be set aside on grounds such as misrepresentation, undue influence and unconscionability but a guarantee is not in itself a contract of the utmost good faith (as is an insurance contract).
- P Latimer, Australian Business Law (2001), 20th Ed, CCH Australia Ltd, Sydney, paras 13-360, 13-370, pages 920 – 922.
- S Graw, An Introduction to the Law of Contract (1998), 3rd Ed, LBC Information Services, North Ryde, pgs 2 – 5.
- B Collier & G Masel, ‘A Contract of Guarantee is a contract by which a guarantor agrees to answer for the debt, default or miscarriage of a debtor’ 1997, The Laws of Australia – TLA, Lawbook Online, [TLA 8.6.1]