Thursday, June 08, 2006

By Sanguita Popatlal
In any financing transaction banks and other lenders seek to protect their financial exposure by taking some form of security.  A guarantee by a third party, often the holding company of the borrower or a bank, is used if the banks are comfortable with the creditworthiness of such third party. A contract of guarantee has been defined to mean a “collateral engagement to answer for the debt, default or miscarriage of another person”.  It is thought to impose an absolute liability on the guarantor; if the guarantor fails to make good the guarantee, he will be liable for breach of contract.
Contracts of guarantee create primary obligations which are not dependent on the existence of any other debt or agreement.  The contract of guarantee can be distinguished from the contract of suretyship, which create an accessory obligation.  An accessory obligation is an obligation that is dependant on the existence or coming into existence of a valid and effective principal obligation.  There can be no accessory obligation when the principal obligation to which it relates to is a nullity or if the principal obligation has been extinguished, for example, by performance or payment.  Therefore, in a contract of suretyship there must be an underlying valid principal obligation between someone other than the surety as debtor (the principal debtor) and the creditor that the surety binds himself to.
The contract of surety is of Roman Law import.  A surety is “one who takes upon himself the obligation of another, that other still being liable”.  Caney maintains that the surety firstly undertakes to the creditor that the principal debtor, who remains bound, will perform his obligation, and secondly that insofar as the principal debtor fails to do so, the surety will perform it or failing that indemnify the creditor.  This indemnity usually takes place by the payment of money to the creditor.  Caney distinguishes suretyship from guarantee by stating that where a person has done no more than guarantee or undertake to pay in the event of the debtor not doing so, this is an original undertaking made on the condition of non-payment by the debtor.  Therefore, in a guarantee the guarantor does not undertake that the principal debtor will perform his obligations and only failing that will the guarantor be liable. 
Joubert supports the view that contracts of guarantee create primary obligations which are not dependent on the existence of any other debt.  Joubert is of the opinion that a party’s obligation will be termed as a primary one if his liability does not depend on the breach of contract of another person.  On Joubert’s view of the contract of guarantee, if a guarantee is made conditional on the default or breach of contract of the principal debtor is not a “guarantee” in the strict sense of the definition since it is dependent on the existence of another debt.  In such a case, the undertaking to pay by the guarantor cannot come into existence until and unless the principal debtor has breached the contract with the creditor in some manner.  The guarantor’s liability would also be limited in those circumstances to the extent of the liability of the principal debtor in terms of the principal obligation. 
List v Jungers 1979 (3) SA 106 (A) remains the precedent in the distinction between the contracts of guarantee and suretyship.  The Appellate Division held that the words “guarantee” and “warrant” have a variety of meanings and their precise meaning must be obtained from the particular context in which they are used.  It was held that “guarantee” may in a particular context be used in connection with the accessory obligation of a surety but in other cases the parties may have intended that the guarantor undertake a primary obligation to pay the debt of the principal debtor. 
In Carrim v Omar 2001 (4) SA 691 (W), the Honourable Judge Stegmann stated that the legal issue to be decided in the appeal was whether the defendant validly undertook the enforceable primary obligations of an indemnifier or guarantor or whether the defendant merely purported to undertake the accessory obligations of a surety for the indebtedness of the principal debtor (the Islamic Bank Ltd) to the plaintiff.  Judge Stegmann disagreed with Caney’s proposition that an essential element of suretyship is that the surety must undertake that the debtor will perform his obligation to the creditor.   
There are times when the wording of the guarantee will be such that it is an unconditional undertaking to bind the guarantor as co-principal debtor.  If the wording is such, then it is submitted that such a guarantee is not a suretyship and therefore, does not require the creditor to first try and obtain performance from the debtor, he can demand payment or performance from the guarantor first. 
In terms of common law, a surety is discharged if the principal obligation is extinguished, for example, due to performance by the principal debtor or to impossibility of performance or invalidity of the debt.  A suretyship may also be terminated if the accessory obligation between him and the creditor is extinguished even though the principal obligation between the principal debtor and the creditor is still in force, for example if the surety performs the accessory obligation or in the event of irregular conduct of the creditor that prejudices the interests of the surety. 
A guarantee, on the other hand, due to the fact that it is a principal obligation, can only be discharged if there is performance of the principal obligation or payment on the part of the guarantor. 
In conclusion, the contract of “guarantee” does not have a defined legal meaning in South African law.  If a guarantee is given conditional upon the breach of contract, or default of the principal debtor, such a guarantee is accessory in nature and therefore, ranks as a suretyship.  It is submitted that this is not a true “guarantee”.  However, if a guarantee takes the form of an absolute and unconditional promise it cannot be a suretyship and is principal in nature.  The practical implication of a guarantee drafted so that it creates a primary obligation, is that the guarantor does not have the same defences available to him as that of a surety, the main one being that of excursion, that the creditor should first try to obtain performance from the principal debtor and only insofar as he fails to do so will the guarantor be liable.