Which is better?

Credit is a term many people will encounter during their lifetime – either because of their particular type of business or because they are leasing or purchasing a high-value asset (like a property) or simply by virtue of the fact that their affordability may have come into question by the institution actually providing the credit.

But what is “credit”? 

According to the National Credit Act 34 of 2005 (the NCA), credit when used as a noun is defined as –

“a deferral of payment of money owed to a person, or a promise to defer such a payment; or a promise to advance or pay money to or at the direction of another person”

Credit can therefore be described as a “type of security” that is provided to a financial institution (like a bank or other lending institution) by a third party to mitigate any loss that may arise should the person taking out the loan (known as the principal debtor) be unable to service it. Sort of like an “insurance policy” for financial service providers. 

• When we talk about an “insurance policy” we are not referring to an insurance product at all. We mean this rather “tongue-in-cheek” as a description to reflect a financial institution limiting their financial exposure. 

What is clear is that when providing loans of whatever kind, financial institutions, may require a form of security. 

Security – which provides a “safety net” for a creditor (the financial institution) should the debtor be unable to satisfy the debt, includes both suretyships and guarantees. These are terms, many of us may have encountered over the years. Things we may have even been asked to “stand for” when a business, family member or perhaps even a friend has needed or taken out a loan. 

They are also terms that are often used interchangeably, but which have very specific and different meanings.

But what do these terms mean?

A Suretyship

In Caney’s The Law of Suretyship authors  CF Forsyth and JT Pretorius, have defined suretyship as follows – 

“accessory contract by which a person (the surety) undertakes to the creditor of another (the principal debtor), primarily that the principal debtor, who remains bound, will perform his obligation to the creditor and, secondarily, that if and so far as the principal debtor fails to do so, the surety will perform it or, failing that, indemnify the creditor”.

A definition that has been supported by various courts in South Africa. Specific matters include Trust Bank of Africa Ltd v Frysch 1977 3 SA 562 (A) (at 584F); Sapirstein v Anglo African Shipping Co (SA) Ltd 1978 4 SA 1 (A) (at11H) (the “Sapirstein matter”); Nedbank Ltd v Van Zyl 1990 2 SA 469 (A) (at 473I) and in Basil Read (Pty) Ltd v Beta Hotels (Pty) Ltd 2001 2 SA 760 (C) (at 766F).

The above definition is echoed by authors E.P. Ellinger, E. Lomnicka, and C. Hare in Ellinger’s Modern Banking Law, where they discuss securities, which are –  

“distinct arrangements in terms of which a third party – the surety (guarantor) – agrees to assume liability if the debtor defaults or causes loss to the creditor”.

It can therefore be accepted that a suretyship arises due to the existence of a principal obligation or a principal debt in terms of which a third party undertakes to settle the debt of the principal debtor should he/she fail to do so. 

A suretyship is therefore not a distinct or separate obligation but one which arises from the principal debt or obligation. It can therefore be seen as secondary to an existing obligation. An accessory obligation, if you will, that arises due to the existence of another obligation. In fact, a suretyship is dependent on the existence of or coming into existence of a valid and effective principal obligation.

Simply put – a suretyship is conditional on the default or breach of the principal debtor.

A Guarantee

It has been set out in the Guide to ICC Uniform Rules for Demand Guarantees (URDG) by authors Dr Georges Affaki and Sir Roy Goode that a guarantee (or “demand guarantee”) –

“stands between the accessory guarantee (i.e., suretyship guarantee) and the commercial letter of credit in the sense that it is secondary in intent but primary in form. Performance in terms of the underlying contract is due, in the first instance, from the principal and the demand guarantee is intended to be resorted to only if the principal has failed to perform. Although this is the intention of the parties, the demand guarantee is not in form linked to default under the underlying contract, nor is there any question of performance of that contract by the guarantor. The only purpose of the demand guarantee is to hold the beneficiary risk free up to the agreed maximum amount; and the only condition of the guarantor’s (e.g., bank’s) payment liability is the presentation of a demand and of all the other documents (if any) specified in the guarantee in the prescribed manner and within the period of the guarantee”. 

If we look at the above definition, it’s clear that a guarantee is primary in its nature. In other words, it’s not secondary to, or an accessory of a primary or principal debt. 

A guarantee has been said to impose an absolute liability on the guarantor. Contracts of guarantee create a collateral engagement to answer for the primary obligation(s). A guarantee is therefore not dependent on the existence of any other debt or agreement. In this case, if the guarantor fails to make good on the guarantee, he/she/it will be liable for breach of contract.

As a guarantee is not dependent on the existence of a principal debt, a guarantee can be demanded when the conditions of the guarantee have been met. The guarantor will then be obliged to perform in full as contracted under the guarantee agreement. The liability of the guarantor under a guarantee is equal to the amount, which is guaranteed.

If it turns out that a guarantee is conditional on the default or breach of the principal debtor, then the contract is not a guarantee contract – Why? Because the obligation is dependent on the principal debtor failing to service the principal debt. It would be dependent on something else and not a standalone agreement. 

Simply put – a guarantee is an independent, stand-alone, collateral agreement and results in independent liability. 

So, which should is better? The Suretyship Agreement or the Guarantee Agreement?

By virtue of the fact that a guarantee establishes an independent liability for the principal obligation, the guarantor cannot rely on the creditor (the bank or other financial institution) seeking payment from them because of or due to the failure by the principal debtor to discharge the debt first.

Because it’s independent to the principal debt and results in independent liability on the part of the guarantor (once the conditions of the guarantee are met), one could objectively conclude that a guarantee agreement is a stronger form of security especially when a person is signing as security for the performance of company obligations, such as a lease agreement, supply agreement and/or credit application.

If you require assistance with your guarantee agreements, Inhouse Lawyer is perfectly poised to assist you in a way that makes every nuance of this agreement easy as pie. In fact,  if you change your Suretyship to a Guarantee, you are able to obtain a free copy of the guarantee agreement from our website.If you have any questions relating to the information we have set out above or if you are interested in booking a free demo, feel free to drop us a line.