“If you want a guarantee, buy a toaster” – Clint Eastwood
As financial markets continue to experience uncertainty and interest rates rise, it is expected that banks will adopt stricter lending protocols. Whether you are borrowing for the first time or seeking to refinance or restructure, clients may find themselves being asked to provide personal guarantees or guarantees though related entities to secure debts. If you have already provided such a guarantee, or are considering providing one, it is a timely moment to refresh your understanding as to what rights and obligations you may have as a guarantor, with your co-guarantors.
What is Contribution?
Contribution arises where multiple parties have guaranteed the obligations or debts of a principal borrower. The guarantors are not required to be bound jointly and/or severally, or even be aware of the other guarantor.
The rationale of the doctrine is that people under "coordinate liabilities", who have guaranteed a debt that is called on, should share that burden pro-rata (see for instance Albion Insurance Co Ltd v Government Insurance Office (NSW) (1969) 121 CLR 342 at 349-50 per Kitto J).
Put simply, two or more parties who have guaranteed the same debt, are liable to each other for an equal share of the whole debt, or of that part of it which remains unpaid by the principal borrower. This means that in the event of a default by the principal borrower, the lender can recover the debt from each guarantor and/or the principal borrower. If a co-guarantor then pays out the full debt amount to the lender, that guarantor would then have a right of reimbursement from:
(a) the principal borrower; and
(b) each other co-guarantor, in equal shares.
However, contribution can only be sought to the limit of the respective guarantees.
The starting position at law is that guarantors, who have co-ordinate liabilities, should only be required to contribute equally to the repayment of a debt. However, this position can be altered where parties have guaranteed disproportionate amounts of a debt.
It is also important to note that contribution can only be claimed where the debt has been called upon or there is a real possibility that the debt will be called upon.
A practical application
Company A is the principal borrower and is seeking to restructure its facilities. In order to do this, the bank requires a guarantee from:
(a) the Director of Company A; and
(b) Company B, who is a related entity.
The Director of Company A guarantees 100% of Company A’s obligations. Company B is only required to guarantee 50% of Company A’s obligations.
In the event of a default by Company A, both the Director of Company A and Company B, as co-guarantors, have a right of reimbursement from:
(c) Company A, as the principal borrower; and
(d) each co-guarantor, in equal shares (to the limit of their respective guarantees).
This right of reimbursement arises once one of the guarantors pays a debt or fulfils an obligation on behalf of the principal borrower.
This means that if the Director of Company A pays 100% of the Company A’s debt, the Director of Company A would have a right to seek reimbursement from Company B in the amount of 25%, being half of their 50% guarantee.
