Execution of Guarantees - Think twice before seeking to avoid liability for a guarantee

When obtaining finance, directors of family businesses will often be required to provide guarantees.  

Importantly, and as the discussion below indicates, directors may become unwittingly bound by guarantees they did not know they had provided.

Therefore it is important that prospective guarantors fully understand when a guarantee will be taken to have been provided, as well as understanding that executing a contract in their directorial capacity may, if the agreement so provides, expose them to personal liability under a guarantee.    

What is a guarantee?

A guarantee is an agreement by which the guarantor accepts responsibility for a debt owed by someone (borrower), to someone else (the lender). It has long been recognised that a guarantee must be in writing in order for it be legally enforceable. A logical extension of this principle is that the guarantee once reduced to writing, must be signed by the guarantor.

Recent Australian cases

Two recent Australian cases have considered whether the signing requirement is satisfied where a person signs a document in a capacity other than as a guarantor.

In the first case, the court dealt with the common argument relied on by guarantors, that they are not liable for the debt because they did not sign the guarantee document, which is often a separate document to the principal contract.

The question was whether a director's signature on a lease document that contained a director's guarantee would bind the director.

The director asserted that she signed the lease in her capacity as a director of the lessee company, and not in her personal capacity as guarantor.

The Lease contained guarantee provisions and made reference to the guarantor as guarantor of the lessee’s obligations under the lease. The lease also contained separate execution clauses for signing by the lessee company and the guarantor, however, the director only signed the execution clause for the lessee company in her capacity as director.

The guarantor argued that she was not required to personally fulfil the business’ obligations under the lease as she had not signed the guarantee. However the court rejected this argument on the basis that capacity in which the guarantor signed the lease is irrelevant to the question of enforceability.

The court held that the signature of the guarantor as director of the lessee was sufficient to make the guarantee enforceable.

In the second case, two directors signed a lease in their capacity as directors of the lessee company. They did not separately sign in their personal capacity.

The lease in question actually named the directors as being guarantors and further provided that the guarantee applied if those persons "signed the lease".

The directors submitted that to be bound by the guarantee, he needed to sign the lease a second time, in his personal capacity.

Similarly to the first case, the court held that the directors' signatures bound them personally to the guarantee because the signing requirement is not dependent upon the capacity in which the document is signed.

The intention of the director to be bound in his or her personal capacity is a different question and one which is viewed in light of the construction of the document and the surrounding circumstances, rather than the silent belief or intention of the signor.

A signature should assist the court to ascertain the intention of the signor because the signature would ordinarily infer an intention to be bound.

Conclusion

The above cases are good examples of how the signing requirement has been interpreted by the Courts.

Parties to any transaction involving a guarantee need to be aware that an enforceable guarantee can arise even if there is no formal guarantee prepared or signed.

The safest course is to ensure that there are two separate signing clauses for both the borrower and the guarantor. Parties should also make it clear that no binding agreement is reached until formal documents are signed. Even then, the cases show that guarantors cannot escape liability because they sign in some other capacity or do not place their signature in the right execution clause.

For further information please contact:

Ben Broadhead
Special Counsel
Harwood Andrews
03 5226 8549
bbroadhead@harwoodandrews.com.au