Drafting of Surety Agreements: Important considerations

Drafting of Surety Agreements: Important considerations

Author
Martin Kotze
Martin Kotze
8 min read
Commercial law Suretyships

INTRODUCTION

Suretyships, in general, are legalese ridden documents that the general public do not fully understand.
This article will provide a high-level overview of important considerations when drafting a Suretyship. We will first have a look at specific legislation that may impact on a Suretyship and the difference between a Suretyship and a Guarantee. Secondly, we focus more on the clauses usually inserted in Suretyships and discuss specific relationships between the Surety and Debtor as well as the Surety and the Creditor.

THE GENERAL LAW AMENDMENT ACT, 50 OF 1956

The General Law Amendment Act, 50 of 1956 provides that a valid suretyship agreement must be embodied in a written document signed by or on behalf of the Surety.

THE MATRIMONIAL PROPERTY ACT

Section 15 of the Matrimonial Property Act,1984, provides that a spouse married in community of property may not bind themselves as Surety without the written consent of their spouse attested by two competent witnesses in respect of each such transaction.
If a person married in community of property signs a surety without the necessary permission from their spouse, the Suretyship will, in most instances, be invalid and unenforceable.
The only exception to this rule is where someone who is married in community of property signs a suretyship in the ordinary course of their profession, trade or business.

FINANCIAL ASSISTANCE IN TERMS OF SECTION 45

Something that is often overlooked is section 45 of the Companies Act, 2008.
For example, a Creditor may require a holding company to sign Surety for debt to be incurred by a subsidiary. The aforementioned constitutes "financial assistance" and triggers various actions required by the board and the shareholders of the company.
Section 45 requires a special resolution of the shareholders of the holding company, and the board of the holding company will need to be sure that:
  • immediately after providing the financial assistance, the company would satisfy the solvency and liquidity test; and
  • the terms under which the financial assistance is proposed to be given are fair and reasonable to the company; and
  • any conditions or restrictions in respect of the granting of financial assistance set out in the company's Memorandum of Incorporation have been satisfied.
If the board of the holding company does not act within section 45 of the Companies Act, 2008, then the Suretyship may be void, and the directors may be held personally liable.

THE NCA

In Firstrand Bank Ltd v Carl Beck Estates (Pty) Ltd the court stated that the NCA could apply to suretyship agreements and that it fell within the definition of a "credit guarantee" as set out in section 8(5) of the NCA.
However, it would only apply to a Surety to the extent that the NCA applies to the underlying credit facility or credit transaction (principal debt) in respect of which the Suretyship is granted.

PLAIN LANGUAGE

Although the NCA will not always apply to a Suretyship, and there will not necessarily be a requirement to provide a document that is in plain and understandable language, we still believe it is a good idea to draft a Suretyship in plain and understandable language.

SURETYSHIP VS GUARANTEE

When considering whether to draft a Suretyship or a Guarantee Agreement it is important to remember that a Surety who bounds him or herself as co-principal Debtor remains a Surety whose liability arises wholly from the Suretyship.
A guarantee, on the other hand, is an undertaking by a guarantor to pay or fulfil an obligation to a creditor upon the occurrence of a certain event. In the case of a guarantee, the obligation of the guarantor to pay is principal in nature and exists independent of an underlying obligation or the existence of any other debt.
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. The guarantee must be an absolute and unconditional promise to be regarded as a guarantee in the true sense.
A guarantee is generally seen as a stronger form of security than a surety which is accessory in nature as it establishes independent liability for the principal obligation.
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 or her as that of a surety (the main one being 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).

AGREEMENT SPECIFIC CONSIDERATIONS

When drafting the Suretyship, it is essential to consider whether the Surety will bind himself or herself in respect of all the obligations that may arise between the Creditor and the principal Debtor or only in respect of a specific obligation.
When structuring the Suretyship, it is possible to either make the Suretyship unlimited or limited to a specific amount. If the Suretyship will be limited to a specific amount, it is important to specifically stipulate whether the amount that the Surety is liable for, includes interest and costs.
Continuing covering suretyship clauses are often included in Surety Agreements without considering the possible effects thereof. These clauses can potentially bind the Surety in perpetuity for the debts of the principal Debtor, and bind the Surety for debts that may become due any time in the future, even if that Surety is no longer involved in any way with the Debtor.

LIABILITY OF CO-SURETIES

Where two or more persons have bound themselves as sureties for the same Debtor and in respect of the same principal debt, they are termed co-sureties and are liable singuli in solidum (this means each Surety is bound for the total debt). Unless the Surety expressly waived the benefit of division, the aforementioned, does not mean that the Surety cannot demand from the Creditor that the debt be divided between the Sureties.

Because persons may be co-sureties even if they have bound themselves by separate instruments, or at different times, or unbeknown to each other, it is essential to always include the applicable co-surety clauses in your Suretyship.

WHAT ARE THESE BENEFITS THAT SURETIES USUALLY RENOUNCE IN THE SURETY AGREEMENT?

The benefits of division (beneficium divisionis)
If a Creditor claims the total debt or more than a proportionate share of it, a co-surety may insist that the debt be divided between the sureties so that he or she will only be held liable for his or her proportionate share.
If a Surety renounces this benefit, he or she will not be able to insist that the Creditor only claim the proportioned share of the debt from him or her.
The benefits of excussion (beneficium ordinis seu excussionis)
If a Creditor claims performance of the secured obligations from the Surety, then the Surety may insist that the Creditor must first excuss the Debtor (in other words - the Creditor must first claim and recover from the principal Debtor before turning to the Surety for payment of the debt).
If a Surety renounces this benefit, the Surety will not be able to insist that the Creditor must first excuss the Debtor before the Creditor can enforce the obligation arising from the Suretyship against the Surety.
If a Surety binds him or herself as a co-principal debtor, then the Surety in effect renounces the benefits of excussion and division.
Also, when the Surety binds him or herself as co-principal Debtor then the debt becomes enforceable the same time as the principal debt.

RELATIONSHIP BETWEEN THE SURETY AND THE PRINCIPAL DEBTOR

A surety who has paid the whole of the principal debt can recover from the principal Debtor not only the amount of the debt which he or she has paid but also any loss that he or she has suffered or expense that he or she has reasonably incurred as a result of the principal Debtor's failure to pay the debt him or herself.
In practice, a Creditor may want to require from the Surety that the Surety waive, in favour of the Creditor, the benefit of the cession of actions (beneficium cedendarum actionum).
The reason a Creditor would want a Surety to waive the benefit of the cession of actions is that the Creditor would not want to be in a position where the Surety tries to delay payment by a plea that seeks to delay the action on procedural grounds.
This renunciation will not disentitle the Surety from obtaining cession but merely prevents the delay of the action on procedural grounds.

CONCLUSION

Often it happens that Clients are under the wrong impression that their liability under a Suretyship is capped or that they are only liable for the proportionate share of the debt secured by the Suretyship.
When drafting a Suretyship Agreement, make sure that the intention of the Parties is correctly reflected in the Suretyship and that any Latin phrases are explained in plain and understandable language (especially the renunciations).

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