Guarantees under misconception

THE word guarantee is used in different situations, where a person agrees to undertake the fulfilment of the obligation of another. One is where a person takes a loan and another is asked to guarantee the loan.

Another is where a person gets a scholarship and a guarantor is required. The person who is giving the guarantee is the guarantor. In the Contracts Act 1950, a guarantee is defined as follows:

“A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the ‘surety’, the person in respect of which default the guarantee is given is called the ‘principal debtor’, and the person to whom the guarantee is given is called the ‘creditor’.”

Many people who sign guarantees do so without much thought.

They think it is merely a matter of putting their signature down to help another get a loan or a scholarship.

The horror of the consequences only dawns when the borrower defaults.

The guarantor may then find himself facing a demand for repayment of the loan.

Where it is a scholarship, the guarantor will find himself being asked to pay the agreed liquidated damages stipulated for a breach committed by the scholar.

When such a situation arises, unless the guarantor steps forward to fulfil his obligations or make suitable arrangements to meet these obligations, he will go about asking how he could get out of the situation.

Recent amendments to the Bankruptcy Act 2016, expected to be enforced in June, aim to prevent those who act as social guarantors being declared bankrupt if borrowers fail to repay their debts. (Social guarantors are defined as those who do not profit and who provide a guarantee for an education loan, a housing loan for a personal dwelling, etc.)

And under existing legislation, where a guarantee has been improperly obtained, there is room to deny liability for the demand.

However, this must be on the basis that the law recognises for not enforcing a guarantee.

Such can be the case where there is fraud, misrepresentation or undue influence.

These grounds for non-enforcement are clearly defined in law and frequently discussed in cases decided from time to time.

Fraud misrepresentation and undue influence must be strictly proved.

This is especially so where a person signs a guarantee under a misconception.

Making an assumption that the scholar will complete his studies, come back and serve his term, or that the borrower has the means to pay when the need arises, are misconceptions.

They do not constitute fraud, misrepresentation or undue influence.

For example, you may be invited by a friend for parties in his impressive bungalow.

It would be embarrassing to ask your host whether it is his own property.

One day this friend approaches you and tells you that he has suddenly encountered some minor, temporary financial difficulties and needs a loan of RM250,000 to tide him over.

He does not ask you for a loan but is merely asking you to be a guarantor.

You tell yourself that the amount to be guaranteed is possibly a fraction of the cost of his house. So you oblige.

Not too long after, you learn that he has defaulted in the repayment of the loan.

Before long, you receive a letter of demand to repay up the arrears of unpaid instalments or even the entire loan.

You cannot believe it and you talk to a mutual friend who is in the same quandary.

So you act and start off by calling the borrower. Your calls are not answered.

You go to his house. It is no longer occupied by him.

Instead, you find someone else living there and discover to your dismay that it was a rented house.

The other misconception many guarantors face is that they think they will not have to pay if the borrower has assets. So it is not the case that the debtor is unable to pay or is unwilling to pay.

In fact, the total assets of the borrower may far exceed the debt owed.

Most, if not all, guarantors think the lender will be able to recover the money from the borrower without approaching them.

In Bank Bumiputra Malaysia Bhd. v. Esah Binti Abdul Ghani, the bank lent money to the borrower and as security took a charge over land belonging to the borrower and two others. Esah Binti Abdul Ghani was a guarantor for the loan.

The borrower failed to pay the loan.

The bank took foreclosure proceedings on the land but before the issuance of an order of sale, one of the owners died.

The foreclosure was not proceeded with.

Instead the bank took proceedings against Esah as guarantor.

Following judgment, bankruptcy proceedings were instituted against Esah for the amount owing.

Esah tried to stop the bank from proceeding with the bankruptcy petition on the ground that the bank should first proceed against the borrower. Though the High Court stayed the bankruptcy proceedings, this was not how the Supreme Court looked at it. The decision of the High Court was reversed and the bank was held entitled to proceed with the bankruptcy proceedings against the guarantor.

The court took the view that unless it was otherwise provided, the bank could proceed against the guarantor by not staying the proceedings and even filing an action against the borrower to start with. The court also relied on the following paragraph from Halsbury’s Laws of England Vol. 20:

“After the guaranteed debt has become due, and before he has been asked to pay it, the surety may require the creditor to call upon the principal debtor to pay off the debt. In the absence of agreement the creditor is, however, not bound to sue the principal debtor before suing the surety. Moreover the surety, even where he deposits the amount of the guaranteed debt, cannot without such agreement compel the creditor to proceed against the principal debtor unless he undertakes to indemnify the creditor for the risk, delay and expense which he thereby incurs, and, apparently satisfies him that the principal debtor is solvent.”

Any comments or suggestions for points of discussion can be sent to [e-mail]. The views expressed here are entirely the writer’s own.