Often directors and/or shareholders of a company are called upon by creditors to take up surety for credit offered to their company.
There are various forms of credit that a company may choose to take-up with the most common forms being a bank overdraft, term loan or trade credit from suppliers.
In this article we provide a basic insight into a surety document and some of the more common clauses that accompany it and that business owners should watch out for.
What is a ‘suretyship’?
In simple terms, a suretyship agreement is an agreement in terms of which one person (the surety) undertakes to a second person (the creditor) to fulfil the obligations of another person (the principal debtor and generally the company). Therefore, a typical suretyship arrangement involves three separate parties: the creditor, the debtor and the surety. Through a written contract, a creditor can mitigate the risk of lending by involving a third party in the event that the creditor is unable to recover the loan plus interest from the principle debtor. The surety undertakes in his/her personal capacity to fulfil all the obligations of the principle debtor in the event that the principal debtor fails in whole or in part to fulfil the obligations himself. In essence, the surety agrees to step into the principal debtor’s shoes, if that debtor can no longer fill those shoes financially, so to speak, vis-à-vis his creditor.
What to look out for in suretyship agreements?
We all know that creditors go to great lengths to mitigate their risk of lending and to that end there are numerous provisions which are inserted in suretyship agreements which one may not necessarily understand or even note. Of course, the creditor will most likely only lend on its own terms however it is important to at least understand some of these terms in order to fully appreciate the extent of your liability as a surety.
“Surety and co-principal debtor”: In almost all suretyship agreements, the creditor will want the person signing surety to also bind themselves as co-principal debtor. This allows the creditor to recover the debt owing directly from the surety without first trying to recover from the principal debtor (your company).
“Excussion”: Legally a creditor must try and recover amounts owed firstly from the principal debtor before proceeding against a surety. Typically, creditors look to bypass the excussion process by inserting a waiver of the right in the agreement which allows the creditor to go directly for the surety in the event default by the principal debtor.
“Joint and several liability”: When surety is taken, the principal debtor and the surety will generally be held jointly and severally liable for the debt which allows the creditor to recover what is owed from both parties or 1 party only.
“Limited or unlimited liability”: The surety’s undertaking may be for a limited or unlimited amount and period. As a surety you are entitled to insist that you will be liable for up to a specified amount and for a specified period or debt transaction e.g. the loan for that car only.
“Continuing suretyship”: In the case of a continuing suretyship, the surety’s liability extends to a series of debts and/or transactions and generally accompanies an unlimited suretyship. The transactions or debts may relate to some future debt to be incurred or to an existing debt already incurred by the principal debtor. With continuing suretyships, it is important to note that suretyship agreements are not automatically cancelled once the debt has been repaid; or when the business for which the surety was originally signed has been sold; or even if the surety dies. The creditor must release the signatory from such an agreement − in writing.
Should you ever find yourself in a situation in which you are called upon to stand as surety for another party, make sure you satisfy yourself as to the identity of the parties concerned, the nature and extent of the debt and the period for which you can be held liable. In this regard, it is worth noting that “continuing covering suretyship” clauses are often included in credit agreements thereby binding the surety in perpetuity for the debts of the principal debtor, including debts that may be incurred in the future when that surety is no longer involved in any way with the debtor.
A practical example is where an MD of a company binds himself as surety in perpetuity for that company’s debts in relation to a particular supplier or service provider in the face of a suretyship in perpetuity. In such an instance, that surety can successfully be held to a suretyship agreement, even after he leaves the employ of the said company or has sold his shares – a most unpleasant surprise that potentially lies in waiting for the unsuspecting surety, long after signature of the initial suretyship agreement.
Contact us at My Finance Partner for a complementary consultation to discuss and review your current and future surety commitments and options to reduce your existing exposure. info@mfpartner.co.za
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